PC Connection Inc (CNXN) 2005 Q4 法說會逐字稿

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

Thank you and good morning everyone. This is Steve Baldridge, VP of Finance and Corporate Controller. Patricia Gallup, Chairman and CEO; Bob Wilkins, Executive Vice President; Jack Ferguson Vice President and CFO and Peter Cannone, Senior Vice President, Sales Subsidiaries, are also here with us today. We are pleased to have you join us today for PC Connection's 2005 fourth-quarter conference call.

If you have not already seen our press release, you can contact Suzanne Stanley at 603-683-2217 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 Connections' website and at streetevents.com.

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 conditions in the Company's quarterly report on Form 10-Q for the quarter ended September 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 give you an overview of the quarterly results as announced in our press release this morning. I hope you have all have the opportunity to read it.

Net sales for the quarter ended December 31, 2005 increased $59 million, or 17.4% to $398.6 million from $339.6 million for the quarter ended December 31, 2004, and increased $27.5 million, or 7.4%, from $371.1 million for the quarter ended September 30, 2005. These increases were due to the positive effects of the Amherst Technologies asset acquisition and to continued organic growth. Included in the fourth quarter of 2005 were $25.2 million of sales by the former employees who joined our organization from Amherst Technologies, representing 7.4 percentage points of the year-over-year increase.

Net income for the quarter was $11,000, or substantially breakeven, compared to $2.1 million, or $0.08 per share, for the prior-year quarter. As stated in our press release, the quarters ended December 31, 2005 and 2004 included special charges. Had these charges not been incurred, pro forma net income for the current year quarter would have been $0.8 million, or $0.03 per share, compared to $3.1 million, or $0.12 per share for the prior year quarter. Our press release includes a reconciliation of these amounts.

I'm now going to turn the call over to Pat Gallup for her remarks on our quarterly and year-end results. Pat?

Good morning everyone and thank you for joining us. I will begin by commenting on our small and medium-size business, or SMB, which is our original core business.

Net sales for this segment increased by 9.1% from the fourth quarter of 2004 to $223.5 million. Through our customer acquisition initiative, we acquired new accounts and increased market share. Sequentially, SMB net sales increased by 9.8% from the third quarter of 2005 due in part to increased Internet sales. Sales to large corporate account customers, our large account segment, increased 46.4% to $112.3 million from the corresponding period a year ago and increased 39.7% sequentially from the third quarter of 2005.

The 2005 sales included sales of $23 million from our former Amherst Technologies sales account managers. Excluding the Amherst sale, large account sales grew by 17.1% year-over-year and by 11.7% sequentially during the fourth quarter.

Sales to government and education customers, our public sector segment, increased 8.2% from the fourth quarter of 2004 to 62.8 million. More specifically, sales to state and local governments increased year-over-year by $5.2 million, or 14%, while sales to the federal government were flat year-over-year. Federal gross profit dollars increased 9.1% year-over-year, however.

The total number of sales representatives increased to 618 as of December 31, 2005 from 581 December 31, 2004 and increased from 585 at September 30, 2005. We added 39 sales representatives from Amherst in late October with 32 of these working within our large account segment.

On a consolidated basis, annualized sales productivity for the fourth quarter increased year-over-year by 11.4% and by 6% sequentially. Sales productivity in our SMB segment increased by 11.6% sequentially and by 4.8% year-over-year. Sales productivity in our public sector segment increased 7.7% from the fourth quarter of 2004. This increase was largely attributable to our 17.8% increase in our federal sales productivity.

Sales productivity in our large account segment increased sequentially by 7.9% and year-over-year by 15.5%. This productivity increase was the result of our increased penetration of our existing customer base, as well as the addition of new accounts. Our consolidated gross profit dollars increased over the fourth quarter of 2004 by $1.3 billion due primarily to the Amherst acquisition. However, gross profit margin decreased by 1.5% to 11%. The decrease in margin rate resulted from an increasingly competitive sales environment, lower vendor consideration to product mix and the targeting of high-value customers.

We continue to focus on generating more gross profit dollars per transaction and increasing gross margin. Our efforts to improve product margins include increasing our higher margins sales of third-party warranty installation and (technical difficulty) services, maximizing vendor incentive programs and increasing sales productivity.

In addition to our efforts to improve product margins, we initiated a new sales training program which we call Core One. We expect that moving forward, this program will further improve both productivity and retention in our sales forces.

Total SG&A expenses increased 3.9 million year-over-year in the fourth quarter of 2005. However, as a percentage of sales, SG&A expenses decreased to 10.5% for this quarter compared to 11.1% for the fourth quarter of 2004.

