PC Connection Inc (CNXN) 2006 Q4 法說會逐字稿

Good day everyone and welcome to the PC Connection Fourth Quarter 2006 Financial Results Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to the Vice President of Finance and Corporate Controller, Mr. Steven Baldridge. Please go ahead sir.

Thank you and good morning everyone. This is Steve Baldridge, VP of Finance and Corporate Controller. Patricia Gallup, Chairman and CEO; Jack Ferguson, Senior Vice President and CFO; and Tim McGrath, Senior Vice President, PC Connection Enterprises are also here with us today.

We are pleased to have you join us today for PC Connection's 2006 Fourth Quarter Conference Call. If you haven't already seen our press release, you can contact Janice Rush at 603-683-2322 and she will fax or email 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 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 Risk Factors in the company's quarterly report on Form 10-Q for the quarter ended September 30th, 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 rely on these forward-looking statements as representing our views as of any date subsequent to today.

I am now going to turn the call over to our CEO, Patricia Gallup for her remarks on our quarterly and annual results. Pat.

Good morning everyone and again thank you for joining us.

Today we announced that net sales for the fourth quarter 2006 increased $33.3 million or 8.3% to $431.9 million from $398.6 million for the fourth quarter 2005. Consolidated sales for the quarter were for the third consecutive quarter the highest in the company's history. The year-over-year increase was due to strong demand we experienced in the large enterprise market and our positive growth in the small and medium-sized business and public sector markets.

Net income for the quarter was $4.6 million or $0.17 per share compared to $11,000 for the prior year quarter. As stated in our press release, the quarter ended December 31st, 2005, included special charges. Had those charges not been incurred, pro forma net income for the prior year quarter would have been $0.8 million or $0.03 per share. We did not incur special charges in the fourth quarter of 2006. Our press release includes a reconciliation of the 2005 pro forma amounts.

We realized significant overall year-over-year sales growth during the fourth quarter. I'll begin by commenting on our SMB segment, which is our original core business. Net sales increased by $8 million or 3.6% from the fourth quarter 2005 to $235.1 million. Although consumer sales were generally unchanged year over year for the quarter, corporate outbound sales grew 7% year over year.

We continue to execute on our customer acquisition and penetration strategies by focusing on customer-driven IT solutions. We are acquiring new small and medium-sized SMB customers while simultaneously increasing gross profit margins.

In Q4 alone we increased our active corporate SMB customer base by more than 11% on a year-over-year basis. Sales to large corporate account customers, our large account segment, increased $20.2 million or 18% to $132.5 million from the corresponding period a year ago. In addition to the integration of the Amherst business, our large account segment continues to experience increased demand from existing customers.

Sales to government and education customers, our public sector segment, increased by 8.1% from the fourth quarter 2005 to $67.9 million. Revenues increased in the fourth quarter in both the federal government and state and local government and education markets.

Consolidated gross profit dollars increased over the fourth quarter of 2005 by $8.1 million or 18.6% due to increases in both sales and gross profit margins. Gross margin increased year over year by 100 basis points to 12%. Q4 was our fourth consecutive quarter in which we achieved year-over-year gross margin improvements in all three business segments. This was accomplished through stronger focus on increased customer invoice margins as well as improvements in vendor consideration, software referral fees, and service revenues.

Total SG&A expenses increased $2.5 million year over year in the fourth quarter of 2006. As a percentage of sales, however, SG&A expenses decreased to 10.2% for the quarter compared to 10.5% for the fourth quarter of 2005. The dollar increase was primarily attributable to increased variable compensation expense resulting from our gross profit growth, incremental operating costs associated with our new Texas sales office, and other variable support costs related to our revenue growth. The 2006 reduction in SG&A as a percentage of sales resulted from improved leveraging of our expense structure.

Income from operations for the quarter increased to $7.8 million or 1.8% compared to $0.9 million or 0.2% for the fourth quarter of 2005. Net income for the quarter increased to $4.6 million compared to breakeven for the 2005 fourth quarter.

On an annual basis, sales increased over 2005 by $191.4 million or 13.3% with growth in all three segments. Our gross profit growth at 22.4% was even higher than our revenue growth, reflecting a 90 basis point improvement in our gross margin rate. Again, we experienced gross profit and gross margin growth in all three segments.

Our operating income improved by $14.4 million or 152% to $23.9 million and our net income tripled to $13.8 million or $0.54 per share compared to $4.4 million or $0.18 per share in 2005.

Two keys to our revenue growth are the growth of our sales force as well as sales productivity. Our total number of sales representatives increased by 48 to 666 as of the end of 2006, up from 618 at the end of 2005.

Annualized average sales productivity for the fourth quarter decreased on a consolidated basis by 3% year over year. Productivity increases in both our large account and public sector segments were offset by a decrease in our SMB segment. Overall productivity in our SMB segment decreased by 11% due primarily to the new hires that joined our Texas sales office. Excluding the effect of this new call center, SMB productivity increased 2%.

In our public sector segment, sales productivity increased by 5% primarily as a result of an increase in our federal sales productivity. In the large account segment, sales productivity increased 18% from the fourth quarter of 2005 due primarily to increased demand we experienced from our existing customer base.

Now onto product sales trends. Notebooks and PDAs continue to be the largest selling product category, accounting for nearly 17% of total sales with desktops and servers at 14% and Video, Imaging, and Sound at 13%.

The highest growth categories this quarter were Net/Com products, storage devices and accessories and other. Net/Com sales grew by 25% year over year and both storage devices and accessories and other sales grew by approximately 11% year over year.

Average selling prices or ASPs for computer systems decreased during the quarter by 3% compared to the fourth quarter of 2005, but increased sequentially by 5%. The year-over-year decrease resulted from a 3% decreased in notebook ASPs and a 4% decrease in desktop ASPs, offset by a 2% increase in server ASPs. The sequential increase in ASPs resulted from a 4% increase attributable to both notebooks and desktops and a 6% increase attributable to servers offset partly by a 12% ASP decrease for work stations.

Notebook revenues increased 5% compared to the fourth quarter of 2005 on a 9% increase in unit sales. Desktop revenues increased 6% year over year as a 10% increase in unit sales was offset by a 4% decline in ASPs. Fourth quarter revenues from server sales increased 6% year over year due to a 4% increase in unit volumes and a 2% increase in average selling prices.

We continue to grow and invest in our service initiatives. These included the continued development of managed or [skewable] service offerings in our SMB segment and custom service referrals through our service connection brand; continued growth in service sales from our MD Professional Service Division; increased product certifications, which enable us to promote higher margin solution selling and provide access to additional vendor funding; and increased levels of sales training and promotion of services to our customer base. We believe these incremental investments strategically position PC Connection to capture a larger portion of the services market moving forward.

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 in systems, brands, and new customer acquisition programs to support our sales organization and grow our customer base.

We have stated in past calls we continue to evaluate opportunities in a consolidating market and will consider acquiring additional businesses with complementary corporate cultures that add new customers and talent.

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

Thanks Pat. Cash flow generated from operations for the year ended December 31, 2006, was $26 million compared to $9.6 million for the prior year. The majority of this increase was due to our increased earnings in 2006.

Capital expenditures were generally comparable year over year. In 2005, however, we also made the final payment of our more direct acquisition, earn out obligation and funded our Amherst transaction, affecting our cash flows from investing activities in that year. Cash flows from financing activities in 2006 were impacted by the repayments on our bank line of credit, partially offset by proceeds received from the exercise of stock options.

As to the balance sheet, accounts receivable as of December 31, 2006, increased by approximately $8 million to $170 million compared to the prior year end balance. This increase was fully attributable to our growth in sales. Days sales outstanding or DSOs improved year over year to 45 days at the end of this quarter from 47 days as of December 31, 2005.

Inventory balances decreased by $6 million to $69.4 million at December 31, 2006, compared to the prior year end balance. Net sales of products drop shipped by distributors and other vendors directly to customers accounted for a record 52% of total net sales for the fourth quarter compared to 47% in the fourth quarter of last year. Both our large account and federal government businesses primarily used drop shipping to meet their customers' demand.

