PC Connection Inc (CNXN) 2004 Q4 法說會逐字稿

Good morning and welcome to the PC Connection's 2004 fourth quarter conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Steve Baldridge, sir, you may begin.

Thank you and good morning, everyone. This is Steve Baldridge, VP of Finance and Corporate Controller. I'm pleased to have you join us today for PC Connection's 2004, fourth quarter conference call. If you haven't already seen our press release, you can contact Eileen Gagnon at 603-683-2322 and she will fax or email you a copy immediately. You can also view it on our website. Today's call is also being webcast. It will be available from PC Connection's website and at streetevents.com. Before I turn the call over to Patricia Gallup, Chairman and CEO of PC Connection I'd like to inform our participants that any statements or references made during the conference call that are not statements of historical fact, may be deemed to be forward-looking statements.

Various remarks that we may make about the company's future expectations, plans, and prospects continue -- constitute forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements.

As a result of various important factors, including those discussed in, factors that may affect future results and financial condition, in the company's quarterly report on Form 10-K, for the quarter ended September 30, 2004, which is on file with the Securities and Exchange Commission. In addition, any forward-looking statements represent our views only as of today, and should not be relied upon as representing our views as of any subsequent date.

While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change, and therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today. I will now turn the all over to Pat.

Good morning and, again, thank you for joining us. Bob Wilkins, Executive Vice President, and Jack Ferguson, Interim CFO, are also here on the call with us today. As reported in our press release, net sales for the three months ended December 31, 2004, decreased by 18.8 million or 5.2 percent to 339.6 million, from 358.4 million for the quarter ended December 31, 2003.

Net income for the quarter ended December 31, 2004 on a generally accepted accounting principle GAAP basis at 2.1 million, or 8 cents per share, compared to 7 -- .7 or 3 cents per share for the quarter ended December 31, 2003. Both of these three-month periods included special charges relating primarily to the GSA contract cancellation reported previously.

Had these charges not been incurred performa net income for the quarter ended December 31, 2004 would have been 3.1 million or 12 cents per share compared to 1.7 million or 7 cents per share for the quarter ended December 31, 2003. That is an 82 percent year-over-year increase in performa net income. Our press release includes a reconciliation of these amounts. Our initiative to improve gross profit margins continue to be the key drivers behind our improvement in earnings.

Our overall gross profit dollars increased over the fourth quarter of 2003, by $5 million, despite an $18.8 million decrease in sales, increasing gross profit margins 203 basis points to 12.2 percent. This gross margin improvement included an 86 basis point increase as a result of a reclassification in the fourth quarter, that we'll describe in more detail later. Net sales for our small and medium-sized business, SMB segment increased by 2.6 percent from the fourth quarter of 2003, to 204.9 million.

Sequentially our SMB segments net sales increased 4.6 percent over the third quarter of 2004. Sales to government and education customers, our public sector segment, decreased by 31.3 million or 35.1 percent from the fourth quarter of 2003 to $58 million. More specifically, sales to the federal government decreased year-over-year, by 29.6 million or 58.3 percent, reflecting the loss of general services administration or GSA contract reported previously.

We received a new GSA schedule in mid-August, 2004, unfortunately, too late to participate fully in the federal government's seasonally strong third and fourth quarters. We did see some improvement in sales, however. We have put together a talented and experienced management team and they are dedicated to rebuilding our federal business in 2005.

Although sales to state, local and education customers decreased this quarter by 4.5 percent year-over-year, gross profit dollars increased by 19 percent over the same period. Sales to large corporate account customers, our large account segment, increased 10.5 percent to $76.7 million from the corresponding period a year ago but decreased 1 percent sequentially from the third quarter of 2004.

The total number of sales representatives increased to 591 as of December 31, 2004, from 571 on September 30, 2004, and from 567 at December 31, 2003. On a consolidated basis, annualized sales productivity for this quarter, decreased 6.6 percent sequentially and 9.2 percent year-over-year. Sales productivity in our SMB segment decreased 6.6 percent from the fourth quarter of 2003, and decreased 1 percent from the third quarter of 2004.

Primarily as a result of an overall decrease in sales and an increase in new sales representatives. Sales productivity in the public sector decreased by 36.9 percent from the fourth quarter of 2003. The year-over-year public sector decrease was largely attributable to the decreased federal sales resulting from the loss of the GSA contract, and our decision to retain the seasoned sales force during this period.

Offsetting these decreases, however, sales productivity in our large account segment increased by 4.8 percent over the third quarter of 2004, and by 36.2 percent over the fourth quarter of 2003. Gross profit margins increased this quarter to 12.2 percent from 10.1 percent for the fourth quarter of 2003, or over 200 basis points.

