PC Connection Inc (CNXN) 2007 Q4 法說會逐字稿

Good day, everyone, and welcome to the PC Connection Fourth Quarter 2007 Financial Results conference call. Today's call is being recorded.

At this time for opening remarks and introductions, 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, Senior 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 are pleased to have you join us today for PC Connection's 2007 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 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 September 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 and annual results. Pat?

Good morning, and again, thank you for joining us.

Today we announced record net sales of $490 million for the fourth quarter 2007, which represents an increase of $58 million, or 13%, from $432 million for the fourth quarter 2006. All three of our sales segments achieved year-over-year sales growth, with our SMB and Public Sector segments increasing sales by 14% and 25%, respectively.

Net income for the fourth quarter of 2007 was $6.2 million, or $0.23 per share, compared to $4.6 million, or $0.17 per share, for the prior-year quarter. As stated in our press release, the quarter ended December 31, 2007 included special charges. Had those charges not been incurred, pro forma net income for the fourth quarter would have been $6.5 million, or $0.25 per share. We did not incur special charges in the fourth quarter of 2006. Our press release includes a reconciliation of the pro forma amounts.

I'll begin by commenting on our SMB segment, our original core business. Net sales increased by $32.3 million, or 14%, from the fourth quarter of 2006 to a record $263.8 million. Corporate outbound sales for the quarter grew 25% year over year. Higher video product sales contributed to our fourth quarter revenue growth.

In Q4, we recorded several large sales of video product to three commercial customers. These sales accounted for the majority of the corporate outbound group's sales growth. Consumer sales decreased, reflecting our continued focus on commercial account growth.

Sales to large corporate account customers, reported as our Large Account segment, increased by $8.4 million, or 6%, to $140.8 million from the corresponding prior-year quarter. Through our more direct subsidiaries' consultative sales and solutions process and their seasoned sales representatives, this segment continues to acquire new customers as well as win a greater share of existing customers' business.

Sales to government and education customers, reported as our Public Sector segment, increased by 25% from the fourth quarter of 2006 to $85 million. Through our GovConnection subsidiary, Public Sector revenues increased primarily due to sales made under recently awarded federal government contracts, including ADMC2, SEWP IV, and First Source.

Consolidated gross profit dollars increased in the fourth quarter of 2007 over the fourth quarter of 2006 by 11%, or $5.5 million, to $57.5 million.

Gross margin, representing gross profit as a percentage of net sales, was 11.7% in the fourth quarter of 2007.

Excluding the effect of the low-margin video sales, gross margin in the fourth quarter would have been 12.5%, compared to 12% in the fourth quarter of 2006. Larger software agency fees, additional vendor consideration, and lower customer rebates in the fourth quarter of 2007, however, partially offset the effect of the video product sales.

SG&A expenses totaled $46.9 million for the fourth quarter of 2007, compared to $44.1 million for the fourth quarter of 2006.

Total SG&A expenses increased $2.8 million, or 6.3%, year over year in the fourth quarter of 2007. The dollar increase was primarily attributable to increased personnel and advertising expense.

SG&A expense as a percentage of sales improved to 9.5% for the quarter, compared to 10.2% for the fourth quarter of 2006. 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 29% to $10.1 million, or 2.1% of net sales, compared to $7.8 million, or 1.8%, for the fourth quarter of 2006.

Net income for the quarter was $6.2 million, compared to $4.6 million for the fourth quarter of 2006.

On an annual basis, sales increased over 2006 by $150 million, or 9.2%, with sales growth in all three segments.

Our gross profit dollars for 2007 increased 9.4%, slightly higher than our revenue growth, reflecting a slight improvement in our gross margin rate. We experienced gross profit growth in all three segments.

SG&A expense increased in 2007 by only $7.7 million, or 4.4%. SG&A expense as a percentage of sales improved 46 basis points over the prior year.

Our annual operating income improved by $12.9 million, or 54%, to $36.8 million in 2007. Operating income as a percentage of net sales was 2.1% in 2007, compared to 1.5% in 2006, reflecting primarily our improved expense leverage and cost reductions in 2007.

Net income increased to $23 million, or $0.85 per share, compared to $13.8 million, or $0.54 per share in 2006.

Annualized average sales productivity for the fourth quarter increased on a consolidated basis by 19% year over year.

In the Large Account segment, sales productivity increased 21% from the fourth quarter of 2006. This significant increase resulted from enhancements to sales support activities.

Average sales productivity for our Public Sector segment increased by 19% due to improvement in this segment's average sales representative tenure, as well as to the additional contract vehicles I mentioned earlier.

Overall productivity in our SMB segment improved by 20%, also due to improved sales representative tenure.

Now, on to product trends, sales trends. Our largest-selling product category in Q4 was Video, Imaging and Sound, accounting for 18% of our overall sales. The large video product sales noted earlier drove most of this product category's growth.

