PC Connection Inc (CNXN) 2005 Q2 法說會逐字稿

Good morning, and welcome to the PC Connection 2005 second quarter conference call. (OPERATOR INSTRUCTIONS). It is now my pleasure to turn the floor over to your host, Steve Baldridge. Sir, you may begin.

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 second quarter conference call. If you haven't already seen our press release, you can contact Virginia Reynolds at 603-683-2322, and she will fax or e-mail a copy to you immediately. You can also view it on our website. Today is 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 would like to inform our participants that any statements or references made during the conference 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 quarterly report on Form to 10-Q for the quarter ended March 31, 2005, 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, Treasurer and CFO, are also here with us today. I hope you have all had the opportunity to read our press release, which announced that net sales increased both year-over-year and sequentially in all three sales subsidiaries. Net sales for the three months ended June 30, 2005 increased by $15.4 million, or 4.6%, to 350.7 million from 335.3 million for the quarter ended June 30, 2004. Net income for the quarter ended June 30, 2005 was $1.7 million, or $0.07 per share, compared to 2.3 million, or $0.09 per share, for the quarter ended June 30, 2004.

Specifically, despite an increasingly competitive sales environment, net sales for our small and medium-size business, SMB segment, increased by 6.8% from the second quarter of 2004 to $207.3 million. Sequentially, SMB net sales increased by 3.5% from the first quarter of 2005. Sales to large corporate account customers, our Large Account segment, increased .7% to $78.5 million from the corresponding period a year ago, and increased 2.7% sequentially from the first quarter of 2005.

Sales to government and education customers, our Public Sector segment, increased 2.6% from the second quarter of 2004 to $65 million. More specifically sales to the federal government increased year-over-year by 4.5 million, or 41.2%. Our ability to drive increasing levels of federal sales is dependent on our success in continuing to expand our current GSA contract and in negotiating new contract vehicles. We have recently added several key vendors to our GSA schedule, including Apple, Adobe, APC, Common Vault (ph), Sony, Xerox and ViewSonic. Sales to state, local and education customers decreased this quarter by 5.6% year-over-year, partly due to direct competition from manufacturers.

The total number of sales representatives increased to 602 as of June 30 2005 from 586 at March 31, 2005, and from 563 at June 30, 2004. On a consolidated basis, annualized sales productivity for the second quarter decreased 1.8% year-over-year, but increased sequentially by 6.4%. Sales productivity in our SMB segment decreased 5% year-over-year, but increased 1.1% sequentially.

Sales productivity in our Public Sector segment increased 5.5% from the second quarter of 2004. The year-over-year Public Sector increase was largely attributable to our 41% increase in federal sales referred to earlier. Sales productivity in our Large Account segment increased sequentially by 2.7%, and year-over-year by 10.7%. The Large Account productivity increases resulted from the success of this segment's increased penetration of its existing customer base and from new account acquisitions, offsetting a decrease in the number of sales representatives.

Our overall gross profit dollars increased over the second quarter of 2004 by $4.5 million. And gross profit margins increased by 80 basis points to 11.6%. The dollar increase was primarily the result of a refinement of our reclassification of certain vendor consideration proceeds from selling, general and administration expenses to cost of sales as required by issue No. 02-16 of the Emerging Issues Task Force.

During the second quarter we reclassified an additional $3.6 million of vendor consideration to cost of sales. This classification was based in a revision of our estimates of advertising costs and reimbursements related to EITF Issue No. 02-16. Such vendor consideration had previously been recorded as an offset to SG&A expenses, and this reclassification increased gross margin by 103 basis points. and increased SG&A expenses as a percent of sales by 105 basis points for the quarter.

We continue to direct the sales culture to improve their focus on generating more gross profit dollars per transaction. The SMB margin rate for the quarter increased sequentially by 11 points, due primarily to greater participation in vendor programs. Year-over-year SMB and Public Sector gross margin rates increased by 63 and 129 basis points, respectively. These increases were primarily the result of a refinement in our estimates related to EITF 02-16 as discussed earlier. However, profit margins for our Large Account segment improved 72 basis points over the second quarter of 2004, due to favorable customer mix. 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.

