PC Connection Inc (CNXN) 2006 Q3 法說會逐字稿

Good day everyone and welcome to the PC Connection Third Quarter Earnings Results Conference Call. Today's call is being recorded.

At this time I would like to turn the call over to the Vice President of Finance and Corporate Controller, Mr. Steve Baldridge, VP of Finance and Corporate Controller. Please go ahead sir.

Thank you, and good morning, everyone. This is Steve Baldridge, VP Finance and Corporate Controller. Pat Gallup, Chairman and CEO; Jack Ferguson, Senior Vice President and CFO; and Pete 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 third quarter conference call. If you haven't 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'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 Risk Factors in the company's quarterly report on Form 10-Q for the quarter ended June 30, 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, Pat Gallup, for her remarks on our quarterly results. Pat?

Good morning, everyone, and again, thank you for joining us. Today we announced net sales for the third quarter 2006 increased $44.1 million or 11.9% to $415.2 million from $371 million for the third quarter 2005.

Consolidated sales for the quarter were the highest in the Company's history. The 11.9% year-over-year increase was due to strong demand in the SMB and large enterprise markets and the positive effects of Amherst transaction that occurred in October 2005. The third quarter of 2006 included sales generated by former Amherst employees who joined our organization.

Net income for the quarter was $4.4 million or $0.17 cents per share compared to $1.9 million or $0.08 per share for the prior year quarter. As stated in our press release, the quarters ended September 30, 2006 and 2005 included special charges. The 2006 charges were related to tentative settlement with the DOJ of our previously recorded 2003 GSA audit matter and the 2005 charges related to the management restructuring. Had these charges not been incurred, pro forma net income for the current year quarter would have been $5 million or $0.20 per share compared to $2.5 million or $0.10 per share for the prior year period. Our press release includes a reconciliation of these pro forma amounts.

We experienced 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 $17.8 million or 8.8% from the third quarter of 2005 to $221.3 million. We continue to execute on our customer acquisition strategies. We are acquiring new SMB customers while simultaneously increasing gross profit margins. In Q3 alone, we increased our active SMB customer base by more than 8% on a year-over-year basis.

Sales to large corporate account customers, our large account segment, increased $33.3 million or 41.4% to $113.7 million from the corresponding period a year ago. In addition to the integration of the Amherst business, our large account segment continues to experience strong demand from both our existing and new customers.

Sales to government and education customers, our public sector segment, was down by 8.1% from the third quarter of 2005 to $80.2 million. Revenue declined in the quarter as a result of management's decision to focus on higher margin sales opportunities. However, despite this year-over-year decrease in sales, our public sector team achieved an 8.6% increase in gross profit dollars compared to the prior year period.

Consolidated gross profit dollars increased over the third quarter of 2005 by $9.1 million or 21.5% due to increases in both sales and gross profit margins. Gross margin increased year-over-year by 100 basis points to 12.3%. Q3 was our third consecutive quarter in which we achieved gross margin improvement in all 3 business segments. This accomplishment resulted from higher customer invoice margins, increased vendor consideration, increased service revenues, and larger software referral fees.

Total SG&A expenses increased $5.8 million year-over-year in the third quarter of 2006. As a percentage of sales SG&A expenses increased to 10.4% in the quarter compared to 10.1% for the third quarter of 2005. This increase was primarily attributable to increased personnel costs associated with our Amherst transaction, increased variable compensation expense resulting from our gross profit growth, incremental operating costs associated with our new Texas sales office, and continued investments in our services business.

We continue to grow and invest in our services initiatives. These included the continued growth in service sales support from former Amherst service engineers who were 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] service offerings in our SMB segment through our service connection brand. We believe these incremental investments strategically position PC Connections to capture a larger portion of the services market moving forward.

We are pleased to report that income from operations for the quarter nearly doubled to $6.8 million, or 1.6% compared to $3.7 million or 1% for the third quarter of 2005; net income for the quarter increased by 128% to $4.4 million. Approximately $350,000 was due to the decrease in income taxes caused by changes in the Company's tax filing status in certain States, which reduced our effective tax rate.

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'd like Pete Cannone to make some additional comments on our sales segments and the trends in their respective markets. Pete?

Thanks Pat; over the past several years our Company has worked very hard to establish effective sales subsidiaries to grow its customer base. Our separate sales subsidiaries focus on the customer market place based on organizational type, size, vertical industry, as well as geographic location. This sales model continues to work well for us and has aided in our ability to foster even closer relationships with our vendor partners.

Two keys to our revenue growth are the stability and growth of our sales force, as well as sales productivity. Our total number of sales representatives increased by 93 to 678 as of the end of Q3 2006, up from 585 at the end of Q3 2005, and from 659 at the end of Q2 2006.