Inventory turns this quarter were unchanged at 20 turns compared to the fourth quarter of 2005. Based on quarter end levels, inventory days improved to 17 days at December 31, 2006, versus 19 days at December 31, 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.

Thank you. [OPERATOR INSTRUCTIONS] We'll go first to Charles Siegel at Elazar Advisors.

Hi guys. Congratulations on a great quarter.

Thank you.

Thank you.

Just had a couple of questions. I was just wondering. I know you don't give much guidance, but how you feel about the growth rate potentially for next year? And also if you can talk about how demand was leaving the quarter, maybe starting the new quarter?

If you look at last year's Q1 sales of $380 million and we look at the adjusted market growth, year over year, at this point in the quarter we don't see any reason why we shouldn't grow in line with that suggested market growth. I'm not sure I can be more specific than that. Tim, maybe you have--

This is Tim McGrath. With regard to our demand, I think that what we saw exiting Q4, customer demand was solid exiting Q4 and really in line with our expectations.

Anything further Mr. Siegel?

I'm very good, thank you.

We'll go next to Brian Alexander, Raymond James.

Thank you. A few questions. First of all on the demand environment, there's been a lot of evidence that maybe the industry didn't see as much demand in Q4 in North America with growth decelerating primarily in the PC category. It doesn't seem like maybe you saw that. I just want to clarify and maybe ask the question as to why you think you didn't see that. And then Jack you mentioned the ability to grow at least in line with the market growth in Q1, what do you think the market growth rate is or what's kind of your benchmark?

Hi Brian, this is Steve Baldridge. As to the first part of your question on the IDC releasing the preliminary PC unit shipment results, we experienced very strong PC unit sales in Q4 and can't speculate as to the cause for any industry noted slowdowns.

As far as our understanding of the suggested market growth, and keep in mind this is year-over-year growth, is roughly around 6%.

Okay and is that in terms of customer segments, are you detecting any unusual strength or weakness in any of the customer segments or I guess the other way of asking is, do you expect growth to be pretty evenly distributed around that 6%?

Hi Brian, Steve Baldridge. At this point in the quarter, I think the growth will be pretty evenly distributed among our segments.

Okay and then moving on to margins Steve, you guys did a really good job in '06 raising the gross margin from 11.3% to 12.2%, so almost a 100 basis point increase. Some of the factors that probably helped you like software referral fees may not repeat necessarily in '07. I was wondering if-- like prior quarters, if you can maybe break out for the year the components of that gross margin increase and more importantly, the confidence level that you could sustain 12%+ gross margins going into '07 and through '07?

Sure. First let me speak about Q4 and then I'll chat about the annual margin improvement. In Q4, the fourth quarter was the fourth consecutive quarter in which we achieved year-over-year gross margin improvement and in all three business segments. The 100 basis point improvement we saw in the fourth quarter resulted from a stronger focus on increased customer invoice margins, which was 17 basis points of the 100 basis point improvement as well as improvements in vendor consideration, 52 points; agency and software referral fees, 16 basis points; and service revenues and other components of cost of goods sold, 15 basis points.

In terms of our annual gross margin improvement of 90 basis points between 2005 and 2006, it's a fairly similar theme, about 9 basis points of that year-over-year improvement was in invoice margin improvement; 49 basis points was with our vendor consideration programs; 23 basis points were with increased agency and software referral fees; and 9 basis points coming from our services and other factors affecting cost of goods sold.

So I guess your confidence level that you'll be able to sustain this level seeing that 23 basis points of the increase in '06 was related to software referral fees. It was part of that. And a lot of activity ahead of the Vista launch. I mean is that something that you would expect to sustain in '07? And then I guess a follow-on on the 49 basis points of vendor consideration, does that all reflect increased funding or are you shuffling vendor consideration from SG&A into cost of goods sold, which might explain part of that increase?

No those numbers would be before any change in the EITF transfer. We're talking about straight vendor consideration.

