PC Connection Inc (CNXN) 2007 Q3 法說會逐字稿

Good day, everyone, and welcome to the PC Connection 2007 third quarter 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 Stephen 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 third 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 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 10-Q for the quarter ended June 30, 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.

Good morning, and, again, thank you for joining us. Today we announced record net sales of $456 million for the third quarter 2007, which represents an increase of $41 million, or 10%, from $415 million for the third quarter of 2006. All three of our sales segments achieved year over year sales growth, with our public sector and large account segments each increasing sales by over 14%. Net income for the third quarter of 2007 was $7.7 million, or $0.28 per share, compared to $4.4, or $0.17 per share, for the prior-year quarter.

I'll begin by commenting on our SMB segment, our original core business. Net sales increased by $13.5 million, or 6%, from the third quarter of 2006 to $234.9 million. Corporate outbound sales for the quarter grew 16% 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, reported as our large account segment, increased by $16.3 million, or 14%, to $130 million from the corresponding quarter a year ago. Through our MoreDirect subsidiary, consultative sales, and solutions process and their seasoned sales representatives, this segment continues to obtain new customers and a greater share of existing customers' business.

Sales to government and education customers, reported as our public sector segment, increased by 14% from the third quarter of 2006 to $91.6 million. Through our GovConnection subsidiary, public sector revenues increased primarily due to sales to higher education customers and sales under recently awarded federal government contracts, including [ADNC2, SUP4, and FirstSource].

Consolidated gross profit dollars increased in the third quarter of 2007 over the third quarter of 2006 by $6.4 million to $57.5 million. Gross margins, representing gross profit as a percentage of net sales, was 12.6% in the third quarter 2007 compared to 12.3% in the prior-year quarter.

As we noted in previous conference calls this year, we recorded substantially all vendor consideration in 2007 as a reduction of cost of inventory purchases rather than a reduction of advertising expense. Accordingly, this additional vendor advertising consideration recorded in the third quarter of 2007 accounted for a 22-basis-points increase in gross margin compared to the prior-year quarter. Larger software agency fee revenues were largely offset by lower back-end vendor rebates in the third quarter of 2007 compared to the prior-year period.

SG&A expenses totaled $45.6 million for the third quarter of 2007 compared to $43.3 million for the third quarter of 2006. SG&A expense as a percentage of sales improved to 10% for the quarter compared to 10.4% for the third quarter of 2006. Total SG&A expenses increased $2.3 million, or 5.3%, year over year in the third quarter of 2007. Improved personnel expense leverage and cost reductions in other areas accounted for the decrease in SG&A as a percentage of sales.

Income from operations for the quarter increased 76% to $12 million, or 2.6% of net sales, compared to $6.8 million, or 1.6%, for the third quarter of 2006. Net income for the quarter was $7.7 million compared to $4.4 million for the third quarter of 2006.

Annualized average sales productivity for the third quarter increased on a consolidated basis by 17% year over year. In the large account segment, sales productivity increased 28% from the third quarter of 2006. This significant increase resulted from higher sales volume, lower sales headcount, and enhancements to sales support activities. Average sales productivity for our public sector segment increased by 9% due to the 14% sales increase noted earlier. Overall productivity in our SMB segment improved by 15% due to higher corporate sales, increased sales support staff, and fewer SMB sales representatives. Consumer sales continued to increase year over year this quarter, reflecting our focus-- decreased year over year this quarter, reflecting our focus on corporate business accounts.

Now, on to product sales trends. Notebooks and PDAs continue to be the largest selling product category, accounting for 16% of total sales. Desktop and server sales and video, imaging and sound, each accounted for 14%, and software products accounted for 13%. The highest year over year growth categories this quarter were storage devices and desktop servers, which grew 19% and 16%, respectively, year over year from the third quarter of 2006, reflecting industry demand for these products.

Average selling prices, or ASPs, for computer systems increased by 3% in Q3 2007 compared to the third quarter of 2006 but decreased by 3% from the second 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, primarily due to a 7% increase in unit sales. Third quarter server sales increased 27% over 2006, due primarily to higher average selling prices.

We continued to invest in our services initiatives, with sales of services increasing 53% year over year. This growth reflects the continued development of managed or skewable service offerings in our SMB segment through our ServiceConnection brand, continued growth in consumer service sales from our new professional services subsidiary, ProConnection, and through partner referrals, increased product certifications, 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.

While we improved the leverage of 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. Additionally, we plan to continue to make investments in systems, brands, and new customer acquisition programs to support our sales organization and grow our customer base. Accordingly, we are evaluating opportunities in a consolidating market, and we'll 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.

Thanks, Pat. Cash flows generated from operations for the nine months ended September 30, 2007 was $8.9 million compared to $19 million for the prior-year period. The cash flow effect of our increased earnings in 2007 was largely offset by an increase in accounts receivable and inventory. 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 our continued ability to minimize borrowings on our bank line of credit. In 2006, year-to-date cash flows from financing activities were impacted by net repayments of $13 million on our credit line.

Now to the balance sheet. With our $41 million increase in quarterly sales, accounts receivable as of September 30, 2007 increased by $17 million to $187 million compared to the balance at December 31, 2006. Day sales outstanding, or DSOs, increased slightly to 45 days as of September 30, 2007 from 43 days as of September 30, 2006 but was level with DSOs as of December 31, 2006. Inventory balances increased by $6.1 million to $75.5 million at September 30, 2007 compared to the balance at December 31, 2006. This increase was attributable to inventory stage for planned customer rollouts in Q4. Inventory increased by $7.1 million over the September 30, 2006 balance due to higher levels of inventory stock and to the customer rollouts. Inventory turns were 22 this quarter, unchanged from the third quarter of 2006 and the second 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 third quarter compared to 49% in the third 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.

Thank you, sir. (OPERATOR INSTRUCTIONS). And we'll take our first question from Brian Alexander with Raymond James.

This is [Bob Grundyke] filling in for Brian. Congratulations on another good quarter. I just wanted to talk a little bit about gross margins in the quarter. I know they were up 29 basis points year over year. I think 22 of that came from the EITF reclassification. I'm just wondering if you could talk about the sustainability of gross margins at these levels. You all have done a good job of improving them pretty consistently for several quarters now. I'm just wondering if you could discuss the sustainability at these levels.

So let's summarize our consolidated gross margin rate year over year and sequentially. The gross margin of 12.6% in Q3 was up 28 basis points from the 12.3% that we had from the previous year. And, as you noted, the vendor advertising consideration that was recorded in the third quarter of 2007 did account for 22 basis points of the improvement. The other improvement, and the remainder of the increase, came from software agency fees that were largely offset by lower back-end vendor rebates in the quarter. Sequentially, gross margin was up 35 basis points from 12.3% in Q2 to 12.6% in Q3 of this year. That sequential improvement in margin rate resulted from higher software agency fees and lower costs associated with customer rebate programs.

Relative to gross margin rates looking forward, gross margin rates may vary due to many factors. But we'll continue to focus on growing the business profitably, as evidenced by our earnings performance this quarter. Additionally, software agency fees are typically stronger in Q2 and Q3 than they are in the fourth quarter and first quarter of a calendar year.

Okay. Thanks. If you could maybe discuss the demand-- You had strong growth in all three segments in the third quarter. I just was wondering if you saw the same demand through October and if you've seen any shifts by customer segment outside of normal seasonality.

If you look at customer demand for Q4 and starting with October, I think customer demand was solid exiting Q3 and, at this point, in line with our expectations. As you know, we're not giving future guidance on those results.

Okay. Tim, I think it's our recollection that MoreDirect, I think, has a decent exposure to the financial services market. Given what IBM said and just the turmoil in that market, I just wonder if you'd comment specifically on demand maybe in Q3 and what you've seen in Q4 in that vertical.

Sure. I think, again, customer demand in our large account segment continues to be strong with 14% sales growth in Q3. Going forward, MoreDirect subsidiary's consultative sales and solution process, the seasoned sales representatives-- This segment continues to obtain-- They're growing their account base in the segment by winning new accounts and by garnering a greater share of existing customer business. So the demand in the large account segment for Q4 is, as you know, considered to be a good quarter for the segment.

So you haven't seen very much weakness in financial services up to this point?

Any softening in the financial services or housing industry experienced with our enterprise customers was offset through growth in other industries and through new account acquisition. So, definitely, I think we're seeing nothing that's different from what the rest of the country is experiencing but have been able to offset that softening through growth in other industries and new account acquisition.

Okay. Great. If you could discuss the growth trends, I guess, in the notebook segment-- It looks to be flattish again this quarter. From what we can tell, notebook units in the U.S. are still growing over 20%. I was just wondering if it's just a segment that you're focusing less on in terms of a profitability standpoint or if there's something else going on there in that product area.

I think notebooks and PDAs are the Company's largest product category. In fact, that accounted for 15.7% of our net sales in Q3 compared with 17.4% in the corresponding quarter of last year. There were several large, low-margin notebook sales transactions last year that we decided not to repeat this year.

Okay. Thank you very much.

(OPERATOR INSTRUCTIONS). And we have a follow-up from Brian Alexander with Raymond James.

I guess I'll come back to you. In terms of headcount, it looks like you've been trending down a little bit over the last few quarters. I think in the press release you mentioned that you were going to perhaps do some hiring in the fourth quarter. I wonder if you could just talk a little bit more about your plans in terms of building headcount. If you can talk about maybe which segment it's going to be in or if it's going to be across the board - how you're going to build that out. I'm talking about account manager headcount. Sorry.

We will continue to focus on profitable growth. We're going to be improving our sales schools and systems and retain the best people in the industry. We will invest in the sales force, if needed, and we are estimating that our sales headcount will be up to about 685 by the end of this year. That's a pretty uniform split in terms of adding people.

Okay. That's my other question. Thank you.

And there appear to be no further questions at this time. I'd like to turn the call back to Ms. Patricia Gallup for any additional or closing comments.

Thank you, operator. In closing, we're pleased to have achieved such positive results, including delivering the largest revenue quarter in the Company's history in this, the 25th anniversary, year of the Company's founding. Many people have worked hard and smart over the years. But, more importantly, we've worked together to achieve our Company's goals. I'd like to thank our customers for their business and our vendor partners and dedicated coworkers for their support. I would also like to thank those of you on the call this morning. We appreciate your time and interest in PC Connection. Have a great day, everyone.

And, again, that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.