PC Connection Inc (CNXN) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. My name is Robbie, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the PC Connection 2006 second-quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded. It is now my pleasure to turn the floor over to your host, Mr. Stephen Baldridge, VP of Finance and Corporate Controller. Sir, the floor is yours.

Thank you, and good morning, everyone. This is Steve Baldridge, VP Finance and Corporate Controller. Patricia Gallup, Chairman and CEO; Jack Ferguson, Senior Vice President and CFO; and Peter Cannone, Senior Vice President, Sales Operations are also here with us today.

We are pleased to have you join us today for PC Connection's 2006 second-quarter conference call. If you have not already seen in our press release, you can contact [Janice Rush] 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, and will be available from PC Connection's website.

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 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 Risk Factors in the company's quarterly report on Form 10-Q for the quarter ended March 31, 2006, 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 to rely on these forward-looking statements as representing our views as of any date subsequent to today.

I'm now going to turn the call over to our CEO, Patricia Gallup, for her remarks on our quarterly results. Pat?

Good morning, everyone, and again, thank you for joining us. I hope you have all had the opportunity to read our press release, which announced that net sales for the quarter ended June 30, 2006 increased $57.4 million or 16.4% to 408.1 million from 350.7 million for the quarter ended June 30, 2005.

Consolidated sales for the quarter were the highest in the Company's history. The year-over-year increase was due to strong demand in the large enterprise market and the positive effect of Amherst transaction which occurred in October 2005. The second quarter of 2006 included sales generated by former Amherst employees who joined our organization.

Net income for the quarter was $3.1 million or $0.12 cents per share compared to 1.6 million or $0.06 per share for the prior year quarter. As stated in our press release, the quarter ended June 30, 2006 included special charges related to our previously recorded GSA contract review. Had these charges not been incurred, pro forma net income for the current year quarter would have been $3.4 million or $0.13 per share. No special charges were incurred in the second quarter of 2005. Our press release includes a reconciliation of these pro forma amounts.

We enjoyed significant overall year-over-year sales growth. I will begin by commenting on our small and medium-size business segment, or SMB, which is our original core business. Net sales increased by $7.8 million or 3.8% from the second quarter of 2005 to 215.1 million. SMB outbound sales increased 9.5% in the quarter, offset by decreased sales in the Web and inbound sales channels. These decreases reflect a reduction in the number of catalogs we distribute and an increased focus on more diverse marketing strategies and programs designed to reach our business customers.

Sales to large corporate account customers, our large account segment, increased $49.9 million or 63.6% to 128.3 million from the corresponding period a year ago. Our large account segment experienced strong demand from both existing and new customers.

Earlier, I mentioned the second quarter 2006 included sales generated by former Amherst employees who joined our organization. Because that group is now fully integrated, as we stated in the last quarter's conference call, we will no longer report the Amherst revenue separately.

Sales to government and education customers, our public sector segment, was down slightly from the second quarter of 2005 to $64.7 million. More specifically, sales to the federal government decreased by 16% due to larger deferrals of revenue in the second quarter of 2006 over 2005, as well as increased agency sales which are recorded net. However, sales to state and local government and education increased by 4.4% year-over-year.

Despite the year-over-year decrease in federal revenues, gross profit dollars from federal sales increased 13.6% year-over-year. Gross profit dollars from state and local government and education increased by 12.4% year-over-year, again, at a higher growth rate than sales. Consolidated gross profit dollars increased over the second quarter of 2005 by $10.4 million or 25.7% due to increases in both sales and gross profit margins.

Margin increased year-over-year by 90 basis points to 12.4%. This improvement incurred in all three segments, and resulted from higher customer invoice margins, increased [in] under consideration, increased service revenues, and larger software referral fees. We believe that our increased emphasis on higher attachment sales and services and companion products has been a key factor driving our margin growth.

Total SG&A expenses increased $7.2 million or 19.1% year-over-year in the second quarter of 2006. This increase was primarily attributable to increased operating costs due to the Amherst transaction, increased variable compensation expense resulting from our gross profit growth, and continued investment in our sales training, internal systems, and our new call center in Texas. As a percentage of sales, SG&A expenses increased slightly to 10.9% for the quarter compared to 10.6% for the second quarter of 2005.