Total SG&A expenses as a percentage of sales increased to 10.7% for the second quarter of 2005 compared to 9.4% for the second quarter of 2004. The reclassification described earlier added 105 basis points to SG&A this quarter. Higher advertising costs and our investment in making our systems and sales tools more flexible and responsive, also contributed to a year-over-year rate increase in SG&A expense.

Income from operations declined by $0.7 million from the second quarter of 2004 to $3.2 million, and corresponding operating margins decreased to .9%. Sequentially, however, our operating margins increased from .6% in the first quarter to .9% this quarter.

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 complementary corporate cultures that add new customers and management talents, and that are immediately accretive to our earnings and key operating ratios.

In summary, during the quarter sales increased year-over-year by 4.6% to $350.7 million, and earnings per share declined by $0.02 year-over-year to $0.07 per share. Nonetheless, given our margin enhancement initiatives, and continuing investment in our sales organizations and systems, 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're making our systems and sales tools more efficient, flexible and responsive, allowing our sales representatives to be more productive, as well as enhancing the buying experience for our customers. 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.

And now I would like Bob Wilkins to make some additional comments on our process improvement initiatives, as well as operational trends and enhancements.

As we have stated in past calls, we continue to make significant investments in our internal systems to allow for faster and better experiences for our customers, and greater productivity from our salesforce. During the quarter we incurred incremental expense of approximately $500,000 as a result of this investment. Going forward we will make increased investments in e-systems enhancements, and expect to seem improved productivity as result of this initiative beginning in the second half of 2006.

Secondly, this year, we completed a project to improve our SMB website design by enhancing navigation and search capability, along with converting the technology platform. During the second quarter Internet sales from this segment increased 24% over the second quarter of 2004 to $38 million. We're pleased with the progress and expect continued improvement in this area.

Additionally, we continue to execute the roll out of our new ServiceConnection offering. Though still in the early stages of promoting our new private label, the SMB value add service team increased gross margin dollars year-over-year by 9% during the quarter.

Now on to the business trends. Average selling prices, or ASPs, for computer systems were relatively flat during the quarter, decreasing by .06% compared to second quarter of last year. ASPs decreased 5.6% compared to the first quarter of 2005. The sequential decrease resulted from a 5% decrease in server ASPs, a 3% decrease in desktop ASPs, and a 4.3% decrease in notebook ASPs. The year-over-year decrease in ASPs resulted from a 6.6% decrease in notebook ASPs, a 1.8% decrease in desktop ASPs, partially offset by a 17.7% increase in server ASPs. Notebook units increased .5%, but notebook net sales dollars decreased by 6.1% compared to second quarter of 2004. Desktop revenues decreased 4.3% year-over-year on a 2.5% decrease in unit volumes, and a 1.8% decrease in ASPs. However, the revenues from service sales increased 36.4% on a 15.9% increase in unit volumes, and a 17.7% increase in ASPs as compared to second quarter 2004.

We continue to monitor our operating costs and review our spending plans and programs to insure the best possible deployment of our resources. We plan to continue our focus on 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 in key growth initiatives, such as hiring more experienced sales account managers, improving marketing programs, and expanding our efforts in developing our ServiceConnection program. We also expect to continue to make significant investments 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.

Cash flow generated from operations for the first six months of 2005 was $23.5 million compared to $11.1 million in the same period a year ago, due primarily to lower inventory levels at June 30, 2005. Accounts receivable increased 3.9 million to $123.7 million on June 30, 2005, compared to the June 30, 2004 balance, due to higher sales in 2005. Days sales outstanding, or DSOs, were unchanged at 41 days compared to the second quarter of last year, but improved from 23 days as of March 31, 2005.

Inventory balances were reduced by $18.8 million to $61.6 million at June 30, 2005 compared to the June 30, 2004 balance. Additional focus this year on supply chain initiatives contributed substantially to the decreased inventory levels. Inventory turns this quarter improved to 19 turns compared to 16 in the second quarter of 2004, and 16 in the first quarter of 2005. Based on quarterly levels, inventory days also improved to 18 days at June 30, 2005 versus 24 at June 30, 2004, and 23 at March 31, 2005. 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 dropped shipped by distributors and other vendors directly to customers reached its highest level in Company history, accounting for 42.1% of total net sales in the second quarter compared to 40.8% of total net sales in the second quarter of last year. Both our federal government and large commercial account businesses, primarily use drop shipping to meet their demand. And recent SMB initiatives have also escalated drop shipments.

