PC Connection Inc (CNXN) 2008 Q2 法說會逐字稿

Good day everyone and welcome to the PC Connection 2008 second quarter conference call. Today's call is being recorded.

I would like to turn the conversation over to the Senior Vice President of Finance and Corporate Controller, Mr. Steven Baldridge.

Thank you. And good morning, everyone. This is Steven 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 PC Connection enterprises are also here with us today.

We are pleased to have you join us today for PC Connection's 2008 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 would 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, 2008, 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. Net sale for the second quarter of 2008 increased $8 million, to 449 million, from 441 million for the second quarter in 2007. Although this increase was modest, it represents the 13th consecutive quarter of year-over-year revenue growth for our company. As in recent quarters, our public sectors segment led the way, increasing its sales by 13%.

Net income for the second quarter of 2008 was $5.1 million, or $0.19 per share, compared to 5.8 million, or $.21 per share for the prior year quarter. I'll begin by commenting on our SMB segments, our original core business. Net sales increased by $4.4 million, or 2% from the second quarter 2007, to 236 million. Our corporate outbound sales to small and medium-sized businesses for the quarter grew 4% year-over-year, while consumer sales decreased, reflecting our continued focus on commercial account growth.

Sales to large corporate accounts customer reported as our large account segment decreased by $6.2 million, or 5%, to 127 million from the corresponding prior year quarter. More direct experience decreased revenues from enterprise accounts that curtailed IT spending in Q2. Both our SMB and large account segments continue to be challenged in this uncertain business environment. Sales to government and education customers reported as our public sector segment, increased, as I mentioned earlier, by 13% from the second quarter of 2007, to $86 million.

Revenues for our gov connection subsidiaries increased for our federal, state, and local government and education customers. Consolidated gross profit dollars increased year-over-year in the second quarter of 2008, by 5%, or $2.8 million, to 56.8 million. Gross margin, representing gross profit as a percentage of net sales, was 12.6% in the second quarter of 2008, compared to 12.3% in the second quarter of 2007. Increased vendor consideration in the second quarter 2008 compared to the prior year quarter, was the primary factor in our increased margins.

SG&A expenses increased $48.2 million for the second quarter 2008, compared to 45 million for the second quarter of 2007, a 7% increase. This increase was primarily attributable to increased personnel costs, which represent the majority of our operating expenses. Incremental variable compensation related to increased revenue and gross profits in 2008, and additional investments in sales personnel and sales promotion costs, contributed to the year-over-year increase in costs.

SG&A expense as a percent of sales was 10.7% for the quarter, compared to 10.3% for the prior year period as a result of the weaker demand environment, as well as the costs previously mentioned. Given the continued softness in commercial customer demand, management is taking actions to reduce costs to be in line with anticipated sales volume. Income from operations for the quarter was $8.7 million, or 1.9% of net sales, compared to nine million, or 2% for the second quarter of 2007.

And as I said earlier, net income for the quarter was 5.1 million, compared to $5.8 million for the second quarter of 2007. On a consolidated basis. Average annualized sales productivity for the second quarter was unchanged from the prior year. Average sales productivity in our SMB segment decreased 3% year-over-year due tow hiring of new sales personnel.

Overall sales productivity for our public sector segment increased by% due to gains achieved under recently awarded federal contract vehicles and the acquisition of new higher education customers. In the large account segments, sales productivity increased 5% from the second quarter of 2007. Now on to Q2 product sales trends.

Our largest product category was notebooks and PDAs, which accounted for 16% of total sales. Video imaging and sound was the second largest selling category, accounting for 14% of our overall sales. Desktop and server sales accounted for 14%, and software sales were 13%. The highest year-over-year growth category was Netcom products. Which grew by 43%, reflecting industry demand for total solutions sales.

We also experienced strong revenue growth in video imaging and sound products. Average selling prices or ASPs for computer systems decreased year-over-year by 12% in Q2 2008, and decreased by 5% compared to the first quarter of 2008. Q2 notebook and PDA revenues decreased by 3%, and desktop and server revenues decreased by 1% year-over-year, as lower ASPs were partially offset by net unit growth. We continue to invest in our services initiatives through increased levels of sales, training, and promotions of services to our customer base.

Sales of services increased year-over-year, reflecting continued growth in customer service sales from our professional services subsidiary, Pro Connection, and through partner referral. Increased sales of managed or skewable serviceable operations through our service connection brand, and increased product certifications, which enable us to promote higher margin solution selling, as well as provide access to additional vendor funding.

We believe these continuing investments strategically position PC Connection to capture a larger portion of the services market. We strive to improve the leverage of our expense structure and will continue to monitor our operating costs and review our spending plans and programs to enable the best possible allocation of our resources. We have taken steps in Q3 to bring our costs in line with current sales levels.

However, we plan to continue to make investments in systems, sales representatives, and new customer acquisition programs to support the growth of our sales organization and customer base. In addition, we continue to evaluate opportunities in a consolidating market, and will consider acquiring additional businesses with complimentary corporate cultures that add new to 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 provided by operations for the six months ended June 30, 2008, was $33.6 million, compared to $400,000 for the prior year period. The majority of this increase was due to a reduction in inventories and accounts receivable in 2008, which ultimately improved cash flow.

Capital expenditures in the six months ended June 30, 2008, were higher than in the prior year period, amounting to $5.4 million in 2008, compared to $3.2 million in 2007. As noted last quarter, we completed an extensive internal desk top up grade in Q1 of '08 which accounted for much of this increase. Financing activities in the six months ended June 30, 2008, represented a $1 million use of funds compared to a $2.6 million source of funds for the prior year period. We purchased over $900,000 in treasury shares earlier in the year, whereas in 2007, the exercise of stock options provided $2.5 million in cash.

Our cash balance increased by approximately $27 million in the six months ended June 30, 2008, compared to a modest decrease in the comparable period last year. Our cash flow remains strong with no outstanding quarter end borrowing from our credit facility. Now to the balance sheet. Accounts receivable as of June 30, 2008, decreased by $9 million, to 194 million, compared to the balance of December 31, 2007.

Day sales outstanding were 45 days as of June 30, 2008, compared to 42 days as of June 30, 2007. Inventory balances decreased by $11 million, compared to the balance at December 31, 2007. Correspondingly, inventory turns were 24 this quarter, compared to 22 turns for the prior year quarter. 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 our customers, accounted for 56% of total net sales in the second quarter of 2008, compared to 52% in the second quarter last year. We continue to focus on increasing drop shipments where appropriate, and cost effective, which allows us to maintain lower inventory levels. In summary, the balance sheet remains very healthy.

We will now entertain your questions. Operator?

Thank you, sir. (OPERATOR INSTRUCTIONS) We'll go first to Brian Alexander with Raymond James.

Thank you. Can you guys just talk about if there was anything else in the large enterprise space that caught your attention this quarter?

We normally see a pretty big sequential increase, and we didn't see it this quarter, and I'm just wondering, is that really all macro related, or are there any specifics you could go into from a vertical perspective where you notice disproportionate weakness or anything else in the business that you think might be causing a change in trend here?

Again, we saw the revenue up less than seasonal, and the gross margins were the lowest we've seen in a while, so I'm not sure if you've seen some of your -- some of your vendors go more direct to some of your large customers, or if there's anything else beneath the surface we should know about?

Brian, this is Tim, I'll take that. So, overall, if you look at the industry trends, as noted by your demand survey, what the other analysts are saying, clearly the enterprise segment has been under some pressure, and there really isn't anything extraordinary, Brian, in that.

I think that we've got the right team in place. We've got the right strategy. What we simply saw with a number of our large accounts, their budgets were cut. They just weren't spending.

There wasn't a specific vertical, there was not any specific competitive threat from a vendor overall, it really was just a reduction of enterprise budgets. I think the good news in that is that we're very close to our customer base, our value proposition is strong, and we're not losing those customers, we're just off in their buying cycle.

Okay. And then on the SMB side, I think you talked about outbound being up 4%, I believe, but consumer being down, and I could probably do the math offline after the call. But if you have it handy, what does consumer represent as a percentage of revenue now? I know it used to be close to 10%, I'm just wondering if it's below five at this point?

Hi, Brian, Steve Baldridge. On a consolidated basis, the consumer represents something around 6% or less of our business.

Okay. And any strategic change there? is that a customer set that you are looking to be more aggressive in, or how would you kind of characterize the strategy in the consumer business?

Hi, Brian, this is Tim. Again, the consumer is an important component of our overall strategy, but as the competitive landscape changes, clearly solutions and the business customer has been our primary focus. So from a consumer perspective, we're not making any significant changes, but it really is not our business focus.

Okay. And then if I could move to the balance sheet, you're DSOs were up quite a bit year-over-year, and they are up a little bit sequentially as well.

Given that it sounds like the quarter may have gotten worse as time went on, it didn't strike me as this was a heavily back end loaded quarter. I'm just wondering, any other explanation for why the receivables were up as much as they were, and any plans going forward to bring those down to more hist historical levels?

This is Jack. The DSOs went up primarily because of the growth in the sales in our public sector. Typically, we find that the public sector sales typically have a slightly longer collection period.

I don't think there's anything out of the ordinary there, but in relation to the sales in the other segments, that, I believe, is the primary factor in seeing the DSOs go up. We are bringing those back in line, of course.

Okay. And then just on the product categories. I guess what struck me on the up side was the strength in networking, and on the other side, the weakness you saw in the storage segment.

Help us understand what drove the networking growth, which looks to be well above market what are customers doing in that area. Is that voice over IP driven, or is that more there traditional networking, and on the storage side, remind us how much of that storage category you would call network storage, and, again, what is the weakness there?

This is Tim. I'll take that. So overall, we are their pleased with our net/com growth, networking product growth, and we're seeing a number of trends that are affecting that. First, the actual growth did come from the traditional routing, switching, and security areas, as well as the wireless, but we do expect to see double-digit growth in all three of those areas.

And we're seeing that across multiple vendors. Certainly our Pro Connection, our solutions approach, has helped a lot. Some of our higher level certifications that Pro Connection brings, drives a lot of that, but overall, your correct in that virtualization has been a very strong trend, which also helps our software space, and I think that will continue.

The conversion space of video, voice and data also drives revenue in this area. On the storage side, that really is a function, again, of a lot of factors coming together. We did see a slightly softer demand, but I think that was in a year-over-year, coming off a tough comparable.

We did have some large storage orders in Q2 '07, so that makes the comparable a little tough for us.

Okay. Just a fine one for me. Your balance sheet looks pretty good. I think you have the highest net cash position you've had in a while.

You've talked about the possibility of entertaining acquisitions. What's keeping you from asking the board for a stock buyback, given where the stock is trading now at about tangible book and three to four times EBITDA? Thanks.

Brian, this is Jack. We actually do have authority from our board for stock repurchase programs. As you recall, we did actually buy back nearly a million dollars in stock with treasury in Q1, and we continue to look at the -- all of the alternatives. Obviously with our high cash balance we'll be continuing to look at that.

It's a balancing as to what the best use of our cash funds are, whether its stock purchase, whether its investment in the business, or for any other needs that we have going forward. So certainly it's something that we're looking at, and we have the authority to do so.

Could you remind us of what's remaining on that authorization, Jack?

The board -- it's about 11.8 million under the board authorization. It's a little less than ten million, as far as our bank loan covenant, but it's -- both numbers are plenty large enough for us to get into a program.

I guess I would just voice my opinion that with the stock trading where it is, I can't imagine there being acquisition opportunities that would be as attractive as buying your own stock at tangible book. That's it for me. Thanks.

Thanks, Brian.

(OPERATOR INSTRUCTIONS) We'll go next to Matt Sheerin with Thomas Weisel Partners.

Yes, thank you. Just regarding your guidance, which suggests that you'll be up a little bit sequentially and flat year-over-year. Where is that growth on a sequential basis coming from? Is that from your public sector, where you see a normal federal budget flush there, or -- and what is your outlook sequentially for your SMB and enterprise customers?

Hi, this is Tim. I'll take that. So I think overall we're expecting our demand to kind of mirror last year, so, again, we don't have great visibility, and obviously we saw the softness in Q2, but clearly a strength area is going to to be our public sector.

Okay. But you don't -- would you say you have less visibility on the corporate side then?

Yes. Again, we -- we can't anticipate, but right now our guidance is to be very similar to last year.

Okay. And -- and on the corporate side, both SMB and enterprise, given the softer demand environment, are you seeing more pricing pressure from competitors?

It's interesting, if you note from our Q2 performance, clearly we had a very strong margin performance, SMB is up 14.1%, and, again, I do think that we have the right strategy and the right team in place.

That said, as we get up into the larger opportunities, the mid-market space in particular, there is no doubt that as demand softens, several competitors show up. So clearly margin pressure will continue, so our strategy, then, is to look to the overall solution and bring in lots of our value-added services there that augment the traditional product margin pressure.

Okay. