PC Connection Inc (CNXN) 2005 Q3 法說會逐字稿

Good morning ladies and gentlemen. My name is Stacy and I will be your conference of facilitator today. At this time, I would like to welcome everyone to the PC Connection third-quarter 2005 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks that will be a question and answer period. (Operator Instructions). Thank you. It is now my pleasure to turn the floor over to your host, Mr. Steve Baldridge, Vice President of Finance and Corporation Controller. Sir, you may begin your conference.

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 third-quarter conference call. If you have not 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'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 would 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 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-Q for the quarter ended June 30, 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 Interim 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 in the third quarter increased both year-over-year and sequentially. Net sales for the three months ended September 30, 2005 increased by 5.6% to $371.1 million from 351.3 million for the quarter ended September 30, 2004 and by 5.8% from 350.7 million for the quarter ended June 30, 2005.

Net income for the quarter was $1.9 million, or $0.08 per share, compared to $2.8 million, or $0.11 per share, for the prior year quarter. The quarters ended September 30, 2005 and 2004 included special charges. Had these charges not been incurred, pro forma net income for the current year quarter would have been $2.5 million, or $0.10 per share, compared to 3.9 million, or $0.16 per share, for the prior-year quarter. Our press release includes a reconciliation of these amounts.

Despite an increasingly competitive sales environment, net sales for our small and medium-sized business, the SMB segment, increased by 3.9% from the third quarter of 2004 to 203.5 million. Sequentially, SMB net sales decreased by 1.8% from the second quarter of 2005, similar to historic trends. Sales to large corporate account customers, our large accounts segment, increased 3.8% to $80.4 million from the corresponding period a year ago and increased 2.5% sequentially from the second quarter of 2005.

Sales to government and education customers, our public sector segment, increased 12.1% from the third quarter of 2004 to 87.2 million. More specifically, sales to the federal government increased year-over-year by 4.3 million, or 23.5%. This represents a good beginning to our recovery in this sector. 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 contracts. Sales to state, local and education customers increased this quarter by 8.5% year-over-year due to new customer acquisition and stronger back to school sales. The total number of sales represented increased to 585 as of September 30, 2005 from 561 September 30, 2004, but decreased from 602 at June 30, 2005.

On a consolidated basis, annualized sales productivity for the third quarter was unchanged year-over-year, but increased by 5.9% sequentially. Sales productivity in our SMB segments decreased by 1.5% sequentially and by 5.3% year-over-year due to having a larger percentage of new hires.

Sales productivity in our public sector segment increased 12.1% from the third quarter of 2004. The year-over-year public sector increase was largely attributable to our 23.5% increase in federal sales referred to earlier. Sales productivity in our large accounts segment increased sequentially by 3.2% and year-over-year by 11.2%. This productivity increase was a result of our success in increasing penetration of our existing customer base and from our acquisition of new accounts, offsetting a slight decrease in the number of sales representatives.

Our consolidated gross profit dollars increase over the third quarter of 2004 by 2.7 million and gross profit margin increased by 12 basis points to 11.3%. The largest contributor to our improvement in gross profit dollars and gross profit margin was our SMB segment. Year-over-year, this segment increased gross profit dollars by $2.3 million in gross profit margins by 67 basis points.

We continue to focus on generating more gross profit dollars per transaction. Our ongoing efforts to improve profit margins include increasing add-on sales to accessories and other companion products to our system sales, the level of our enterprise product sales and sales of third-party warranty installation and other services. In addition to our efforts to improve product margins, we initiated a new sales training program which we expect moving forward to further improve productivity and decrease attrition in our sales force.

Total SG&A expenses as a percentage of sales increased to 10.1% for the third quarter of 2005 compared to 9.3% for the third quarter of 2004. Higher advertising costs and our investments in service connections and in sales-related information systems also contributed to a year-over-year rate increase in SG&A expenses. We continue to make improvements in our systems and sales tools, enabling our sales force to be more efficient and responsive. Income from operations for the quarter declined by 1.1 million from the third quarter of 2004 to 3.7 million, or 1% of net sales.

