PC Connection Inc (CNXN) 2005 Q1 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the PC Connection 2005 first-quarter conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be opened for questions following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Steve Baldridge. Sir, the floor is yours.

Thank you. And good morning everyone. This is Steve Baldridge, VP of Finance and Corporate Controller. I am pleased to have you join us today for PC Connection's 2005 first-quarter conference call. If you haven't already seen our press release, you can contact Eileen Gagnen (ph) at 603-683-2322, and she will fax or email a copy to you 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 constitute forward-looking statements for purposes of the Safe Harbor provisions 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 conditions in the Company's Annual Report on Form 10-K for the year ended December 31, 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 call over to Pat.

Good morning. And again, thank you for joining us. Bob Wilkins, Executive Vice President, and Jack Ferguson, and Interim CFO are also with us here today.

I hope you've all had the opportunity to read our press release in which we announced net sales for the 3 months ended March 31, 2005 decreased by 3.7 million or 1.1% to 323.9 million from 327.6 million for the quarter ended March 31, 2004. Net income for the quarter ended March 31, 2005 was 0.9 million or $0.04 per share compared to 1.2 million or $0.05 per share for the quarter ended March 31, 2004.

During the quarter, strong year-over-year sales growth in our large account segment was offset by softness in our small and medium-sized business, or SMB, sector and public sector segments, which as you know, we had previously announced. Specifically, total net sales for our commercial business increased year-over-year by 1.1% to $276.7 million for the quarter compared to 273.8 million for the first quarter of 2004. Within this group, net sales for our small and medium-sized business segment decreased by 3.4% from the first quarter of 2004 to $200.3 million. Sequentially, our SMB segment's net sales decreased by 2.2% from the fourth quarter of 2004. However, sales to large corporate account customers, our large account sale segment, increased 15.1% to $76.4 million from the corresponding period a year-ago and remained substantially the same sequentially from the fourth quarter of 2004.

Sales to government and education customers, our public sector segment, decreased by $6.7 million or 12.4% from the first quarter of 2004 to 47.2 million. More specifically, sales to the federal government decreased year-over-year by 4.4 million or 30.7%, reflecting the loss of the general services administration contract reported previously. Although we received a new GSA schedule in mid-August 2004, we believe it will take some time to rebuild the federal business to its previous level. We have put together a talented and experienced management team at GovConnection, and they are dedicated to rebuilding our federal government business.

Sales to state, local and education customers decreased this quarter by 5.7% year-over-year. However, gross profit dollars increased by 13.7% over the same period reflecting our focus on improved profitability in this sector.

The total numbers of sales representatives increased to 597 as of March 31, 2005 from 591 at December 31, 2004 and from 558 at March 31, 2004. On a consolidated basis, annualized sales productivity for this quarter decreased by 5.5% sequentially and 7.5% year-over-year. Sales productivity in our SMB segment decreased 4.7% sequentially and 14.9% year-over-year, primarily as a result of softer demand and an increase in new sales representatives.

Sales productivity in the public sector decreased 8.1% from the first quarter of 2004. The year-over-year public sector decrease was largely attributable to decreased federal sales we referred to earlier and our decision to retain the seasoned sales force during this rebuilding period.

Sales productivity in our large account segment decreased sequentially by 3.2% but increased by 26.4% over the first quarter of 2004. The year-over-year increase in productivity resulted from the success of this segment's increased penetration of its existing customer base and from new account acquisitions. Overall gross profit dollars increased over the first quarter of 2004 by $3.4 million, despite a 3.8 million decrease in sales, increasing gross profit margins by 118 basis points to 11.5%. Approximately 79 of these basis points were due to (technical difficulty) a reclassification of this quarter of an additional $2.8 million in vender consideration from SG&A expenses to cost of goods sold and inventory.

As announced in our fourth-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 its reclassification increased gross margin by 79 basis points and increase SG&A expenses as a percent of sales by 85 basis points for the quarter. However, even excluding the effect of this reclassification and including the (technical difficulty) effects of increased freight costs this quarter, gross profit margins increased by 39 basis points over the first quarter of 2004. Margin rate improvements were realized in all three business segments year-over-year.