Approximately 86 of these basis points were due to our reclassification of this quarter, of an additional $3 million in vendor consideration from SG&A expense -- expenses to cost of goods sold and inventory. As announced in our third quarter press release this reclassification was based on a revision of our estimates of advertising costs and reimbursements related to EITF issue number 02-16.

Such vendor consideration had previously been recorded as an offset to SG&A expenses, and this reclassification increased gross profit margin -- gross margin by 86 basis points and increased SG&A expenses as a percent of sales by 89 basis points for the quarter. However, even excluding the effect of this reclassification, gross profit margins increased by 117 basis points over the fourth quarter of 2003.

Margin rate improvements were realized in all three business segments sequentially and year-over-year. We continue to successfully direct the sales culture to improve their focus on generating more gross profit dollars per transaction, the largest contributor to our improvement and consolidated gross profit margin dollars -- gross profit dollars was our SMB segment. Year-over-year for the fourth quarter this segment increased gross profit dollars by $5.3 million.

The SMB segment has realized year-over-year margin rate improvements for three consecutive quarters. Excluding the reclassification effect, the SMB segment increased gross profit margins by 87 basis points over the fourth quarter of 2003. Gross profit margins for our public sector improved by 181 basis points over the fourth quarter of 2003.

The majority of the improvement in gross profit margin for the SMB and public sector segments was due to our initiatives launched in the first quarter of 2004. Profit margins for our large accounts segment also improved 61 basis points over the fourth quarter of 2003. Our ongoing efforts to improve product margins continue to focus on increasing add-on sales of accessories and other companion products to our system sales. As well as increasing the level of enterprise product sales and sales of third-party warranty, installation and other services.

We also implemented a number of sales and gross profit improvement initiatives including tighter management of the discounting more extensive and focused sales training on costs and margins, targeted improvements in sales pricing, sales incentives and account management, and better communication and administration of vendor rebate programs. Total SG&A expenses as a percentage of sales increased to 10.8 percent for the fourth quarter of 2004, compared to 9.2 percent for the fourth quarter of 2003.

The reclassification described earlier added 89 basis points to SG&A this quarter. Lower overall sales volumes and higher advertising costs from increased catalog circulation also contributed to a year-over-year rate increase. Income from operations increased by $1.4 million over the fourth quarter of 2003, and operating margins improved year-over-year by 45 basis points to .9 percent.

As we have commented in past conference calls, we remain alert for opportunities in a consolidating market, however, we will only consider acquiring businesses with complimentary corporate cultures that add new customers and management talent and that are immediately accretive to our earnings and key operating ratios.

In summary, during the quarter, the company grew earnings per share by 167 percent, despite a 5.2 percent decrease in sales. Given our margin enhancement initiatives and continuing investment in our sales organizations, along with our new GSA schedule, we believe PC Connection has the strategies and resources necessary to enhance the long-term shareholder value. Now, I'd like to -- Bob Wilkins to make some additional comments our margin improvement initiatives as well as some operational trends and enhancements. Thanks.

Thanks, Pat. During the last three conference calls we spoke about our initiatives to increase our gross profit dollars per transaction and our overall gross margin rate. We continue to be pleased with the progress we are making with this initiative. As Pat mentioned, our gross margins improved significantly over last year. More importantly, our gross profit dollars grew over last year by 2 million, even after the EITF reclassification.

And despite an almost $19 million decrease in net sales, our focus on increasing our gross profit dollars per transaction will carry on into the future and we're optimistic it will stabilize and continue to improve our overall gross margin rate. Average selling prices or ASPs for computer systems were relatively flat during the quarter, increasing by .2 percent compared to the fourth quarter of last year.

ASPs increased 3.6 percent compared to the third quarter of 2004. Sequential increases resulted from a 12.5 percent increase in server ASPs, 7.2 percent in desk top ASPs, and by a 1.9 percent increase in notebook ASPs. The year-over-year increase ASPs resulted from a 2.9 percent increase in notebook ASPs offset by a 9.6 percent decrease in desk top ASPs and by a 5.1 percent decrease in server ASPs. Notebook, unit and net sales dollars decreased 7.4 percent and 4.7 percent respectively compared to the fourth quarter 2003.

Desk top revenues decreased 19.1 percent year-over-year on a 10.5 percent decrease in unit volumes and a 9.6 percent decrease in ASPs. However, revenues from server sales increased 17.2 percent, on a 23.5 percent increase in unit volume, as compared to the fourth quarter of 2003. The average order size for the fourth quarter decreased year-over-year by 5.8 percent to $1,132. Our stabilized operating costs are a primary result of our focus on continuing to manage costs in our business. We continue to review all spending plans and programs to ensure the best possible deployment of our resources.