In summary, during the quarter, sales increased year-over-year and sequentially to $371.1 million while earnings per share declined year-over-year to $0.08 per share. We invested in our systems and sales tools to make them more efficient, flexible and responsive, allowing our sales representatives to be more productive. We also invested in our new service connection business through additional personnel and a new advertising brand campaign. With this, we believe PC Connection has the strategies and resources necessary to enhance long-term shareholder value. As we have commented in past conference calls, we remain alert for opportunities in a consolidating market and will consider acquiring businesses with complementary corporate cultures that add new customers and talent. Earlier this week, we announced the acquisition of certain assets of Amherst Technologies for $7.8 million in cash. Amherst Technologies was an IT solutions provider that focused on the medium to large corporate market. The acquired assets include all customer relationships and related intangibles, intellectual properties and miscellaneous furniture fixtures and equipment. Most of the acquired assets will be combined with the Company's more direct subsidiary to expand its reach into the medium to large corporate customer segment and enhance its sales efforts.

The remaining assets will be combined with the Company's PC Connection Sales Corporation subsidiary, which sell to the small and medium-sized business market. The Merrimack (ph) Services Corporation subsidiary, which does business as PC Connection Services and provides back-end services to all sales subsidiaries, or a service connection, a subsidiary that offers a suite of value-added IT services. This acquisition particularly reinforces our commitment to the medium to large corporate sector and at the same time, helps build our service connections business by offering an even broader range of higher-end services to fulfill all of our custom needs. And now I would like Bob Wilkins to make some additional comments on our process improvement initiatives as well as operational trends and enhancements. Bob?

Thanks, Pat. As we have stated in past calls, we continue to make some big investments in our internal systems to allow for faster and better experiences for our customers and greater productivity for our sales force. During the quarter, we incurred incremental expenses of approximately 400,000 as a result of this investment. Going forward, we'll make increasing investments in these system enhancements and expect to see improved productivity as a result of this initiative beginning in the second half of 2006.

Secondly, as stated in our Q2 conference call, we completed a project to improve our SMB web site design by enhancing the navigation and search capabilities along with converting the technology platform. During the third quarter, Internet sales for this segment increased 26% over the third quarter of 2004 to $38 million. We're pleased with the progress and expect continued improvement in this area.

Additionally, we continue to execute on the rollout of our new service connection initiative. This included the hiring of a new president, Charles Burnham, the addition of personnel to support a creative variety of service connection offerings for the SMB segment and the initial investment in the creation of a national advertising campaign to be rolled out in 2006. These investments, along with our acquisition of Amherst Technology's assets, strategically position us to capture a larger portion of the IT services market going forward.

Now onto business trends. Average selling prices, or ASPs, for computer systems decreased during the quarter by 7% compared to the third quarter of last year. The ASPs decreased by 3% compared to the second quarter of 2005. The year-over-year decrease resulted from a 9% decrease in both desktop and notebook ASPs and a 16% decrease in workstation ASPs, offset by a 9% increase in server ASPs. The sequential decrease in ASPs resulted from an 8% decrease in desktop ASPs, a 5% decrease in server ASPs and a 12% decrease in workstation ASPs.

Notebook units increased 4% but notebook net sales dollars decreased by 6% compared to the third quarter of 2004. Desktop units increased 6% year-over-year but net sales dollars decreased by 3%. However, revenues from server sales increased 15% on a 6% increase in unit volumes and a 9% increase in ASPs compared to the third quarter of 2004.

We continue to actively monitor our operating costs and review our spending plans and programs to ensure the best possible deployment of all resources and we plan to continue our focus on controlling discretionary expenditures. We expect our SG&A expenses may vary depending on changes in sales volumes as well as the levels of continued investments and key growth initiatives, such as hiring more sales experience -- more experienced sales account managers, improving marketing programs and expanding our efforts in developing our service connections program. We also expect to continue making significant investments in our overall system enhancements for 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 nine months of 2005 was $10.6 million compared to $18.5 million in the same period a year ago due primarily to higher receivable levels at September 30, 2005. Accounts receivable increased $25.1 million to $148.6 million on September 30, 2005, compared to the September 30, 2004 balance due to higher sales during the second half of the quarter. Also as a result, days sales outstanding, or DSOs, increased to 46 days from 41 days as of September 30, 2000 for and from 41 days as of June 30, 2005. Inventory balances, however, were reduced by $10.5 million to $66.9 million at September 30, 2005 compared to the September 30, 2004 balance.