And I think Brian, this is Steve Baldridge, relative to 2007 we're not giving any guidance as you know on sales and profitability indicators. What we do know is that we had a consistent theme in 2006 and that was that each quarter we focused and executed and found ways to improve our margin rate. So we're hopeful that that momentum will carry into 2007.

And then my final question just on OpEx leverage, you've made a lot of investments in the business and quarter where we saw revenue growth outpace expense growth. Is that something you would expect to continue in 2007? And maybe more specifically, if we were to assume a given revenue growth rate, let's just call it 10% round numbers, how much incremental OpEx would you have to add to support that revenue growth considering that this is still more of a variable cost than a fixed cost model? Thank you.

Okay, this is Jack. Keep in mind that within a narrow range of say 10% sales growth, a good portion of our expenses are relatively fixed in nature. So we would expect to leverage our expense structure such that 10% growth in revenue, we would not expect SG&A costs to go above half of that rate or even less. And that's before implementing any cost saving initiatives. That's strictly on leverage alone.

Are there any cost savings initiatives that you're planning for 2007?

We continue to review all of our operations through system changes; process improvements; at the sales level, certainly sales productivity improvements; increasing order size. All of those factors we take into account and we're constantly reviewing our operating structure. So we will continue to do that in 2007 and would expect results from that.

And my final question on acquisitions, obviously you can't comment on unannounced activity but more strategically as you look at some of the deals that have happened in the sector over the last 12 months with CDW buying Berbee and Insight buying Software Spectrum, you know two different acquisitions, one service focused and enterprise focused one, more software focused. I guess strategically are you contemplating similar types of deals or are you more likely to look at other direct marketers whose business models are very similar to yourselves?

I think that we look at any valuation, any acquisition opportunity as how it would fit our particular company. And so I think we do on a case-by-case basis on an opportunistic basis. We're not tied to any particular acquisition schedule. And we would not acquire something if it wasn't accretive to earnings and complementary to our culture. So I don't think I can say any more than that. And just that there's no set schedule for doing this.

Maybe not a time line per say, but in terms of strategic importance, I guess maybe outline for us the characteristics of an acquisition that you're looking for, cause these are clearly strategic changes to both businesses, and I'm just wondering if that's something you think is necessary for your business?

Again I'd say that the-- I think it would be opportunistic. We'd look at each of our business segments and see how a particular acquisition might fit, not focusing on any one more than the other.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] We'll go next to Andre [Gardner] at Argus Management.

Thank you. Several questions. One is do you break out the internet portion of your sale-- that number, the percentage of sales that come in through the internet? Number two is the whole industry seems to be more competitive. If you look at some of your competitors, they're releasing or announcing better results. And is there some industry influences that are helping everybody, i.e. are vendors giving larger discounts? And I guess three is how much of your sales are repeat sales? And I guess fourth question is how much of your sales are drop shipments, where you just get the order and it-- and let's say with Hewlett Packard, they would ship the product for you?

Maybe I can answer the fourth one because I did make that mention in the-- in my comments. That's 52% in the fourth quarter were drop shipments.

Okay.

And this is Steve Baldridge. In terms of the percentage of our sales that are on the internet, let's say roughly a third of our sales are processed online through the internet. As to part two of your question on vendor consideration, our response throughout 2006 was really a sharper focus on our execution against the vendor consideration programs that are being offered and being successful in driving our performance to maximize the consideration that was available to us. We see vendors continue to link incentives with their strategic initiatives and a specific reseller performance. I think our vendor partners acknowledged our 13% year-over-year annual sales growth and reward upside performance for partners that help them growth their business.

Excellent. Well terrific quarter and thank you very much.

Thank you.

We'll go next to Stirling Levy at [Helm] Partners.

Hi guys. Thanks for taking my question. I do have a few and Tim congratulations on your promotion.

Thank you.

The first question is regarding gross margin. Overall for Q4 to compare to Q3, not a huge difference, down I think 20, 30 basis points. But if you look at gross margin by segment, there were some sharp changes, most notably in the large corporate segment. Your gross margins were down 70 basis points sequentially. And then in the government section, your gross margins expanded 110 basis points sequentially despite the drop in revenue sequentially. So I was hoping you could just give a little more color on why we see such volatility in the gross margins by segment?