We continue to successfully direct the sales culture to improve their focus on generating more gross profit dollars per transaction. The SMB segment had realized year-over-year (technical difficulty) margin rate improvements for four consecutive quarters. However, sequentially the SMB margin rate for the quarter decreased by 171 basis points due primarily to higher freight costs (technical difficulty) and lower EITF reclassification and other vendor consideration amounts.

Gross profit margins were for our public sector improved by 140 basis points over the first quarter of 2004. The improvement in gross profit margin for this segment was due to our initiatives launched in the first quarter of 2004 and increased in agency sale. Profit margins for our large account segment also improved 59 basis points over the first quarter of 2004.

Our ongoing efforts to improve product margins continue to focus on increasing add-on sales of accessories and other companion products to our systems sales as well as increasing the level of enterprise product sales and sales of third-party warranty, installation and other services. Total SG&A expenses, as a percentage of sales, increased to 10.9% for the first quarter of 2005 compared to 9.4% for the first quarter of 2004. The reclassification described earlier added 85 basis points to SG&A this quarter. Higher advertising costs from increased catalog circulation and our investment in additional personnel in our public sector segment also contributed to a year-over-year rate increase.

Income from operations declined by 3 -- 0.3 (ph$) million from the first quarter of 2004 to 1.9 million, and operating margins decreased to 0.6%. As we have commented in past conference calls, we remain alert for opportunities in a consolidating market. However, we'll only consider acquiring businesses with complimentary corporate cultures to add new customers and management talent and that are immediately accretive to our earnings and key operating ratios.

In summary, during the quarter, earnings per share declined by $0.01 year-over-year to $0.04 with a 1% decrease in sales. Nonetheless, 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 long-term shareholder value. To improve performance going forward, we will continue to work on sales, service and process improvement initiatives designed to enhance both our top and bottom lines. More specifically, we are making our systems and sales tools more flexible and responsive, allowing our sales representatives to be more productive as well as enhancing the buying experience for customers.

We are rolling out our new service connection offering, which is a suite of IT Services that can reduce the total cost of ownership for our SMB customers and gives us a new platform for growth. Overall, we continue to believe that an innovative customer-centric yet disciplined approach is the key to success in our business and to building long-term shareholder value.

I'd now like to have Bob Wilkins make some additional comments on our margin improvement initiatives as well as operational trends and enhancements.

Thanks, Pat. During the last several conference calls, we spoke about our initiatives to increase our overall gross margin rates. In Q1, our gross profit grew over last year by nearly $1 million, even after the EITF reclassification and despite an almost $4 million decrease in net sales. Our focus on maintaining our gross margin rate will continue. We believe we will be able to first stabilize and improve the margin rate, while we increase our sales.

On industry trend front, average selling prices, or ASPs, for computer systems were relatively flat during the quarter, increasing by 1.9% compared to the first quarter of last year. ASPs decreased 2.2% compared to the fourth quarter of 2004. This sequential decrease resulted from a 7.2% increase in server ASPs, a 4.5% decrease in desktop ASPs, and by a 6.2% decrease in notebook ASPs.

The year-over-year increase in ASPs resulted from a 0.3% decrease in notebook ASPs, offset by 8.5% decrease in desktop ASPs and by a 22.6% increase in server ASPs. Notebook unit and net sales dollars decreased 7.5% and 7.9% respectively compared to first quarter of 2004. Desktop revenues decreased to 12.5% year-over-year on a 4.4% decrease in unit finance volumes and 8.5% decrease in ASPs. However, revenues from server sales increased 54.2% on a 25.8% increase in unit volumes, as compared to the first quarter of 2004.

As we move forward, we continue to monitor our operating costs and review our spending plans and programs to ensure the best possible deployment of our resources. While we plan to continue our focus in controlling discretionary expenditures, we expect our SG&A expense may vary depending on changes in sales volume -- as well as a level of continued investments and key growth initiatives, such as hiring more experienced sales account managers, improving marketing programs, expanding our efforts in developing our service connection programs, and investing in our overall system enhancements to support our sales organization and our customer base.