We continue to make significant investments in our internal systems to provide a better buying experience for our customers and to increase the productivity of our sales force. During the quarter, we incurred expenses of approximately $500,000 and made capital expenditures of approximately 1.1 million as a result of these enhancements. Going forward, we will make additional investments in our systems into 2007 and expect to see improved productivity as a result.

We also continue to grow and invest in our services initiatives. These included the continued growth in service sales support from former Amherst service engineers, successfully integrated into our MoreDirect organization, increased levels of sales training and promotion of services to our customer base, and continued development of managed or [SKU-able] services offered in our SMB segment through our service connection brand. We believe these incremental investments strategically position us to capture a larger portion of the services market moving forward.

Income from operations for the quarter was $5.8 million, or 1.4% representing a 93% increase from $3 million for the second quarter of 2005. As we have stated in past calls, we remain alert for opportunities in a consolidating market, and will consider acquiring additional businesses with complementary corporate cultures that add new customers and talent.

We will continue to monitor our operating costs and review our spending plans and programs to enable the best possible deployment of our resources. Furthermore, we plan to continue making investments to support our sales organization and better serve our customer base.

Now, I would like Peter Cannone to make some additional comments on our sales segment and the trends in their respective markets. Pete?

Thanks, Pat. Our total number of sales representatives increased by 57 to 659 as of June 30, 2006; from 602 June 30, 2005; and from 650 at March 31, 2006.

On a consolidated basis, annualized sales productivity for the second quarter increased year-over-year by 6%. This was due largely to productivity gains in our large account segment. In this segment, sales productivity increased 29% from the second quarter of 2005. In our public sector segment, sales productivity decreased by 2% driven primarily by a 5% decrease in our federal sales productivity and a 2% decrease in our state and local government and education sales productivity. Sales productivity in our SMB segment decreased year-over-year by 5%, mostly due to the additional number of new hires that joined PC Connection in Q2 2006.

Now onto product sales trends. Notebooks and PDAs continue to be the largest-selling product category, accounting for 18% of total sales, with desktops and servers at 13.7%. The highest growth category this quarter were software and accessories, increasing more than 21%.

Average selling prices, or ASPs, for computer systems decreased during the quarter by 3% compared to the second quarter of 2005, and decreased by 4% compared to the first quarter of 2006. The year-over-year decrease resulted from a 9% decrease in desktop ASPs, an 8% decrease in server ASPs, and a 7% decrease in workstation ASPs. The sequential decrease in ASPs resulted from a 9% decrease in desktop ASPs, a 16% decrease in server ASPs, offset by a 12% increase in workstation ASPs. Notebook ASPs were largely unchanged from both the second quarter of 2005 and the first quarter of 2006.

Declining ASPs required our sales company to generate higher unit sales to sustain our revenue growth in these categories. Notebook revenues increased 15% on a 17% increase in unit sales compared to the second quarter of 2005. The desktop revenues were flat year-over-year on a 9% increase in unit sales. Revenues from server sales increased 13% on a 22% increase in unit volumes compared to the second quarter of 2005.

And now, Jack Ferguson will discuss our balance sheet and cash flow in more detail. Jack?

Thanks, Pete. Cash flow generated from operations for the six months ended June 30, 2006 was $5.4 million compared to $23.5 million for the prior year period. This decrease was due primarily to a decrease in accounts payable during the first half of 2006 compared to an increase in payables during the comparable prior year period. The higher cash flow in 2005 also resulted from a larger reduction in the inventory during 2005 compared to that occurring into the first half of this year.

As for the balance sheet, accounts receivable as of June 30, 2006 increased by $38.2 million to 161.9 million compared to the June 30, 2005 balance. This was due to increased sales, particularly in the last month of the quarter. Days sales outstandings, or DSOs, increased to 44 days from 41 days as of June 30, 2005, but decreased slightly from 45 days as of March 31, 2006.

Inventory balances were reduced by 7.7 million to 67.7 million at June 30, 2006 compared to the December 31, 2005 balance. Continued focus on supply chain initiatives and inventory aging contributed substantially to the improvement in our inventory turns. Inventory turns this quarter improved to 23 turns compared to 19 in the second quarter of 2005 and 20 turns in the first quarter of 2006.

