PC Connection Inc (CNXN) 2007 Q1 法說會逐字稿

Good day and welcome, everyone, to the PC Connection First Quarter 2007 Financial Results Conference Call. This 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. Stephen 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're pleased to have you join us today for PC Connection's 2007 First 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 Web site. Today's call is also being webcast and will be available from PC Connection's Web site.

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 annual report on Form 10-K for the year ended December 31st, 2006, which is now 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 our 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'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 thank you for joining us. Today, we announced net sales for the first quarter 2007 increased $17.7 million or 4.7% to 398.2 million from 380.5 million for the first quarter 2006. The year-over-year increase was due primarily to the 6.8% growth we experienced in our small and medium size business segments.

Our large account and public sector segments experienced nominal year-over-year sales growth this quarter, due to the high level of Q1 2006 sales in our large account segment, which resulted from our Amherst Technologies acquisition and from our increased focus on improving margins in our public sector.

Net income for the quarter essentially doubled year-over-year to $3.4 million or $0.13 per share compared to $1.7 million or $0.07 per share for the prior year quarter. Earnings per share for the first quarter of 2007 are our highest first quarter earnings since 2001.

I'll begin by commenting on our SMB segment, our original core business. Net sales increased by $14.8 million or again, 6.8% from the first quarter of 2006 to 233.9 million. Corporate outbound sales for the quarter grew 11.3% year-over-year while consumer sales decreased.

With our focus on a commercial account growth, the consumer business represents a decreasing component of our business. The double digit growth in our corporate outbound sales demonstrates our success in penetrating existing accounts and adding new customers to our base. We are pleased with the efforts of our business development managers in driving new business and with the progress of our technical support specialists, who are partnering with our sales force to provide complex IT solutions.

Sales to large corporate account customers, our large account segment, increased $2 million or 1.8% to $110.3 million from the corresponding period a year ago. In the first quarter of 2006, we experienced pent up demand due to the Amherst Technologies acquisition and project rollouts with a number of key accounts. Accordingly, we anticipated the lower year-over-year sales growth this quarter.

Sales to government and education customers, our public sector segment, increased by 1.8% from the first quarter of 2006 to $53.9 million. Revenues increased modestly in 2007 in the public sector, partly due to our increased focus on more profitable sales and capturing net agency sales. Agency transactions result in lower sales levels, but higher gross margin rates.

Consolidated gross profit dollars increased in the first quarter of 2007 over the first quarter of 2006 by $3.5 million or 7.5% due to increases in both sales and gross profit margin. Gross margin increased year-over-year by 34 basis points to 12.5%.

As advertising programs we develop with our vendor partners become more comprehensive, it is more practical to record substantially all vendor consideration as a reduction of cost of goods sold and inventory. Accordingly, we recorded approximately $1.9 million of additional consideration in the first quarter of 2007, which accounts for a 48 basis point increase in our 2007 gross margin.

SG&A expense as a percentage of sales was up slightly to 11.1% for the quarter compared to 11% for the first quarter of 2006. Total SG&A expenses increased $2.2 million or 5.3% year-over-year in the sector segment in the first quarter of 2007. The increase was primarily attributable to the recording of additional vendor considerations discussed earlier, which increased SG&A expenses by approximately $1.9 million.

Additionally, the incremental operating costs associated with our new Texas sales office were generally offset by lower professional fees and bad debt expense in Q1 2007 compared to Q1 2006.

Income from operations for the quarter increased 60% to $5.7 million or 1.4% of net sales compared to 3.6 million or .9% for the first quarter of 2006. Net income for the quarter essentially doubled to $3.4 million compared to $1.7 million for the 2006 first quarter.

Annualized average sales productivity for the first quarter increased on a consolidated basis by 2% year-over-year. Productivity gain in our large account segment was in part offset by decreases in our public sector segment.

In the large account segment, sales productivity increased 19% from the first quarter of 2006, primarily due to a decrease in headcount of sales representatives. Due to a larger number of new hires in 2006 in our pubic sector segment, average sales productivity decreased by 3%.

Overall productivity in our SMB segment was level year-over-year, due primarily to the new hires that joined our Texas sales office in the latter half of 2006. Excluding the effect of this new call center, SMB productivity increased 11% year-over-year.

