PC Connection Inc (CNXN) 2007 Q2 法說會逐字稿

Good day and welcome, everyone, to the PC Connection 2007 Second Quarter 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, Executive Vice President and CFO, and Tim McGrath, Executive Vice President Enterprise Group, are also here with us today.

We're pleased to have you join us today for PC Connection's 2007 Second 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 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 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 March 31, 2007, 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'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. Today we announced record net sales for the second quarter 2007, which increased $33 million, or 8%, to $441 million from $408.1 million for the second quarter 2006. All three of our sales segments achieved year-over-year sales growth. Our Public Sector segment led the way with a 17% increase, due primarily to increased sales made under recently awarded federal and state government contracts and agreements. Our Small and Medium-Sized Business and Large Account segments increased sales year over year by 8% and 4%, respectively.

Net income for the second quarter was $5.8 million, or $0.21 per share compared to $3.1 million, or $0.12 per share, for the prior year quarter. Both net income and earnings per share for the second quarter of 2007 represent their highest quarterly earnings in more than six years.

I'll begin by commenting on our SMB segment, our original core business. Net sales increased by $16.8 million, or 8%, from the second quarter of 2006 to $231.9 million. Corporate outbound sales for the quarter grew 14% year over year, while consumer sales decreased. With our continued focus on commercial account growth, the consumer business represents a decreasing component of our business. The double-digit growth in our corporate outbound sales demonstrates the success of our SMB sales representatives in penetrating existing accounts and adding new customers.

Sales to large corporate account customers, our Large Account segment, increased by $5.3 million to $133.6 million from the corresponding prior year quarter. Through our MoreDirect subsidiary's proprietary e-procurement solution, and their seasoned sales representatives, the Large Account segment continues to capture new customers, as well as a greater share of existing customers' business.

Sales to government and education customers, our Public Sector segment, increased by 17% from the second quarter of 2006 to $75.6 million. Public Sector's revenues increased again, primarily due to sales and (inaudible) made under some recently awarded federal and state government contracts and agreements, as well as the acquisition of new accounts.

Consolidated gross profit dollars increase in the second quarter of 2007 over the second quarter of 2006 by $3.3 million, to $54 million. Gross profit margin was 12.3% in the second quarter of 2007 compared to 12.4% in the prior year quarter. As we noted at last quarter's conference call, we recorded substantially all vendor consideration in 2007 as a reduction of process inventory purchases rather than a reduction of advertising expense. Accordingly, this additional vendor advertising consideration recorded in the second quarter of 2007 accounted for a 22-basis-point increase in gross margin compared to the prior year quarter. Offsetting this increase were slightly lower customer invoice margins and additional costs associated with certain customer rebate programs.

SG&A expenses totaled $45 million for the second quarter 2007, compared to $44.5 million for the second quarter of 2006. SG&A expense as a percentage of sales improved to 10.3% for the quarter compared to 10.9% for the second quarter of 2006. Total SG&A expenses increased $0.5 million, or 1.1%, year over year in the second quarter of 2007. Improved expense leverage and cost reductions accounted for the improvement in SG&A as a percentage of sales.

Income from operations for the quarter increased 57% to $9 million, or 2% of net sales, compared to $5.8 million or 1.4% for the second quarter 2006. Net income for the quarter was $5.8 million, compared to $3.1 million for the 2006 second quarter.

Annualized average sales productivity for the second quarter increased on a consolidated basis by 12% year over year due to double-digit productivity gains realized in all three sales segments. In the Large Account segment, sales productivity increased 21% from the second quarter of 2006. Average sales productivity for our public sector segment increased by 10% due to the 17% sales increase noted earlier. Overall productivity in our SMB segment improved by 12% due to increased corporate sales generated by our SMB sales representatives. Consumer sales continued to decrease year over year this quarter again, reflecting our focus on corporate business accounts.

Now onto product trends. Notebooks and PDAs continue to be the largest-selling product category, accounting for 16% of total sales. Desktop and service sales accounted for 14%, and software products and video imaging and sound each accounted for 13%. The highest year-over-year growth category this quarter was memory and system enhancements, which grew nearly 21% year over year from the second quarter of 2006, reflecting industry demand for these products.

Average selling prices, or ASPs, for computer systems increased by 3% in Q2 2007 compared with the second quarter of 2006, but was largely unchanged from the first quarter of 2007. Notebook revenues were comparable to 2006, as both ASPs and unit sales were level year over year. Desktop revenues increased 8% year over year due to a 3% increase in unit sales and a 4% increase in ASP. Second quarter service sales increased 20% over 2006, due primarily to higher average selling prices.

As in Q1, we continue to grow and invest in our service initiative, with sales in services increasing 44% year over year. This growth reflects the continued development of managed or skewable service offerings in our SMP segment through our Service Connection Brand, continued growth in custom service sales from our Professional Services subsidiary, and through partner referrals, increased product certification, 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 target market. We believe these incremental investments strategically position the PC Connection Company to capture a larger portion of the services market moving forward.

While we did leverage our expense structure this quarter, we will continue to monitor our operating costs and review our spending plans and programs to enable the best possible allocation of our resources. Furthermore, we plan to support our sales organization and grow our customer base by continuing to make investments in systems, brands, and new customer acquisition programs, including considering acquiring additional businesses with complementary cultures that will 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 six months ended June 30, 2007, was $400,000, compared to a $5.4 million amount for the prior year quarter. The effect of our increased earnings in 2007 was largely offset by an increase in inventory and a reduction in payables in the period. Year-to-date capital expenditures in 2007 were lower than those in the prior year period. Cash flows from financing activities improved this period due to the proceeds received from the exercise of stock options as well as our ability to minimize borrowing on our bank line of credit. In 2006, year-to-date cash flows from financing activity were impacted by the net repayment of $2 million on our bank line of credit.