Net sales of products drop-shipped by distributors and other vendors directly to customers reached its highest level in Company history. These sales accounted for 51% of total net sales in the second quarter compared to 42% in the second quarter of last year. Both our federal government and large account businesses primarily use drop shipping to meet their demand.

Based on quarterly levels, inventory days improved to 17 days at June 30, 2006, compared to 18 days at June 30, 2005. We believe inventories are in excellent condition, both in quantity and in quality. In summary, the balance sheet remains very healthy.

We will now entertain your questions. Operator?

(OPERATOR INSTRUCTIONS) Brian Alexander, Raymond James.

I think you're the third direct marketer to have very strong gross margins this quarter, which is interesting in light of a lot of the pricing issues out there in the market place -- particularly Dell getting more aggressive, apparently, and obviously seeing their margins erode. So I can't remember the last time we have kind of seen such a divergence between margin trends.

The question would be -- you laid out a number of different reasons for why your gross margins were strong this quarter. I'm just wondering if there's any way to quantify how much of each of those contributed? I think you said product margin, vendor consideration, services, and then also more software sales. Just give us a sense, either in magnitude or directionally, how much each of those contributed, and how sustainable you think those favorable variances are over the next few quarters?

Hi, Brian. This is Steve Baldridge. Though we continued to take market share during the second quarter, we were also focused on growing the business profitably. Our gross margin rates did improve sequentially and year-over-year in all three of our sales segments. And on a consolidated basis, our gross margin improved 92 basis points over the second quarter of 2005.

There are primarily four reasons for our 92 basis point margin rate improvement in Q2. First is higher invoice margins. Second is the increase in vendor consideration. Third is the emphasis on higher attachment sales of both services and companion products. And fourth is the larger software referral fees, primarily Microsoft.

To go back and help you quantify the 92 basis point improvement, services contributed approximately 14 basis points of the year-over-year improvement. The software referral fees resulted in 9 basis points of year-over-year improvement. And the remaining 69 basis points is a combination of invoice margins, mix, and vendor consideration, with the latter being the largest percent of that.

So, Steve, how sustainable -- just to take the vendor consideration, since it sounds like that's the largest. Was there any particular vendor that offered unusually attractive incentives this quarter? Was it across a broad spectrum of vendors? I'm just trying to get a sense for whether this is one time in nature, or if we should expect this going forward, particularly in light of -- just to throw a vendor out there, I know HP has made some changes to their programs. Did that help you, for example?

No, it was a broader range of vendors, I think, Brian that contributed to our vendor consideration left in the quarter. Definitely HP, one of our larger partners, contributed, but as did Lenovo, IBM, Lexmark, and other key vendors during the quarter. So our expectation and belief is that we'll continue to take market share in take it profitably.

Just back to the HP, I know there was some concern in the channel about how their programs would -- particularly changes in the Attach Plus would effect direct marketers. So it sounds like that's had a positive impact on your business?

Brian, this is Pete Cannone. It absolutely has. One of the things that -- when HP announced the program, that we were pleased with -- it aligned with our overall strategies and our focus on attachment. So I think we aligned well with that, and we're maximizing that program.

Great. And just to follow-up on the Microsoft, I think there's been also a lot of strength in renewal activity and enterprise agreements this quarter. Do you think that will carry over into Q3 and Q4? And kind of help us understand what is driving that activity as we head into Vista. Should we think about this as customers are -- rather than engaging in new hardware purchases potentially -- when Vista comes out, they would rather enter into enterprise agreements and then load the software onto the existing hardware that they have?

This is Steve Baldridge. I will make a high-level comment and let Pete jump in. If you look at our software category, sales category for Q2, software sales were up approximately $10 million year-over-year. Over half of that increase related to Microsoft. And the remainder related Adobe, Symantec, and some of the other software vendors.

Brian, this is Peter. Just to build on what Steve is saying, what you're seeing right now with Vista -- Vista is not planned to come out until the end of this year for the business customers, and then the consumer in the first of 2007. Obviously, we are understanding that Vista is going to require some hardware upgrades. We don't see that impacting us right now. I think what you're seeing is just the businesses doing their upgrades, doing their renewals, continuing on. We plan to across all three of our sales companies to continue to take market share and work with our customers and service them and all their software needs.