On a consolidated basis, annualized sales productivity for the third quarter was large unchanged year-over-year, primarily due to the addition of a new call center. Decreases in both our SMB and public sectors productivity were offset by an increase in our large account segment. Average sales productivity in our SMB segment decreased yea-rover-year by 4% due primarily to the additional number of new hires that joined PC Connections at our recently-opened Texas sales office.

In our public sector segment, sales productivity decreased by 8% primarily as a result of our decision to focus on higher margin [inaudible] sales. In the large account segment sales productivity increased 12% from the third quarter of 2005 due to the strong demand from both our existing customers as well as new accounts.

Now onto product sales trends; notebooks and PDAs continue to be the largest-selling product category, accounting for 17.4% of total sales, with video imaging and sound at 13.8% and desktops and servers at 13.6%. The highest growth category this quarter was video imaging and sound, Netcom products, and accessories and other.

Declining selling prices for LCD monitors is driving our growth in video product sales. Average selling prices, or ASPs, for computer systems decreased during the quarter by 7% compared to both the third quarter of 2005 and the second quarter of 2006. The year-over-year decrease resulted from a 14% decrease in notebook ASPs, offset by a 24% increase in work station ASPs. The sequential decrease in ASPs resulted from a 14% decrease in notebook ASPs, offset by a 17% increase in work station ASPs. Desktop and server ASPs were largely unchanged from both the third quarter of 2005 and the second quarter of 2006.

Declining ASPs required our sales company to generate even higher unit sales to sustain our revenue growth in these categories. Notebook sales were largely unchanged, increasing 1% compared to the third quarter of 2005 on an 18% increase in unit sales. Desktop sales increased 5% year-over-year on a 5% increase in unit sales. Server sales increased 7% on a 9% year-over-year increase in unit volume.

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 9 months ended September 30, 2006 was $19 million compared to $10.6 million for the prior year period. This increase was due primarily to our doubling of net income as well as a decrease in accounts receivable in the 2006 period compared to an increase in receivables in the prior year period.

Capital expenditures were generally comparable year-over-year in these 9-month periods and except for the final payment in 2005 of our acquisition earn-off obligation, cash used for investing activities was also generally comparable. The primary changes in cash flow from financing activities relates to the ongoing borrowings and repayments under our bank line of credit.

As for the balance sheet, accounts receivable as of September 30, 2006 increased by $10.4 million to $159 million compared to the September 30, 2005 balance. This increase was due to increased sales. Days' sales outstanding, or DSOs, improved year-over-year to 43 days this quarter from 46 days as of September 30, 2005; DSOs improved sequentially for 44 days as of June 30, 2006. Inventory balances decreased by $6.9 million to $68.4 million at September 30, 2006 compared to the December 31, 2005 balance.

Increased sales of products drop shipped directly to customers and reduced inventory aging contributing substantially to the improvement in our inventory turns. Inventory turns this quarter improved to 22 turns compared to 20 in the third quarter of 2005, a decrease from 23 turns in the second quarter 2006. Net sales of products drop shipped by distributors and other vendors directly to customers accounted for 49% of total net sales in the third quarter compared to 43% in the third quarter of last year. Shipments to our large accounts and federal government customers are primarily drop shipped to meet their demand.

Based on quarterly levels, inventory days improved to 17 days at September 30, 2006, versus 19 days at September 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.

Thanks; can you -- last quarter I think you guys provided pretty helpful breakdown of the gross margin improvement you saw year-rover-year. If you can go over that again for this quarter in terms of the components of gross margin and how much each contributed on a year-over-year basis; and then my follow up would be on SG&A, looks like despite a modest increase in revenue sequentially, SG&A was down over $1 million. I was just wondering what drove that.

Hi Brian, this is Steve Baldridge. On your gross margin question, we were pleased with the year-over-year margin improvement of 100 basis points reflecting the continued improvement in all 3 of our business segments. The accomplishment resulted from 4 focal points; number 1, we increased vendor consideration in all 3 business segments. This accounted for approximately 55 basis points of the improvement in margin; number 2, we experienced larger software referral fees, contributed about 22 basis points of the year-over-year improvement; number 3, higher customer invoice margins, 9 basis points improvement; and 4, increased service revenues in our MoreDirect customized services team and the SMB managed or SKU-able services offerings through our Service Connection brand, approximately 3 basis improvement.

So thanks, very helpful Steve; could you follow up, or could I follow up on the first 2 of those? The vendor consideration and the software fees, could you just talk about the sustainability of both of those? I know that this has been sort of a heavy 2-quarter period for Microsoft renewals. Is that something we should expect to drop off significantly in the next few quarters?