Looking forward, our year-over-year outlook for the third quarter of 2005 is as follows. Sales to SMB customers are expected to remain the same, or grow in the low single digits. Sales to government and education customers are expected to grow in the high single digits to mid teens. Sales to large account segments are expected to grow in the low to mid single digits. Therefore, for the third quarter of 2005, we presently expect to achieve sales in the range of 360 million to $375 million, and earnings per share in the range of $0.07 to $0.10 per share. We presently expect the gross margin rate as a percent of sales for Q3 to be approximately 11.3%, and operating expense, as a percent of sales, to be in the range of 10.1% to 10.4%. We continue to work to insure 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?

(OPERATOR INSTRUCTIONS). Brian Alexander of Raymond James.

This is Bob Gruenbeck (ph) filling in for Brian. I wondered if you guys could just talk about the linearity in the quarter a little bit? We have heard that June ended pretty strong. And I am just wondering if you guys saw the same thing? And from what you had seen July so far is it tracking as much better -- as you had hoped?

This is Bob Wilkins. I think the quarter was actually fairly smooth. It started off well in the beginning, and finished in the last couple of weeks stronger, but nothing in the major hockey sticks that we have seen in last couple of years. So I just felt it was a good strong quarter all the way through. Going forward, July is always a tough month to figure out the quarter from, based on where the 4th hits, people take vacations and so on. We felt like demand was continuing to be strong throughout all sectors, and therefore our guidance.

I just wanted to talk about the tax rate just for a second. It sort of came in above our, at least our expectations, and I was just wondering how we should model that going forward?

This is Jack Ferguson. I think on a modeling going forward what we built into our guidance was using a rate of approximately 40%. But you have a situation as the interaction of the different state tax rates where you will have some subsidiary subject to certain state tax jurisdictions and others subject to other jurisdictions. So you may have some tax losses built into certain subsidiaries that are not necessarily offset by profits in other subsidiaries, hence that may drive up the rate in some situations.

Just a couple of more. Bob, I think you talked about a $500,000 incremental expense in the quarter. I was writing things down so fast, I sort of missed it. Could you run back through that again?

Yes. We started a project about 18 months ago to completely change our systems that our sales people worked through as far as product lookups and search, and order entry. That project started incurring some expenses beginning of this year. And we wanted to point out that it had a $500,000 expense in Q2. It will continue in that type of range, probably it will be greater into Q3 and Q4 of next year. We're expecting to roll out those enhancements in the second half of 2006.

The final question, working capital management was pretty good this quarter. I was just wondering in terms of inventory turns and days, it improved dramatically from quarter to quarter. I was wondering going forward if these levels where you were at right now are sustainable, or do you feel like they're going to creep back up and little bit?

This is Steve Baldridge. I think we focus this year on a number of supply chain initiatives, including reviewing the depth of our inventory and fine-tuning our weeks of supply concept, looking the breadth of what we carry from a stocking model perspective, and adjusting our assortment plans by product category, also improving and increasing the drop ship levels that we realized. And as you heard we achieved the highest level in our history in terms of drop shipments in Q2, representing 42.1% of our sales. And finally, this year, we have I think improved the aging or currency of our inventory. So our expectation is that we will be able to maintain those inventory levels throughout the remainder of this year.

David Lynn of William Blair.

I just had a couple of quick questions. First, can you give us an update about the SMB segment the switch in notebook vendor?

Yes, this is Bob. I think we have successfully moved into a couple of the other notebook vendors at this point and displaced the volume loss that we had in that one particular vendor. Good, strong signals from two major vendors, especially the last 45 days of the quarter. So we feel real confident with that look at this point.

My last question is, I guess HP's dissolution of CSG, any comments you had about good, bad, or neutral to PC Connection?

Right now we're looking at that as a positive. We have met with the executives with HP, with our team. I think two things come across. One is any time they can reduce their SG&A levels and put out a product at a more competitive price against Dell, that helps us. Secondly, it puts more attention on this channel hitting the SMB customer space. And we feel like they're more engaged than ever in working with us and our sales team to pick up market share. So we see it as a positive so far.

(OPERATOR INSTRUCTIONS). There appear to be no further questions.

This is Pat Gallup. Have a great day. Thank you for your time and attention.

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