Notebooks and PDAs was the second-largest product category in Q4 2007, accounting for 15% of total sales. Both software and desktop and server sales each accounted for 13% of total sales.

While the highest year-over-year growth category in the quarter was Video, Imaging, and Sound, we also experienced strong growth in storage devices and software. In Q4, each of these categories increased over 20% year over year, reflecting industry demand for total solutions sales.

Average selling prices, or ASPs, for computer systems decreased year over year by 2% in Q4 2007. However, ASPs were level compared to the third quarter of 2007.

Q4 notebook revenues were level compared to 2006, as a 6% decrease in ASPs was offset by a 6% increase in unit sales.

Desktop revenues increased 6% year over year, primarily due to an 8% increase in unit sales.

Fourth quarter server sales increased 23% over 2006 as both ASPs and unit sales increased by double-digit percentages.

For the third straight quarter, server sales have increased by 20% or more.

We continued to invest in our services initiatives, with sales of services increasing 22% year over year. This growth reflects the continued development of managed or SKU-able service offerings in our SMB segment through our ServiceConnection brand.

Continued growth in custom service sales from our professional services subsidiary, ProConnection, and through partner referral, increased product certifications, such as our recent Cisco Gold 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 customer base. We believe these continuing investments strategically position PC Connection to capture a larger portion of the services market.

While we improved the leverage of our expense structure both for this quarter and for the year, 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 continue to make investments in systems, brands, sales representatives, and new customer acquisition programs to support the growth of our sales organizations and customer base.

Accordingly, we are evaluating 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.

First, the cash flow. Cash flow generated from operations for the year ended December 31, 2007 was $400,000, compared to $26.4 million for the prior year. The effect of our increased earnings in 2007 was offset by increases in accounts receivable and inventory. These increases were due primarily to our $58 million increase in Q4 revenues, which drove the increase in receivables. Inventories also increased by $6.7 million year over year in the quarter.

Capital expenditures this year were slightly lower than in the prior year, amounting to $7.1 million in 2007, compared to $8 million in 2006.

Cash flows from financing activities improved this year due to our continued ability to minimize borrowings from our bank line of credit. In 2006, cash flows from financing activities were impacted by net repayments of $20 million on our credit line.

While cash did decrease slightly year over year in 2007, our cash balance remained strong with no year-end borrowing from our credit facility.

Now, to the balance sheet. With our $58 million increase in quarterly sales, accounts receivable as of December 31, 2007 increased by $32 million to $202 million, compared to the balance at December 31, 2006.

Days sales outstanding, or DSOs, however, improved to 43 days as of December 31, 2007, compared to 45 days at December 31, 2006 and 45 days at September 30, 2007.

Inventory balances increased year over year approximately 10% to $76.1 million at December 31, 2007. This increase was attributable to inventory staged for planned customer rollouts in Q1 of 2008. Inventory turns were 21 this quarter, compared to 20 turns for the fourth quarter of 2006 and 22 turns for the third 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 51% of total net sales in the fourth quarter this year, compared to 52% in the fourth quarter of last year. On an annual basis, drop shipments increased from 50% of sales in 2006 to 51% in 2007. We continue to focus on increasing drop shipments where appropriate and cost effective, which allow us to maintain lower inventory levels.

In summary, we believe the balance sheet remains very healthy.

We will now entertain your questions. Operator?

Thank you, sir. (OPERATOR INSTRUCTIONS)

We'll take our first question from Brian Alexander with Raymond James.

Good morning. Could you guys just talk a little bit about what you're seeing from a demand perspective through the month of January? Obviously, there's a lot of concern out there, and you've got pretty -- your entire business in North America, where there seems to be more concern. So if you can go through the different customer segments and talk about whether you're seeing normal seasonality or if there's any difference in patterns versus your expectations?

Hi, Brian. This is Tim McGrath. I'll take that question. So the question was, how do we see demand by segment for January '08. And customers' demand, as you know, was solid for us in Q4, and at this point is in line with our expectation for the quarter Q1. For January, we are right on our expectation, so we really aren't seeing very much fluctuation, and that is across all three segments.

Okay, great. And then on the large deals that you had in the quarter, it sounds like that was about $30 million of incremental revenue. If I back into what the implied profitability was on the incremental revenue, it doesn't seem like it generated much in the way of incremental margin. Can you just kind of walk us through the margin profile of those deals? Were those to new customers or existing customers, and how should we think about those types of deals going forward? Was this more of a one-off, or might you entertain large deals at very little profit, if that assumption is correct, in the future?

Okay, Brian, again, this is Tim McGrath, and I'll cover that. And I think the question really is, given the large opportunistic deals that we generated in Q4, how did that affect our business? What was the reason and the strategy for that? And I think we'll kind of break that up a little bit. I'll kind of cover the sales aspect, and I'll ask Steve for a little help on some of the go-forward margin aspects.

But overall, as you know, our sales increased 14% in Q4, and a big part of that increase was from the video product sales to three separate commercial customers. These sales were generated as part of a new customer acquisition strategy to drive account growth. The strategy worked really well for us as since that time, we have received higher-margin orders in other product categories from those customers. But if you exclude those video product sales, the corporate outbound team in our SMB organization, where the sales were generated, still increased over 8% year over year in the quarter. So, overall, I think it was the right move for us. We did increase market share, and we'll continue to grow that business in 2008.

Steve, did you want to comment further?

Hi, Brian. On gross margin as a percent of net sales, our rate was 11.7% in the fourth quarter of 2007. Excluding the effect of the low-margin video sales, gross margin rates for the quarter would have been 12.5%, compared to 12% in the fourth quarter of 2006. Partially offsetting the effect of the lower video product sales margins were larger software agency fees, additional vendor consideration, and lower customer rebate costs in the fourth quarter of 2007 versus the fourth quarter of 2006.

On an annual basis, despite the low-margin video sales, the gross margin rate improved slightly, from 12.2% in 2006 to $12.3% in 2007.

So I guess just to follow up and get more specific, what would the revenue have been and what would the gross margin have been in the SMB segment specifically, excluding these deals? It sounds like it's about, what, $30 million in revenue, and gross margins would have been closer to 14%?

Hi, Brian. This is Steve Baldridge. The sales growth in SMB, as we noted, would have been approximately 1% excluding -- excluding those video sales, and that's a result that would end up with about an 8% increase in our outbound corporate sales group in SMB, and that increase was offset by the declining consumer sales.

The impact of the low-margin video sales had approximately a 150-basis-point impact on the SMB margin rates during the quarter.

So it doesn't sound like there was much gross profit generated on those sales at all?

Correct. I think as Tim indicated, this was a new customer acquisition strategy, and the strategy seems to be working as we have since received orders for other products from these customers this quarter.

And those are carrying margins that are more comparable to the corporate average, or are they still depressed?

Yes, Brian, this is Tim. Those are very healthy margins, and they are in line with the corporate average.

Okay. And, let's see, the Public sector for you guys historically has not been profitable given some of the issues you had a few years ago where you had to downsize that business, or at least your run rate was less than it used to be. So now that that business seems to be on track again and you've got double-digit revenue for the last three quarters in terms of growth, are we looking at a scenario where -- I know in the third quarter, it was profitable. I assume in the fourth quarter that segment was profitable. Do we think the Public sector will be profitable in 2008?

Yes, this is Jack Ferguson. We believe that the Public sector will show a slight profit for the year as a result of those two quarters, and we believe going forward that should be continued upward.

So how should we think about operating margins by segment? For 2007, I believe you were under 2% in SMB. In the Corporate segment, I think you continue to show pretty healthy mid-single-digit operating margins. I'm not sure if there's room for expansion there, but could you frame for us the operating margin outlook roughly by segment as we move forward?

I'm not sure I have those numbers handy by segment because, keep in mind, there is an element of corporate costs that obviously have not been completely absorbed within the operating segment. So from an overall company point of view, you have to take that into account, as well. Clearly, as you've seen from our past reports, our Large Account segment has probably the highest operating income with SMB in second place and the Public sector being in third place. We expect growth potential in the Public sector and some in SMB, but I think most of the change will be in the Public sector as we increase our sales. And that's the key.

Okay, and then my final one is Dell seems to have formalized a channel strategy in North America. I'm just wondering if PC Connection is a part of that.

Brian, this is Tim. I'll take that one. And the question really is, our go-forward plans with Dell and Dell's channel strategy, is that right?

Yes.

So, obviously, Dell is a formidable competitor. If we look at what Dell did in Q4, it shipped, as you know, 40 million PCs. If you look at what HP did in Q4, they shipped 50 million PCs. So, clearly, I think the channel has momentum. HP, our partner, for example, is seeing a lot of momentum there, so we are going into the year with our eyes wide open. We have not made any specific commitments in either direction, but we continue to watch that very closely.

Great. That's it for me.

(OPERATOR INSTRUCTIONS)

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

Okay. Thank you, Operator.

In closing, we're pleased with our record quarterly and annual sales and our growth in earnings per share. We're also very pleased with the growth in our service revenues year over year, which were actually at 58%. 2007 was another consecutive record year for us, and we believe going forward that we have the right people and strategies in place to continue to take market share and grow our business.

I'd like to thank all of our customers and vendor partners for their business and support and our dedicated coworkers for all of their efforts. I'd also like to thank those of you on the call this morning for your time and your interest in PC Connection. Have a great day, everyone.

Again, that concludes today's conference call. We do thank you for your participation. You may disconnect at this time.