We will plan to continue our focus on controlling discretionary expenditures and expect our SG&A expense may vary depending on changes in sales volumes as well as the levels of continuing investment in key growth initiatives such as hiring more experienced sales account managers, improving marketing programs, deploying next generation internet web technology and investing in overall system enhancements to support our sales organization and our customer base. Now, Steve Baldridge will discuss our balance sheet and cash flow in more detail. Steve?

Cash flow generated from operations for the 12 months of 2004 was $13.3 million, compared to $3.3 million in the same period a year ago. Accounts receivable were down 23.6 million $120.8 million on December 31, 2004 compared to December 31, 2003 balance, due to lower receivables from federal government customers, and the decrease in day sales outstanding, or DSOs. The DSOs were 42 days compared to 47 days in the fourth quarter of last year.

Inventory balances were down 1.8 million to $78.4 million at December 31, 2004, compared to the December 31, 2003 balance. Inventory turns were 14, compared to 16 in the third quarter of 2004 and 17 in the fourth quarter of 2003. Based on quarterly levels, inventory days were 24 at December 31, 2004, versus 23 at December 31, 2003. We believe inventories are in excellent condition, both in quantity, and in quality. In summary, the balance sheet remains very healthy.

Net sales of products drop shipped by distributors and other vendors directly to customers acted for 36 percent of total net sales in the fourth quarter, compared to 40 percent of total net sales in the fourth quarter of last year and 39 percent of total net sales for the third quarter of 2004. Both our federal government and large commercial account businesses primarily use drop shipping to meet their demand.

Looking forward, our outlook for the first quarter of 2005 is as follows: sales to SMB customers are expected to grow year-over-year in the low single digits, sales to government and education customers are expected to remain generally the same, and sales to large account segments are expected to increase year-over-year in the high single digits to low teens.

Therefore, for the first quarter of 2005, we presently expect to achieve sales in the range of 335 million, to 350 million and earnings per share, in the range of 9 cents to 12 cents per share. We presently expect the gross margin rate as a percent of sales for Q1 to be in the range of 11.9 percent to 12 percent, and operating expense, as a percentage of sales, to be in the range of 10.4 percent, to 10.8 percent.

We continue to work to ensure the best possible near term results, consistent with maintaining a strong financial position, and investing for the future. Thank you for joining us today. We will now entertain your questions. Operator?

Thank you. The floor is now open for questions. If you have a question, please press star one on your touch tone phone at this time. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. Questions will be taken in the order they are received. We do ask that while you pose your question, you pick up your hand set to provide optimum sound quality. Please hold while we poll for questions. Once again that's star one to ask a question. Our first question is coming from Brian Alexander of Raymond James. Please pose your question.

Thank you. Good morning.

Good morning, Brian.

The gross margin guidance for the first quarter seems to imply that there's going to be a sequential decline, but I think your mix, according to your revenue guidance for each segment should be more skewed towards SMB sequentially which is higher margins. So, is this due to the change in the EITF assumption or are you assuming margins decline in certain segments? Could you give us more color on that?

We had -- Brian, this is Steve Baldridge. In Q4, you're right, we had a margin rate of approximately 12.2, and our guidance for Q1 is 11.9 to 12 percent. Some of that reduction is as a result of some of the mix from Q4 to Q1, primarily in some of the heavier consumer business in December, with the web and internet sales.

So within your core SMB business -- I guess segment by segment, are you expecting gross margins to remain relatively flat and then we should factor in this mix shift you are talking about?

Yes, primarily.

Okay. And then just going back to your overall EPS for the quarter, tell me if I'm correct, excluding charges and excluding the tax benefit was EPS 11 cents or 12 cents?

EPS in Q4 excluding special charges was 12 cents

But then you also had a tax benefit. Was that factored into your original guidance? I guess that's my question.

No. The tax -- the tax piece wasn't input into our original guidance, Brian. What basically happened in Q4 is we had a higher level of advertising expense relative to increased circulation, as you can see, in the earnings release. And that higher circulation cost in advertising was offset by the tax benefit.

So what tax rates should we model going forward, Steve?

I would use 38.5 percent

Okay. And then just a couple of questions on the sales growth. If I look at your SMB revenue growth, it looks like it's been decelerating and I'm just wondering is that more a function of your decision to go after more profitable business, or are you starting to see that segment decelerate overall?