Now, onto product sales trends. Notebooks and PDAs continue to be the largest selling product category, accounting for nearly 19% of total sales. Desktop and server sales accounted for 15% and software products and video imaging and sound each accounted for 12%. The highest growth category in this quarter was notebooks and PDAs, growing 14% year-over-year from the first quarter of 2006, reflecting industry demand for these products.

Average selling prices, or ASPs, for computer systems was largely unchanged in Q1 2007 compared to the first quarter of 2006, but increased sequentially by 2% over the fourth quarter of 2006.

Notebook revenues increased 14% compared to the first quarter of 2006 on a comparable increase in unit sales. Desktop revenues decreased 5% year-over-year due to a 2% increase -- decrease in unit sales and a 4% decline in ASPs. First quarter sales were level with 2006 dollars as a 3% decrease in units was offset by higher average selling prices.

We continue to grow and invest in our services initiatives. Sales of services increased 22% year-over-year in this quarter. This growth reflects the continued development of managed or skewable service offerings in our SMB segment through our Service Connection brand, continued growth in custom service sales from our MD Professional Services Division and through partner referrals, increased product certification, which enable us to promote higher margin solution selling and provides 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 recently launched a new redesigned business-to-business Web site. Customers can now more efficiently receive quotes, place orders, manage approvals, track shipments and generate purchase orders. This site also supports a wide range of popular [EPUTS] unit applications, enabling us to integrate slowly with systems that our current and prospective customers already have in place.

We will continue to monitor our operating cost and review our spending plans and programs to enable the best possible allocation 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.

Accordingly, as we have stated in past calls, we continue to evaluate opportunities in a consolidating market and will consider acquiring additional businesses with complimentary 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 quarter ended March 31, 2007, was $5.9 million compared to 5 million for the prior year quarter. The majority of this increase was due to our increased earnings in 2007. In both 2007 and 2006, decreases in receivables, inventories and payables largely offset each other.

Capital expenditures were generally comparable year-over-year. Cash flows from financing activities in 2007 benefited from proceeds received from the exercises of stock options, as well as our ability to forego borrowings on our bank line of credit in the first quarter of 2007. In 2006, cash flows from financing activities were impacted by net repayments of $4.8 million on our bank line of credit.

As to the balance sheet, accounts receivable as of March 31, 2007, decreased by approximately $24 million to 146 million compared to the balance at December 31, 2006. We attribute this decreased to our improved collection efforts. Days sales outstanding or DSOs improved to 42 days of March 31, 2007 from 45 days as of both March 31 and December 31, 2006.

Inventory balances decreased by $2 million to 67.4 million at March 31, 2007 compared to the balance at December 31, 2006, but increased by 6.3 million compared to the March 31, 2006 balance, due to higher amounts of inventory in transit to our customers.

Inventory turns improved to 21 turns in Q1 2007 from 20 turns we experienced in both the first and fourth quarters of 2006. We believe inventories are in excellent condition, both in quantity and in quality.

Net sales of products drop shipped by distributors and other vendors directly to customers accounted for 50% of total net sales in the first quarter this year compared to 48% in the first quarter of last year. Increased drop shipments allow us to maintain lower inventory levels.

In summary, the balance sheet remains very healthy. We will now entertain your questions. Operator?

(OPERATOR INSTRUCTIONS.)

We'll go first to Brian Alexander with Raymond James.

Thanks. Good morning. I was just wondering if you guys could talk a little bit about the linearity you saw in the quarter. One of your major competitors saw a pretty big pickup in their business in March. And I just wondered if you saw anything similar in the month of March. If you could maybe talk about the different customer segments and if you noticed any changes as we went through the quarter. Thanks.

Hi, Brian. This is Tim. So, I think overall, the calendarization or the linearity was just about as we expected, fairly similar to Q1 of '06, March being the strongest quarter when you look at a quarter-to-quarter comparison. So, the linearity is just about as we expected.

Now, there is some slight seasonality to the business and you're aware of that. Historically, SMB has a strong Q1. Historically, public sector and enterprise are a little bit lighter in Q1 compared to other quarters. But, overall, we are on target and as we expected.

So, on a year-over-year basis, you didn't really see any major acceleration in growth in the month of March?

No, it was just as we had expected.

Okay. And then, just, if you could talk about the impact to gross margins on a sequential basis from the EIPF reclassification.

Sure, Brian. This is Steve Baldridge. The gross profit margin, 12.5% in Q1, as we mentioned, was up year-over-year 34 basis points. And 48 basis of that increase in margin was from higher amounts of vendor advertising consideration recorded in Q1 this year as a reduction of inventory purchases. And that increase was partially offset by decreases in our customer invoice margin.