I guess my question is what would be the incentive for businesses to engage in these software license transactions today if their intent is to effectively upgrade their hardware -- maybe it's a year from now? And in doing so, they would basically be getting the software at that time? So why would they be entering into these agreements today if they plan to upgrade in a year?

Well, some of it, Brian, is obviously the renewals. Their anniversary dates are coming up, and we need to renew their software licensing. We also -- Microsoft and some of our partners -- their software assurance program that allow the customer as an insurance policy to -- through software assurance to renew their license, and then when the new product comes out, the customer will be moved into the new product, the new offering.

So the customer continues to need to do business and continue to renew their software needs. So I would just say as part of doing business and the software assurance -- we just will continue to renew their licenses. And I don't think overall, they will continue to just keep doing us. And as far as the software goes, the Microsoft -- Vista is planned for the end of this year. So we're hopeful that happens. But if it rolls into 2007, the customer has got to continue with their software needs.

(OPERATOR INSTRUCTIONS) [Jack Pitts], [Steadfast Financial].

Thanks, I was wondering if you could explain a little better the division of revenues between small and medium-sized businesses, government, and large corporate accounts. It doesn't seem like there's any predictable trends there. The revenues seem to be all over the place. Is that because of your kind of shifting from one area to another the definition? Or is it really just that lumpy for each category?

This is Pete Cannone. The way our Company works is we have three sales companies that focus on each of the marketplaces. Our larger account segment focuses on the enterprise space. Our SMB segment focuses on SMB. And GovConnection focuses on the government space. We're very focused and were very tactical and targeted in the marketplaces we worked there, go after -- we work with our partners.

I don't think -- what you have seen is our ability to respond to that certain marketplace and the buying habits of those customers. So as far as our ability to leverage each of those spaces, the enterprise space we did a very good job. Across all subsidiaries, we continue to do a very good job in gaining market share and leveraging opportunities.

Okay, I guess that doesn't really help me. I'm trying to figure out after the Amherst acquisition, which seemed to add roughly 25 to $30 million per quarter starting in the December quarter -- if you took a look at the difference between December '05 and September '05 quarters, it looked like most of that went to small and medium-sized business. And yet, year-over-year this quarter, you have had a giant massive increase in your MoreDirect business or your large corporate accounts. And yet, I didn't really hear any explanation of that on the call. I mean, obviously there's a giant trend there -- or either that, or you kind of shifted the definition. So I was just trying to figure that out.

This is Steve Baldridge. Let me try this. Historically, the sales mix in our three segments has been weighted approximately 60% to our SMB business and 20% for each of the remaining segments, our public sector and our enterprise large account group. And that has pretty much been the trend through 2004, 2005.

What you're seeing now in the first two quarters of this year is the change in mix as a result of the Amherst transaction that occurred last October of 2005. And that has generated, as you stated, additional sales in the quarter to our larger account segment, which is causing a mix change in terms of the percent of our large account business to our consolidated business.

In Q2, our large account business represented a little over 31% of our consolidated sales. Again, that was driven by the Amherst transaction. We have disclosed the impact of that Amherst transaction on our consolidated sales both in Q4 and in Q1, but because the Amherst transaction has been fully integrated into our large account segment, we're no longer breaking that out.

Okay, I guess I'm confused because the first quarter you integrated -- or you told us sales and then divided up between the three business lines, large corporate accounts was actually down by 18 million in December '05 from the preceding quarter. And it was also down year-over-year. And now were seeing the opposite even though we have had our third quarter of integrating that acquisition.

So I guess I'm a little confused because it seemed like Amherst added the small/medium-sized business and government rather than large corporate accounts, but now in this most recent quarter, it's all in large corporate accounts. So is Amherst -- just has some crazy seasonality between their three segments, or --? I guess I'm just trying to figure out where the growth is coming from in each segment.

Jack, this is Peter. I think what [we're] not following here is the Amherst acquisition was integrated into our large account segment, which is our MoreDirect company. The overall business was integrated. The lion's share of the business -- there was a little bit of business that was moved into our SMB space and our GovConnection sales company. But the large percentage of that business through that acquisition was integrated into our MoreDirect subsidiary.