This quarter was an investment quarter for our company. In addition to our acquisition of Amherst, we incurred incremental expenditures related to training customer acquisition programs and other marketing initiatives. We also continue to make improvements in our systems and sales tools, enabling our sales force to be more efficient and responsive. Income from our operations for the quarter was 0.9 million, a decline from 3.1 million for the fourth quarter of 2004.

In summary, during the quarter, sales increased year-over-year and sequentially to $398.6 million, our historic level. Earnings-per-share, however, declined year-over-year due to the decline in gross margin rates and to the investments we talked about earlier. We are encouraged with the progress we have made with the integration of Amherst. We're also on target to open a new sales call center in Texas next month. We expect this call center to give us better coverage in the Western part of the country for our SMB segment, as well as access to an additional large and talented workforce.

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 talents.

Now I would like Bob Wilkins to make some additional comments on our process improvement initiatives and operational trends. Bob?

Thanks, Pat. As we've as 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 sales force. During the quarter, we incurred incremental expenses of approximately $300,000 and made capital expenditures of approximately $500,000 as a result of this investment. Going forward, we will make increased 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, we incurred additional expenditures for SMB Internet marketing programs in the fourth quarter as compared to Q3. Increased marketing, coupled with our recently enhanced Web site design, resulted in a 12.5 million, or a 36% increase, in Internet sales over the fourth quarter of 2004. We are pleased with the progress and expect continued improvement in this area.

Additionally, we continued to execute the rollout of our service initiatives. These included the integration of Amherst service engineers into our more direct organization, increased levels of marketing expenditures and continued development of managed or SKU-able service offerings. These investments strategically position us to capture a larger portion of the IT services market going forward.

Now onto business trends. Average selling prices, for ASP, for computer systems decreased during the quarter by 6%, compared to the fourth quarter of last year. However, ASPs increased by 5% compared to the third quarter of 2005. The year-over-year decrease resulted from a 10% decrease in notebooks and an 8% increase in desktops, offset by a 3% increase in workstation ASPs. The sequential increase in ASPs resulted from an 8% increase in both workstation and desktop ASPs, as well as a 3% increase in server ASP's.

Notebook revenues increased 10% on a 23% increase in unit sales compared to the fourth quarter of 2004. Desktop revenues increased 2% year-over-year, on an 11% increase in unit sales. Revenues from service sales increased 26% on a 27% increase on unit volumes compared to the fourth quarter of 2004.

We continue to monitor our operating costs and we view our spending plans and programs to ensure the best possible deployment of our resources. However, we expect to continue to make significant investments in our overall system enhancements to support our sales organization and our customer base.

Now, Jack Ferguson will discuss our balance sheet and cash flow in more detail.

Thank you, Bob. Cash flow generated from operations for the year ended December 31, 2005 was $9.6 million compared to $13.3 million in the same period a year ago due primarily to higher receivable levels at December 31, 2005. Accounts receivable increased $41.8 million to $162.5 million at December 31, 2005 compared to the December 31, 2004 balance due to higher organic sales as well as sales from the Amherst Technologies acquisition. Days sales outstanding, or DSOs, increased to 47 days from 42 days at December 31, 2004 and from 46 days as of September 30, 2005.

Inventory balances, however, were reduced by $3 million to $75.4 million at December 31, 2005 compared to the December 31, 2004 balance. Additional focus this year on supply chain initiatives contributed substantially to the improvements in inventory turns despite the additional and large year-end inventory buy-ins. Inventory turns this quarter improved to 20 turns compared to 14 in the fourth quarter of 2004 and was unchanged from the third quarter of 2005. Net sales of products drop-shipped by distributors and other vendors directly to customers reached its highest level in company history, accounting for 47% of total net sales in the fourth quarter compared to 36% in the fourth quarter of last year. Both our federal government and large commercial account businesses primarily used for drop-shipping to meet their demands.

Based on quarterly levels, inventory days also improved to 19 days at December 31, 2005 versus 24 days at December 31, 2004. We believe inventories are in excellent condition, both in quantity and quality.

In summary, the balance sheet remains very healthy. Given our recent acquisition that Pat discussed earlier and the current focus on the continued integration of the Amherst assets, employees and customers, we will not be providing guidance for the first quarter of 2006.

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

(Operator Instructions). Brian Alexander, Raymond James.