And now Steve Baldridge will discuss our balance sheet and cash flow in more detail. Steve?

Cash flow generated from operations for the first 3 months of 2005 was 3.7 million compared to 12.9 million in the same period a year-ago due to higher receivable collection levels in the 2004 quarter. Accounts receivable were down $7.9 million to 119.1 million on March 31, 2005 compared to the March 31, 2004 balance due to lower receivables from federal government customers and the decrease in day sales outstanding, or DSOs. DSOs were 43 days compared to 44 days in the first quarter of last year. Inventory balances were up $3 million to 72.5 million at March 31, 2005 compared to the March 31, 2004 balance.

Inventory turns this quarter were 16 compared to 14 in the fourth quarter of 2004 and 16 in the first quarter of 2004. Based on quarterly levels, inventory days were 23 at March 31, 2005 versus 22 at March 31, 2004. 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 accounted for 41.7% of total net sales in the first quarter compared to 37.1% of total net sales in the first quarter of last year and 36.1% of total net sales for the fourth quarter of 2004. Both our federal government and large commercial account businesses primarily used drop-shipping to meet their demand.

Looking forward, our year-over-year outlook for the second quarter of 2005 is as follows. Sales to SMB customers are expected to remain generally the same or to grow in the low-single digits. Sales to government and education customers are expected to remain the same or to grow in the mid-single digits. Sales to large account segments are expected to grow in the low to mid-single digits. Therefore, for the second 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 $0.05 to $0.08 per share. We presently expect the gross margin rate, as a percent of sales for Q2, to be approximately 11.6% and operating expense, as a percent of sales, to be in the range of 10.5% to 10.9%. We continue to work to ensure the best possible near-term results consistent with maintaining a strong financial position in investing for the future.

Thank you for joining us today. We will now entertain your questions. Operator?

(OPERATOR INSTRUCTIONS). Brian Alexander, Raymond James.

When you print out results, I think you indicated that the last half of March was not very strong. And I just wanted to see if you could elaborate on that, as it relates to how things look so far early April.

And also, we've definitely seen some mixed data points about how the quarter finished in Q1. But some of your direct competitors like CDW suggested that it seemed fairly stable and linear. Why do you think you saw different trends? Are there differences in your product mix or customer mix that would explain that? And then again, just comment on what you're seeing so far in April. Thanks.

Brian, this is Bob Wilkins. As you know, March and particularly the last 2 or 3 weeks of March typically have a pretty big uptick for us in prior history. We didn't see that this quarter. So that was part of our shortfall revenue, and it was primarily cross mover (ph) SMB business base. So far for April, we are pleased with what we're seeing in SMB space. It is up year-over-year, so we are doing pretty good.

On the Fed and SLED space, we are still watching it very closely and hoping that we will see a little bit better progress over there. On the large enterprise space, they are also up over last year so far for this quarter.

In the product mix, we do have a little different product mix as far as some of our notebook areas. In particular, in Q1, we lost some share on one particular vendor in the notebook space, as we moved into a different vendor, and we think will offset that this quarter. In the customer space, we are on the lower end of SMB. We believe that we service mostly in the 25 to 115 employee base. We think CDW is a little higher than that. I cannot say that explains why there is a difference between our sales volumes, but we certainly are working with a different customer base.

And I think a couple of your direct competitors over the last year or so, CDW, Insite have voluntarily decided to collect sales tax. Could you just update us on where you are in that process? I think you're still not collecting into the extent that that remains the case. Do you believe that that is a competitive advantage in any way?

Yes, I think that it's too early to really determine the impact of voluntarily registering in every state. We think we want to wait and see how that plays out. We currently don't have any plans to register in all of the states, other than those in which we actually have a nexus of -- or presence in the state. And we are going to continue with that policy until we see the trends going differently.