And on the vendor incentives, I think you've cited this for the past 2 quarters, and I'm trying to get a sense for whether this is PC Connection specific in your opinion in terms of getting additional funding or if you think this is more direct-marketer channel specific; in other words, are your vendors allocating more funding to your specific channel, and if so why do you think that is?

Brian this is Steve; let me start off by saying I think on software referral fees, clearly in Q2 and Q3 we experienced large referral fees. As to how we've accomplished that, I'll let Pete maybe speak to that in just a minute. And on the consideration, vendor consideration, we have had a very strong year so far in terms of focusing on maximizing the programs that the vendors have made available to us. We've worked hard to grow our business with our vendors and have received appropriate consideration for doing that.

So I think Brian it's a combination of our focus and execution in maximizing the programs that are available, and secondly as we outperform the market relative to our market growth, I think companies are rewarded for doing that in the extent of consideration they receive.

I think finally, the product certifications that we continue to obtain in our professional services group also helps us in terms of adding incremental programs.

I'll let Pete talk to the Microsoft piece.

Yes, hi Brian; just a couple of comments, jut to build also on what Steve was saying that when you also look at our sales subsidiaries I think that we're working very closely with our vendor partners as our ability to go to the market with a specific customer segment as I mentioned, whether it's large enterprise, SMB, or government, that provides a more focused strategy for our vendor partners and I think they really like that.

In regards to Microsoft, of the things that I want to just point out; when we acquired Amherst last year, one of the things that we brought over to our MoreDirect large enterprise subsidiary was Microsoft EA expertise. And I think one of the things that's happened over the course of this year is that our MoreDirect team, our large enterprise team has been able to leverage that expertise and add resources so we continue to expand our Microsoft business across our enterprise market place.

As far as what we see going forward, I think yeah, it has been a very crazy time as far as upgrades, but with Vista coming in November, in January, I see that that Microsoft business probably will stay pretty healthy over the course of the next quarter or couple of quarters.

Okay so I guess 2 follow-ups; one I think still the expense question in terms of what drove the sequential OpEx decline and then it sounds like you're fairly confident that gross margins overall can hold above 12%.

We are confident that we will continue to execute in maximizing all the vendor consideration programs and focus I think Brian on growing the business profitably. But we'll give no forward guidance relative to our margin rate in Q4 and beyond.

As to your SG&A question, we're pleased with our ability to continue to reduce our SG&A rate sequentially through this year while we continue to make investments in the business. The sequential reduction in SG&A that you referred to from Q2 to Q3 of this year was primarily driven by reductions in our personnel expense and specifically some of the, our management of medical costs and other benefit costs, in addition to our continued focus to improve efficiency in our organization.

Okay and then final one; I mean, it seems like you guys have righted the ship, so to speak, you had a few solid quarters in a row here. Just curious why not give guidance for Q4 at this point?

I think that's a determination that we would probably not make until after year-end. I think it's a little awkward to begin giving guidance within the middle of the year. I think we'll take that under consideration in certainly, maybe in future quarters, but we're not ready to say we'll give guidance yet.

Okay thanks a lot.

[OPERATOR INSTRUCTIONS].

[Vic Kamar], Soundpost Partners.

Hi guys, good morning; couple of question for you, one actually a follow-up to the previous questioning; so do you see your SG&A's sequential improvement, do you see that continuing? Is that what we're going to be seeing going forward, the reductions in personnel expense and management and medical costs, etc.? Is that sustainable?

We would prefer not to give any forward-looking guidance, but historically, the trend has been to see reducing personnel or SG&A expenses as a percent of sales. Historically also, we've seen a very solid Q4 in terms of sales performance, so with our focus to maximize efficiency and hold SG&A, historically there's been a tendency for the rate to be reduced.

Okay; my next question is around, so you guys had an 8% decrease in revenue in the public segment. Do you see that sort of -- could you give us some more color around that? Is that something that's going to continue going forward, or will that get worse or improve?

Hi this is Pete Cannone; when you look at our public sector business in Q3, one of the things that we decided, management decided is to stay focused on higher-margin opportunities. When you look at, there was a decrease in revenue in the public sector; however, there was an increase in our gross profit performance. And we're very focused on making sure that we're doing our business and acquiring new public sector customers in the most profitable manner. So we're going to stay focused on that strategy and initiative going forward and hopefully continue to grow our public sector business.

Okay last question; the tax rate I think for this quarter was a little bit lower than usual and I was just wondering if that is the expected tax rate going forward, or if it's different?