Now to the balance sheet. Even with our $33 million increase in quarterly sales, accounts receivable as of June 30, 2007, decreased slightly to $169 million compared to the balance at December 31, 2006. We attribute this decrease to our improved collection efforts. Days sales outstanding, or DSO, improved to 42 days at June 30, 2007, from 44 days as of June 30, 2006, and from 45 days as of December 31, 2006. Inventory balances increased by $5.8 million to $75.2 million at June 30, 2007, compared to the balance at December 31, 2006. This increase was attributable to inventory staged for planned customer roll-outs in Q3. Inventories increased by $7.6 million over the June 30, 2006 balance due to higher levels of inventory in transit and to the customer roll-outs. Inventory turns were 22 turns this quarter, compared to 23 turns in the second quarter of 2006, and 21 turns in the first quarter of 2007. 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 52% of total net sales in the second quarter, compared to 51% in the second 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?

Thank you. (Operator Instructions.) I will take our first question from Brian Alexander with Raymond James.

Hi, guys. This is Bob [McGruen] filling in for Brian. Could you talk about the linearity in the quarter? Industry data and some of your peer results suggest that demand improved throughout the quarter. Did you see that happening for Connection, and how is that trend, or how has that trend continued so far quarter to date?

Hi, Bob. This is Tim. I'll take that question. I think that overall, the calendarization that we saw in Q2 versus last year was very similar. June was the strongest month of the quarter in both years.

And quarter to date, has that carried through, through July so far?

Overall, our demand has been strong. As you know, we don't give future guidance.

Right. So anyway, then maybe you could talk about the health of Microsoft EA sales based on data seen from Microsoft and some of your peers. It appears that the sales were fairly healthy in the quarter. Is that something that you also saw?

Hi, Bob. This is Steve Baldridge. Our Microsoft EA sales were up over 50% in Q2 versus the second quarter of last year, and up over 100% sequentially.

Okay. Bear with me. Just a couple more. In your release and your prepared remarks, you referred to some additional costs associated with certain customer rebate programs as a negative factor on gross margin. Could you provide a little bit more clarification as to what you mean by "customer rebate programs"?

Hi, Bob. Steve Baldridge.

Hey, Steve.

The gross profit margin of 12.3% in Q2 was unfavorably impacted by additional costs associated with customer rebate programs, approximately 20 basis points. We use customer rebate programs primarily for competitive inventory-related or promotional reasons. However, we don't expect to incur in Q3 the margin impact we experienced in Q2 from these customer programs.

I see. Over the last several quarters, your expense growth has outpaced sales growth as you all have been investing in the business and adding account managers. This quarter there was a fairly significant reversal of that trend, and it looks like total account managers is starting to fall sequentially. It's fallen in each of the last three quarters. Is this marking a shift in your strategic direction in terms of controlling expenses, and what may be your plans for account manager hiring, i.e., when can we expect to see headcount start to trend upward again?

Hi, Bob. This is Tim. I'll take that one. I think our headcount reductions in SMB and the Large Account segments were partially offset by an increase in our Public Sector headcount. We're going to continue to focus on profitable growth and productivity, improving sales tools and systems, and retaining the best salespeople in the industry. We're going to invest and continue to invest in our sales force as needed.

Okay. Last one, I promise. In your product mix, it looks like notebooks, I think you said were down 1% year over year. Just wondering what factors came into that decline, considering that the notebook market seems to be pretty healthy right now?

Okay, Bob. Tim again. I'll take that. Notebooks and PDAs are the Company's largest product category, and it did account for 16.4% of net sales in Q2 compared to 18% in the corresponding quarter last year. There were several large notebook sales transactions last year that were not repeated this year.

Okay. That's all I have. Thank you.

Thanks, Bob.

Thank you. (Operator Instructions.) We'll take our next question from John Pitts with Steadfast Financial.

Hi. I was just wondering what the projected tax rate is for the next couple of years. It looks like it's kind of varied over the last several quarters by a lot, so I'm just trying to understand what your kind of core tax rate is for the foreseeable future.

Hi, this is Jack Ferguson. As you can appreciate, there are many factors affecting the tax rate, particularly at the state levels and continued changes in the filing status in different jurisdictions, together with recent changes in the accounting rules for income taxes. It makes forecasting the tax rate pretty difficult, but how I would suggest that for modeling purposes, you might consider a rate in the range of 38% to 39%.

Okay. Thank you.

Thank you. As there are no further questions, I'll turn the program back over to Patricia Gallup for any additional or closing comments.

Again, we're pleased with our record sales, increase in earnings, and our continued healthy balance sheet. Q2 was the sixth consecutive quarter that we have achieved year-over-year earnings growth. We will continue to look for and invest in opportunities to grow our business as well as reduce operating costs wherever possible. Our strong and experienced management team is focused on improving the Company's results and building long-term shareholder value. In closing, we appreciate your time and interest. We'd also like to thank our many loyal customers for their business, our vendor partners for their support, and our employees, who have worked so hard to make our Company the success it has become. Have a great day.

That does conclude today's conference. You may disconnect your lines at any time.