Great. Just two more quick questions -- where are you in the CFO search -- just an update on that? And then also Bob, could you just elaborate on the strength in the large corporate segment? You're up 15% year-over-year. I think that is much better than probably the large corporate sector in general. Could you just give us a little bit more color on where you're seeing that strength -- you know, specific product categories that you see large corporations refreshing for example?

Yes Brian, this is Pat. We are on -- the CFO search is going very well. I would say we're about midway through that, which is what we anticipated -- where we anticipated being at this point and where we understand it is the norm to be for a search for a CFO for a public company. So I think that that is going well. We are seeing good people and expect there will be a decision made in this quarter. I'll let Bob answer the second part of the question.

Brian, on the enterprise space, MoreDirect has done a great job of increasing penetration of existing customers. That was a big focus for them last year, and they are seeing the payoff from that. Across the board, we are seeing sales in servers, notebooks, and desktops and software. So there hasn't been any one particular hotspot that has been driving it. It's what you would expect across the channels at this point.

Any particular verticals that strike you as it is better-than-expected, whether it's financial services or others?

No, it has been across the board, again with all our customers. And they have a pretty diverse portfolio of customer types. They don't focus on one particular vertical.

(OPERATOR INSTRUCTIONS). Dan Leben, Robert W. Baird.

Just a follow-up on something you mentioned earlier. In the SMB segment, was that specifically where you were talking about the notebook mix changing? Or is that overall?

That was specifically in the SMB segment.

Okay, could you go a little bit more in-depth in that and give us an idea on what was going on there?

Well, we had one particular vendor, who we determined was not a profitable vendor for us going forward. And we made the decision late last quarter to move that product line into a different vendor. And we were able to move about half the volume over. And we believe we can get the rest of the volume over this quarter, so we will increase our overall gross margin rates and give us long-term profitability.

Was there any sales impact to the move there?

Yes, there was. There was approximately about a $12 million shortfall in notebook revenues from that one particular vendor, when you take out the offset from the increase we had from the other vendor.

Okay, great. And then just a follow-up a little bit on more on the government sector, just talk a little bit about how you think it's going to ramp up on the federal side, being back on the GSA -- and what we should look for going out towards the back half of the year.

Well, our guidance -- this is Steve Baldridge -- our Q2 guidance for the public sector sequentially would be 63 to $68 million. That would be from relatively flat to approximately a 7% increase year-over-year.

Okay. And just going through that -- across the anniversary or being back on the schedule, is there any significance to that in the August timeframe?

This is Bob speaking. I think when we look at the schedule, we have got to remember that we got the schedule back. We got HP back on, and we've recently added a few more vendors to that. But we are far from where we were a couple years ago; we had the schedule. So this is an investment year in that group in getting more vendors back on and the tail-ons (ph) is back up. And we cannot determine that rate or the timing of adding vendors to that schedule.

Okay, great. And could you talk a little bit about kind of the operating profitability of each of the segments? Where that is at? Were you profitable in all the segments and --?

At this point, we will disclose segment profitability when we file the 10-Q next month. So at this point in time, we provide margin summaries by segment but no feedback at this point on operating income.

Brian Alexander.

Just a follow-up on your comment, Bob, about this notebook vendor. I'm just trying to understand -- was this something -- did that vendor change their t's (ph) and c's (ph) recently, which then caused you to decide that it wasn't profitable for you? Or have they not changed their t's and c's, and maybe you're just using more tools to determine whether vendors are profitable for you?

Part of it is a combination of a vendor's t's and c's, Brian, and another vendor's opportunity in wanting to take market share and putting in more profitable program in place for us.

And you probably can't go into too much detail on who these vendors are, but is it fair to assume that the vendor you replaced is a large, well-known notebook vendor that might be focusing more on profitability than they have in the past?

I really can't comment any further, Brian.

(OPERATOR INSTRUCTIONS). I'm showing no further questions. I would now like to turn the floor back over to Mr. Steve Baldridge for any closing remarks.

This is Pat Gallup. I think we are all set. Thank you all for your time and interest. Have a great day.

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