Hi Sterling, this is Steve Baldridge. The sequential decline in gross margin rate from Q3 to Q4 was 30 basis points as you mentioned. And it was consistent with the sequential reduction we saw last year in the fourth quarter. I think the contributing or the factors contributing to the decline sequentially were lower margin rates on consumer sales sequentially along with lower software referral fees in the fourth quarter.

I think more specifically you mentioned our SMB business. The SMB gross margin rate sequential decline was from 13.3 to 12.9. And again that was due primarily to a reduction in invoice margin that can be attributed to the lower margin rate on consumer sales in Q4 versus Q3.

Our public sector, government margin rate sequentially did increase rather significantly from Q3 to Q4. That resulted from our senior team's continued execution on opportunities that provide us higher invoice margins. And additionally we had larger agency referral fee sales in Q4 versus Q3.

Our large account or enterprise segment's sequential margin rate decline was primarily a result of lower software referral fees and to a lesser degree a little smaller vendor consideration sequentially.

Got it. So it sounds like the big swings in large corporate and in the government or the public sector space were the software referral fees? One got less, one got more on a sequential basis.

Correct.

Got it. So does that mean in Q1 perhaps-- how should we think about the gross margins in Q1 for these-- for the large corporate and the government and education?

Well Sterling we're not giving any guidance on Q1. We're up against a historic margin rate of 12.2% as I recall in Q1. And again I think we need to manage this one quarter at a time and continue the momentum and execution that we had in 2006 as we start this year.

Got it. One more question if I could and thanks for the color on the gross margin. You talked about sort of the overall market growing about 6% in Q1. And you thought you sort of would be in line with the overall market. Last year in Q1 you did about-- and I think about your business more on a sequential basis than on a year-over-year basis, simply because you guys have made so many positive changes. And so I think sequential is better than year over year. My question is if you take a 6% growth rate off the $380 million from the first quarter of last year, you get about a $403 million Q1, which implies a down 7% sequential Q1. Is down 7% sequential in Q1, is that normal seasonality?

I'm not sure I can comment on the specific range of seasonality, but there is seasonality or there's cycles in our different segments. As you know the public sector segment the high of the cycles is in Q2 and Q3 whereas in the commercial business, they may tend to offset. I'm not sure Tim whether you could add to that?

Thanks Jack, this is Tim. I'd agree with Jack. Historically I think most folks understand the SMB and commercial sector tend to be in line with expectations and positive in Q1. A little more difficult for the large enterprise business that tends to have a higher ramp at the Q4 quarter. But definitely historically there is that reduction from Q4 to Q1 and it would be probably be more appropriate to look at the year-over-year increases from Q1 to Q1 and etc.

Got it. And then last question is Tim when you talked to your sales guys and when you talk to clients, how excited are people both your sales guys and your clients about Vista or Vista and what impact that might have on hardware sales in '07?

First just to clear up Q4, I'd say there was no substantial change or lift in sales or earnings from Vista in Q4. We are optimistic about the opportunity Vista brings to the entire industry for '07.

Got it. Thanks very much guys.

Our next question comes from [Carthig Shrinavosit] at Giovine Capital.

Yes, my questions were addressed by the last caller. Thank you.

And at this time, we have no further questions. I'll turn the conference back to Patricia Gallup for any closing remarks.

Thank you operator. Again, we're pleased with our record quarterly and annual sales and our growth in earnings per share. This year, 2007, marks our 25th anniversary, a milestone for any company. And I'd like to give credit to the people who helped us grow our business along the way; to our many loyal customers who have been with us over the years; to our vendor community and who supported us with great products and great promotions; to the investment community for your support; and especially to our employees who have worked so hard to make PC Connection a success. I thank all of you for helping PC Connection become the premiere supplier of IT products and solutions we aspired to be when we founded the company back in 1982.

For those of you listening on the call this morning, we appreciate your time and interest. Have a great day.

And that does conclude today's conference. Again thank you for your participation.