Thank you. Just looking at the product mix this quarter, it looks like you had a fairly significant decline in the mix of notebooks despite what appears to be pretty good unit growth out there in the marketplace. One of your peers also reported the other day and also had a similar decline in notebooks sales as a percentage of the total. I'm just trying get a better understanding as to what is causing that. Is there something broader going on here from a vendor perspective, changes in terms and conditions? Because clearly, these trends would not reflect what is going on in the marketplace.

Brian, it's Bob. A couple of things. (indiscernible) we still have an average selling price issue that has been evolved throughout the last six months of the year. And I think we have some anticipation of new dual-core technology in notebooks that's going to come out the first part of this year. So I think we're looking at a transition time right now, and that's part of what you're seeing in the market.

Okay. Any particular vendor issues?

We didn't see any particular vendor issues this quarter, no.

And I think you mentioned vendor consideration being down and having a negative impact on gross margin. Was that a major factor this quarter? And can you give us a little more color about what is going on with the overall vendor incentive programs? Are you seeing vendors pull back on volume rebates for your company for this channel? Is it confined to one or two particular companies, or is it more widespread than that?

Well Brian, I think as we say every quarter, that particular rebate volume that is available to us actually changes quite a bit and the goals for that change quite a bit. We're actually seeing in some of the larger manufacturers more investment in the channel, more vendor rebates available to us. We have seen some of the medium vendors that are, I will call the number three and number four tiered vendors that are struggling right now, hold back a little bit. So the mix changed on us a little bi. Some of the goals might have been a little bit heavier than I think people could actually hit at the end of the quarter. And I think the vendors are realizing some of lot. So a lot of this becomes a readjustment going into Q1. There's a lot of negotiation that happens in all of those rebate dollars.

And I guess my final question relates to gross margin in the SMB segment. You had been making some nice progress on a year-over-year basis for the last five or six quarters. And then this quarter, it looks like the bottom fell out, so to speak, with gross margin in SMB down over 180 basis points. Was that all due to competitive pricing conditions? And how much comfort should we have going forward that gross margin can stabilize or rebound from these levels without resulting in lost sales?

I will take the first part. I think Steve and Pete might take a little bit of this too. We had the mix change. No doubt Apple and the Web was pretty big and the margins a little bit lower there, a little more aggressive in competing with some of our other colleagues. The margin attainment I think going forward can actually move back up. Some of the mix we had was from customer acquisition opportunities which I think the [sales group] did an excellent job on. And I want Stephen to comment a little bit.

Steve Baldridge, Brian. I think just to pick up on Bob's comments, again, in SMB as in the other segments, it was a combination of the competitive sales environment and I think the lower vendor consideration we talked about on the product mix. And also, I think a little targeting of some high-value customers that occurred I think in most of our sales segments. And I think as we noted earlier, we are clearly focused on improving our gross margin dollars and our margin rate going forward. And I think as we focus and continue to roll out our services group, while to Bob's point we maximize the vendor consideration that's available to us on a quarter-by-quarter, in addition to some things we're doing in our sales organization, we feel good about I think our margin rates going forward.

Just to kind of close out the comments that Bob and Steve made, we felt that we were able to take some market share in Q4. And when we look at our initiatives and when you talk about high-value customers and what does that mean, it means that we're looking for customers where we can deliver solutions -- hardware, software and services. And then once we acquire these customers, we want to increase both our depth and breadth selling IT solutions. So as we move forward, these customers, we're hoping that we're going to be able to increase our gross margins with those customers by expanding our offerings to them.

Thank you.

[Kyle Omeara], Robert W. Baird & Co.

Good morning everyone. Another gross margin question for you. In the more direct segment, was that the issue that you were talking about in the SMB, or did Amherst (inaudible).

Kyle, if you can, speak up. We can barely hear you.

I'm sorry. Gross margin in your more direct segment, did Amherst adversely affect that, or was that a mix issue as well?

In our large account segment, clearly the customer mix and the targeting of high-value customers in Q4 impacted the more direct gross margin rates year-over-year.

Just to add, what we also had, we took a more aggressive effort to retain loyal high-value customers in our large enterprise space during this transition.

A follow-up question on that on Amherst. As far as EBIT, was Amherst profitable this quarter? And then a follow up to that was, how fast is it going to be able to ramp to your existing, more direct levels?

If you look at recurring expenses -- this is Jack Ferguson -- Amherst's going rate business was profitable. It earned a slight profit if you exclude the transition costs.

Okay. Thank you.

(Operator Instructions). At this time, there appear to be no further questions. I'd like to turn it back to Mr. Baldridge for any closing remarks.

We appreciate your time and have a great day.

Thank you. This does include today's PC Connection conference call. You may now disconnect your lines and have a great day.