So one of the things that we saw with the acquisition and through our organic large enterprise space was tremendous growth. And I think what you saw in Q1 and Q2 is our ability to integrate this acquisition and leverage those enterprise customers. The Amherst customer base when we acquired it was mostly an enterprise customer base.

And Jack, because of that Amherst transaction in our large account segment, in Q4 of '05, the sales increased year-over-year by 46%. In Q1, the sales in our large account segment increased by 42%. And then this quarter year-over-year the sales in that segment increased by 64%.

So again, the Amherst transaction has driven year-over-year increases in our large account segment. In addition to the base enterprise business that keeps expanding in terms of depth and breadth of its customer sale.

And then could you kind of help us understand -- since it looks like the gross margin improvement has a lot to do with the vendor considerations, what is kind of the scene behind why that is happening now? What are the OEMs -- in other words, what's the logic for them in kind of increasing those amounts?

Jack, this is Pete. There are a few factors. Some of that is just the investment that our manufacturing partners are making at PC Connection -- the realization from the manufacturing partners of our ability to leverage those investments and return ROI to those partners in all three of our sales companies.

Brian Alexander, Raymond James.

Yes, just one follow-up on the balance sheet. It looks like DSOs were up a bit from last year. I know you had stronger growth in the large corporate segment. But if you could just kind of talk about DSOs (technical difficulty) please?

This is Jack Ferguson. DSO is often a function of the timing of the sales in the quarter. And certainly in Q2 of '06, we had a very large amount of sales in the month of June, and that typically, those sales would not have been collected at the end of the quarter. And that generally drives up the DSO calculation. And I think there was a greater extent of that in this quarter than there have been in prior quarters.

Where would you expect to see that trend over the next couple of quarters? Would you expect it to be back down in the low 30s?

I don't know if we've ever gotten to the low 30s before. I think we're trying to get it back down to just 40 or thereabouts -- 40 to 41. That's our goal, certainly.

Right, I think you calculate it differently in terms of excluding net sales, etc.

Just to follow-up on the large corporate -- I mean follow-up on the last question; you had a huge acceleration year over year, which probably is not explained by Amherst. And I know you're not breaking it out. But we're hearing from a lot of your vendors and other companies in the industry that, if anything, large enterprise spending may have slowed in the June quarter, and particularly in the month of June, but you didn't see that.

So if there's any way you can could give us more color on why your large segment was so strong in the second quarter, whether there was one unusually large deal that got booked in the quarter -- kind of help us understand what products are leading to that strength, etc. -- that would be helpful.

Brian, this is Peter. I think that what we saw in our large account business is both existing and new customers. We were able to win several opportunities both in our organic business, as well as new customers that we brought on. The product mix -- we saw tremendous growth in our storage servers -- some of the more enterprise, higher-end enterprise space -- our services business.

I think one of the things we have been able to leverage over the first six months of this year is our ability to get wider and deeper in our existing customers and really get the value of what our solutions are for new customers. So there was not just one deal. There were several large opportunities that our MoreDirect sales organization were able to procure. I am aware of what some of the feedback in the industry has been about some of the demand question. We look at it right now as that we want to continue to take market share, and we want to continue to stay out in front of every opportunity that is out there in the enterprise space.

And I guess just finally, I know you don't give guidance, but as we look at trends basically through the end of July, from an overall demand perspective, have you seen any changes from what you just reported?

Brian, this is Peter. We haven't seen -- we came out of Q2 with strong demand, and we continue to take market share. And that's what our mission is across all three of the sales companies. That's pretty much all I'll comment on that.

(OPERATOR INSTRUCTIONS) At this time, it appears there are no further questions. For any additional or closing remarks, I'd like to turn the program over to Patricia Gallup, Chairman and CEO.

Again, we are pleased with the Company's overall progress during the second quarter. Our record quarterly sales of $408 million were the highest in the history of the Company. Our earnings per share doubled year-over-year to $0.12, and we continue to focus on our gross margins, which improved in all three of our business segments.

To achieve these positive results, we have a lot of people working hard every day. And I would like to thank and congratulate them. We also thank our loyal customers and our vendor community for their business, and for being part of what makes PC Connection a success.

Thank you for your interest and for being on this call this morning. Have a great day.

This concludes today's conference. You may disconnect your line at any time.