This is Jack Ferguson; there were recent changes in the Company's operations to enable us to file a consolidated or combined tax returns in certain States that resulted in a reduced tax rate in those States. Obviously, the changes took place in Q3 but as you know, the tax status applies to the entire year, so there was some catch-up adjustment in Q3. However, going forward, we still expect a slight decrease in future tax rates as a result of this change in filing status.

Okay great; those were all my questions. Thank you so much.

[OPERATOR INSTRUCTIONS].

[Karsix Trinavasin] [inaudible Capital].

Good morning guys; I was wondering if you could talk a little bit about the video segment. I know you experienced a rather significant uptick quarter-to-quarter. Could you just elaborate a little bit on what happened in that segment and what you might expect for Q4?

Hi, this is Pete Cannone; in the video segment what we saw was continued success in our monitors. There's quite a demand out there as far as 19" monitors. We continue in that business as far as you look at our overall growth in demand. Our selling organizations across all 3 subsidiaries are doing a very nice job making sure that they're attaching those video products, monitor products, 2 specific opportunities. I think going into Q4, we're obviously heading into the buying season, the close of the year; I see the video market place staying very healthy over the next quarter or so.

Okay great, thanks.

Jack Pitts, Steadfast Financial.

Hi, thanks for the question; I was just wondering if you could comment a little bit more on what's going on with the GovConnection, and I guess specifically it just seems like an interesting time period to have the sales be off a little bit; I was thinking maybe you might see some improvement there based on some of your competitors' strong performance in that specific sector.

This is Pete Cannone again Jack. First of all, thanks for the question; one of the things that we're really focused on in our public sector as I mentioned earlier was the profitable customer acquisition. So we stay very focused on that. We had a nice 8.6% increase in gross profit. But one of the things that I point you is that we're also out there working very hard to secure additional government contract vehicles. We announced a Brevard County, which is a large K-12 district in Florida, which is a significant win for GovConnection, and we continue to work those opportunities. And we're working those opportunities to make sure that they're profitable for GovConnection.

So we're working hard out there as far as making sure that we're going after the right government vehicle that will allow our GovConnection sales organization to sell in the most profitable manner and service the governments, federal and state local education customer base.

Do you think that's stabilized basically from your focus on higher margins that maybe that we kind of see some pretty good growth there in the future?

It's hard to give, I can't really give forward-looking statement; I don't really have a crystal ball to say what I can see. I want to think that I know that if we stay focused on what our strategy initiative is, as I mentioned earlier, and we can continue to generate better gross profit performance, we know the revenue will come along with it and we'll work hard as far as making sure we get the right government vehicle contracts in place so we cal sell.

So it's hard to tell but we're working hard there.

Okay thanks.

Karsix Trinavasin.

Thanks; I had a couple of follow-up questions. One, on your corporate business and by that I mean the large corporation, your gross margins were up about 70 basis points quarter-to-quarter, and yet your sales were off I think about 11% quarter-to-quarter. I'm just curious given the sales volume declines, how were you able to drive your gross margins up so much?

And then my second question is just in terms of the SMB segment, CDW has been pretty vocal about the fact that their sales force kind of realignment has caused them to miss some sales opportunities. Just curious if you feel like you've been able to capitalize on that and how sustainable that may be going forward?

Hi, this is Pete Cannone; let me comment first on our large enterprise business. One of the things when you notice the sequential, the 11%, one of the things going through the quarter-over-quarter is that our large enterprise business it also has, the selling cycles are a little bit longer. So it's not surprising to see that kind of demand coming in from quarter-over-quarter.

One of the things that our large enterprise business did very, very well in Q3 was they really were able to maximize the Microsoft business, as well as increasing higher margins on product categories such as Netcom and servers and storage. So when you point to the performance, you can point to the product mix and the software, the Microsoft business. But obviously throughout the course of the year large enterprise customers buying cycles' vary.

To comment on the second, our SMB business, I really don't like to comment on anything that's happening in the competitive landscape. What we're very focused on in our SMB market place is profitable customer acquisition, and we think we're doing some of the right things out there right now; we have a tremendous leadership team in all our subsidiaries; they're executing their initiatives and we're working closely with our vendor partners to hopefully continue to grow our SMB market.

Great thanks.

[OPERATOR INSTRUCTIONS].

And it appears there are no further questions; I'll turn the call over the Pat Gallup for closing comments.

Thank you operator; again we're pleased with our record quarterly sales and doubling of earnings per share. To achieve these positive results, we have a lot of people working hard every day; I'd like to acknowledge their efforts. In addition, we thank our loyal customers and our vendor community for their business and for being part of that makes PC Connection a success. Thank you for your interest and for being on the call this morning; have a great day.

That concludes today's teleconference. Thank you for your participation.