No, I think it's -- it's the prior. It's the margin rate that our SMB segment is driving. In Q4, year-over-year, the SMB segment was up $5.3 million in sales, Q4 year-over-year and the margin was up $5.3 million. So clearly, the sales that that group is driving is -- has been at a much higher profitability level.

And then moving on to state, local and education, it looks like that was down a little bit year-over-year. You had been growing that business pretty nicely. Can you just give us a little bit more color on the change in year-over-year growth there?

Yes, in terms of the public sector, the federal business, you know, year-over-year as we indicated was down 29.6 million and that reduction was a result of getting the GSA contract back too late in the quarter. The state, local and education part of our public sector was down just under a couple of million dollars, but offsetting that softer sales year-over-year was an increase in gross margin dollars. That segment, though its sales were down just under $2 million, generated over $600,000 more in gross margin.

Brian, this is Bob Wilkins. There is a conscious effort throughout the organization to shed off some of the higher end sales that are not profitable for us, and go after more volume business that has higher margin. You're seeing some of that in results. We're going after EPS growth and not necessarily some of the top line

Totally understood So if I look out for the entire year of 2005, most people would expect market growth to be somewhere between 5 and 7 percent. Given your focus on going after more profitable business and maybe shedding some more unprofitable business would you expect to still grow in line with the market or should we expect that you might grow a little bit slower

Well, I still think we'll be able to grow in line with the market.

Our Q1 number -- Our goal is to beat the market growth at this point. But we're being conservative in that approach, as we're only three quarters, really, into this.

Okay. And then just the last question, on this GSA charge in the quarter I think you had one last quarter too.

Correct.

Could you just help us understand whether that's going to continue going forward or is this the last quarter where we'll see that

Brian, this is Steve Baldridge. We're -- at this point we are not giving any guidance on the special charge amount for Q1 and I would hate to speculate what that amount would be.

Could you just give us more color on what this relates to? The activities associated with the charge?

It's primarily legal and professional fees, just supporting the closure of our post award audit.

Okay. So is that audit complete?

In terms of the audit being complete, right there's no further, you know, on-site review occurring at this point, and there's nothing more that we're aware of, either in Q4, or at this point, relative to the closure of that audit

Okay. Thanks, I will let some others ask questions.

Thank you. Our next question is coming from David Manthey of Robert Baird. Please pose your question.

Hi, thanks. Just a couple here, and I apologize if you covered this. Did you talk about the growth of the account manager base in 2005?

No. At this point, David, this is Steve Baldridge, we're not giving any guidance on either 2005 sales or earnings for the year, or head count growth at this point.

David, our objective, obviously is to continue to grow the head count but we want to do it in a profitable manner. We've been really working on making sure that the head count that is coming in is meeting our expectations on each month, as far as the EPS growth and so far the SMB team, in particular has done a great job on that. Of course you expect that we'll be able to increase the Fed and Fled head count throughout the year but, again we are not giving guidance on that.

Okay. Thank you. And the other question is, in -- on the third quarter call, you -- you made some comments about how you could compete better by understanding your customer base, and you talked about that 85 percent of your volume is businesses with 20 to 75 employees, and you were looking at ways to make them more reliant on your company. I'm not sure if you stated this or if it was just something that I had surmised about your comments but it -- in my notes I have that there might be a fourth quarter announcement coming. Is there -- is that a part of the program here? Is there something that you are working on specifically that we might hear about in the next couple of weeks?

David, this is Bob Wilkins again. There are several things that we worked on last year that were put into place in Q3 and Q4. One of those was the new website, which you can see out in the public place. We had some very good success with that in December. We had doubling of traffic, and unique visitors coming through. And a higher conversion rate than we experienced in the past, and that's continuing on in through January. A lot of that technology, we put into that will now be implemented into the SMB and Fed and Fled sectors into 2005. We also have been working on initiatives around our service connection brand, which we launched in Q3 and Q4. That has gone very well. We haven't made a public, per se, announcement in a press release, but it has been selling publicly through our catalogs, and through our website. And that's going very well so far.

I see. Okay. Thank you.

Thank you. Our next question is coming from Dan Leben of Robert W Baird. Please pose your question.

Hi, thanks. Quick question on the reclassifications. You know, how much does this vary quarter to quarter? So, how should we think about modeling this going forward?

This is Steve Baldridge. I think at this point, the margin rates that you're seeing for Q3 and Q4 of 2004 would clearly be some historical trends that would support the modeling going forward. I think as you look at the Q3 and Q4 margin rate, in line with the margin rate guidance we're giving in Q1, at 11.9 to 12 percent, I think that would provide you some support in terms of your modeling for 2005.

Okay. So there's -- there's no significant seasonality in the size of the reimbursement then?