On a sequential basis, if you were to adjust the 12.5% margin rate in Q1 by this additional vendor consideration, our gross margin rate sequentially still would have been approximately 3 basis points higher than Q4 of 2006.

Okay. And then, just, could you talk about your expectation for gross margins as we move throughout the year? Excluding this reclassification, are you still expecting gross margins to be up year-over-year for all of 2007?

Well, as you know, Brian -- this is Steve Baldridge -- we don't provide any earnings guidance. And I think as you look at the calendarization of our gross margin rate last year, we're not expecting any significant variances. We will continue to focus on growing the business profitably and would expect to continue to improve our gross margin rates through our partnership with our vendors and our focus on profitable sales.

And Brian, this is Jack. As you know, the different profit margins in our different segments will impact the overall margin. So, it also depends on the relative growth rates of each of those segments. And again, since we're not providing guidance on the growth of the segments, it's a little difficult to provide specific guidance on what those margins are going to be in the upcoming quarters.

And then, just finally, any updated views on Microsoft and its impact on your business in the first quarter and as we go throughout the year?

Hi, Brian. This is Tim again. No, with regards to Vista, we haven't seen a significant impact. We are optimistic about what Vista will bring throughout the year. But, there really was no significant impact to Q1.

Okay. Thank you.

(OPERATOR INSTRUCTIONS.)

We'll go next to Jeff Osher JMP Asset Management.

Yeah, hey, guys. I joined the call a little bit late. I was wondering if you could just repeat from the transcript what the benefit to gross margins was from agency and software referral fees.

Hi, Jeff. This is Steve Baldridge.

Hi, Steve.

On a consolidated basis, what we said is our gross margin rate was 12.5% in Q1, which was up 34 basis points year-over-year versus the first quarter of 2006 and that the impact in Q1 of '07 on the additional vendor advertising consideration that was recorded in the quarter was worth approximately 48 basis points.

I think last call, and I'm just -- if I remember correctly, you broke out in the transcript the gross margin impact or benefit from vendor considerations, as well as agency software referral fees.

Right.

I think, if my memory serves me right, which usually it doesn't, it was 52 BPs and 16 basis points of a benefit last quarter.

Correct. And I think what information we're providing this quarter is that the 34 basis points improvement in our margin rate in Q1 year-over-year was made up of an additional 48 basis points from incremental recording of advertising considerations from our vendors, offset in part by a reduction in customer invoice margins. And then, we saw just a little lift from agency fees and our service revenue.

So, again, substantially, the vendor consideration at 48 basis points offset slightly by the customer margins with a smaller lift in agency fees than services.

Okay. That's great. You're not going to break out like you did last quarter, though, what the agency and software referral fees were?

No. I think last year, the break out was because of the significant increases year-over-year in excess of 100 basis points. We thought it would provide a little more value with that break out.

Okay, great. And one last one. When did you start accounting for the vendor considerations as a reduction of COGs? Was that -- was this the first quarter you did that? No?

No. This Jack. Not at all. That was required, I think, first in 2003. But, you had the option or you had the ability to offset that consideration if you could match it with specific cost of advertising. That matching became more and more difficult over the years as the advertising program changed and became more comprehensive, such that we finally decided it was no longer practical to continue to try to match those costs with the vendor consideration. And so, as a result and pursuant to the EITF requirement, we simply put it up as an offset to cost of sales.

Okay, thanks. I guess, Jack, when did you start -- is this the first quarter -- when did you decide to make that transition?

Well, this was basically the transition for the remaining cost. We have continued to offset them in earlier periods, but not all of the cost or not all of the reimbursement.

Great. Thank you, guys.

Thanks, Jeff.

And there are no other questions at this time. I'll turn the conference back over to Patricia Gallup for any additional or closing comments.

Thank you, operator. Again, we are pleased with our significant increase in earnings and our healthy balance sheet. These results reflect the ongoing successful execution of our business plans and strategies. We will continue to seek opportunities to grow and strengthen our business.

In closing, we'd like to thank our customers and partners for their business, our employees for their time and effort and our shareholders for your continuing support. For those of you listening this morning, we appreciate your time and interest. Have a great day.

This does conclude today's conference. Thank you for your participation. You may disconnect.