Additional focus this year on supply chain initiatives contributed substantially to the decreased inventory levels and improvement in inventory turns. Inventory turns this quarter improved to 20 turns compared to 16 in the third quarter of 2004 and 19 in the second quarter of 2005. Based on quarterly levels, inventory days also improved to 19 days at September 30, 2005 versus 23 at September 30, 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 dropshipped by distributors and other vendors directly to customers reached its highest level in company history, accounting for 43% of total net sales in the third quarter compared to 39% of total net sales in the third quarter of last year. Both our federal government and large commercial account businesses primarily used dropshipping to meet their demand and recent SMB initiatives have also escalated dropshipments.

Given our recent acquisition that Pat discussed earlier and our current focus on the integration of Amherst's operations, employees and customers, we will not be providing guidance for the fourth quarter. 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?

(Operator Instructions) Brian Alexander, Raymond James.

Hi, guys, this is Bob Grundeig (ph) filling in for Brian. I just wanted to talk about the Amherst acquisition for a little bit. Are you guys going to be -- or I guess in the acquisition number, 7 -- I think it was 7.5 million does that include working capital at all, inventory, or are you guys starting fresh there?

It does not include any inventory or receivables. We're basically picking up the relationships with customers and we're hiring selective employees. The assets we're acquiring a basically intangibles; some furniture and fixtures and equipment, but not receivables or inventories work cash.

Okay. And I was just wondering what kind of revenue attrition you all might be thinking about going forward, if there is a lot of customer overlap, if any, between the two companies?

The customer overlap was very minimal that we looked at. The goals and plans we set forth for the revenue numbers we thought we'd peak (ph) out -- we've only been doing this for four days -- look like that we're going to achieve those. So, so far, it looks like a good acquisition.

Okay, great. Let's hit the SMB segment just for a second. If I'm doing the math right, it looks like headcount for (indiscernible) stayed roughly flat sequentially. It looks like the level has been flat for the last three quarters. Just wondering if you expect that to pick up in the future. I know you said you implemented a new sales training program. If that's going to be used for all the account executives and new, just a little more color with that segment would be helpful.

Obviously, we're going to pick up some headcount with the Amherst acquisition, so you will see some of that the next quarter results. We do expect to start increasing our headcount in the SMB marketplace through two things, as Pat mentioned in her comments. One is less attrition going forward, and we're actively looking at some other ways to bring headcount into our technology systems through the S&P segment.

Headcount also in our SMB segment has grown 7% year-over-year, and we continue to stabilize our 10-year rates and look at opportunities to drive productivity.

Okay great. That's all the questions that I have. Thank you.

David Lynn (ph), William Blair.

Hi. I just wanted to ask a question. Can you guys discuss any monthly trends that you saw in SMB or government business? Like was August bad or soft in government business, and maybe what did you see in SMB as well?

Q3 started out rather soft in July across all three business segments and the demand picked up in the August and September period again in all three segments. And the strong momentum that we experienced leaving Q3 has carried on into October, again, across all three of the business segments. So I think one of the opportunistic things is to see such strong momentum carry on in the first month of a new quarter.

My only follow-up question is, I think it was Bob last quarter talked briefly about the tax rate and I guess he was -- I don't know if it's guidance -- but you said it would be around 40% and I think we have seen kind of an uptick in that measure over the last few quarters and I think this quarter it was about 44%. Can you guys talk about the volatility there and where you guys see that going?

The tax rate is really a function of the interaction of various factors state tax jurisdictions. Some subsidiaries may have a tax loss carryforward that is not all incentable against other state tax jurisdictions whereas other subsidiaries have profit (ph). So depending on the relationship of the two, you see a variation in the tax rate. And that's what drove it up in the third quarter.

But do you think we should still be using 40% moving forward?

I think on a long-term basis, 40% would be appropriate.

Okay, that's all I have, thank you.

(indiscernible), Banc of America Securities.

Hello, good morning, I am filling in for (indiscernible). I just had one question in regards to the gross margin. Can you tell me what were the main factors that led to the sequential decrease quarter-over-quarter?

The sequential decrease from 11.6% in Q3 to 11.3% -- 11.6% in Q2 to 11.3% in Q3 was, number one, primarily mix. Our public sector traditionally has lower margin rates than our other business segments and we had very strong Q3 in our public sector, which is traditionally true. So I think the combination of that and some margin decline in our large account segment sequentially.

Thank you very much.

(Operator Instructions). Sir, there appears to be no further questions.

Thank you all very much for your time and attention and have a great day.

This concludes today's PC Connection conference call. You may now disconnect your line at this time and have a wonderful day. The