The only seasonality we'll pick up as our public sector sales continue to increase and make improvement, our public sector margin rates are lower than our large account and SMB rates. So you'll get some mix change in that as we proceed through 2005.

Okay. And on the SG&A increase, can you break that down a little bit, just in terms of how much of it was related to the increased catalog shipments, relative to, you know, other increases and expenses?

Well, the SG&A rate in Q4 year-over-year, if you factor out the EITF adjustment from a dollar perspective was fairly flat Q4 year-over-year. And on a rate basis, factoring out the EITF adjustments would be up about 70 basis points. That 70 basis point improvement or increase is as a result of personnel expenses, relative to the higher margin, and also the increase in advertising expense from the 2 million circ increase. That circ increase had a cost of approximately $550,000 in Q4 of 2004.

Okay. Great. Thanks.

Thank you. Our next question is coming from Brian Alexander of Raymond James. Please pose your question.

Just a couple follow-ups. One is on the large corporate business, why was that not up sequentially? I would imagine that large corporate customers typically have more of a budget flush mentality than your SMB customers and it was up nicely year-over-year, but what is it about your customer base that might be different than my thinking in the sense that it wasn't up sequentially?

Hi, Brian, it's Steve Baldridge. In our large account segment, it's really driven by customer spending habits. And we saw a resurgence in the interest of purchasing IT technology in our large account segment in Q2 and Q3. We had a very strong second and a very strong third quarter, and in the fourth quarter, the sales in our large account segment were only slightly lower than Q3. So I think in spending time with that segment, the response has been pretty much the spending habits of our customer, has impacted our Q3, Q2, and Q4 sales levels

Is that a normal seasonal pattern or are you suggesting that large corporate spending strengthened in the middle of year now appears to be softening?

No, I think -- I'm not sure that it is a normal seasonal pattern. Typically you'll see some larger increases in Q3 and Q4. I think also, Brian, similar to our SMB and public sectors you saw a 50 basis point improvement in our large account segment in Q4 year-over-year -- Q4 year-over-year. So I think continued strong sales in that segment, coupled with a 50 basis point margin improvement may have had some impact also on Q4 for the large account group.

And then the last thing, just relates to the balance sheet inventory and payables. I usually think of those moving in tandem, but it seems like, at least over the last year, your inventory has been rising while your payables have been declining. How do you think about the way that you manage those two? Is there a relationship there? And generally speaking, over the last couple of years, inventory turns are decreasing, despite the fact that you are doing more business with customers that you drop ship to. So, could you just walk us through why that's happening?

sure. This is Steve Baldridge. Two great questions. Let's take the first one. The relationship of AP to inventory. There's a lot of variables going on since our large account segment, our public sector do a very high percentage of drop shipments. So it's difficult, depending on the mix of the business and where we are in a particular quarter, in terms of drop shipping versus shipping from our stocking model. You can't always see a relationship in payables to inventory that we have on hand. Secondly, as part of that, we've got, with our strong cash position, we have gotten more aggressive in taking cash discounts from our vendors, and I think when we are paying our vendors taking discounts, we're dropping the AP levels in relationship to our inventory. The comments on -- in terms of inventory turn, I think the phenomenon at Q4, where you saw a slight dip in the inventory turn, is a relationship of two factors. At the end of 2004, we had several large customer rollouts that were in process at year-end, where we were holding a little higher levels of inventory, of HP product and palm product, relative to those rollouts. And then as a follow-up to that, we have been taking a more aggressive inventory position in Acer. As you know we started that inventory in Acer, position at the end of 2003 and have grown that both in breadth and depth in 2004 and have been driving some incremental sales with Acer. So those are the factors that I think impacted our turn at the end of Q4. And finally, relative to turn, as we focus on driving margin dollars, and which can soften the sales a little bit, that relationship of inventory to sales can also, from a rate perspective, you know, drive it down a little bit.

Okay. And then finally, Bob, are you guys running into Dell on current deals more than you were a quarter or two ago?

No. I think it's about the same level as it has been in the past. If anything, I think we're winning a few more of the deals with the Acer product line and we have seen a stronger relationship with our HP programs that have allowed to us win a few more deals

And that's on printers specifically?

On the -- oh, on the printer line? I'm sorry. No, I haven't -- we have not been running into Dell, any more significantly than in the past on the printer line.

Great. Thanks a lot.

Once again, the floor is open for questions. If you do have a question, please press star one on your touch tone phone at this time. At this time, there appear to be no further questions.

Okay. This is Pat Gallup. We'd like to thank all of you for your interest and your time and attention. Have a great day.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.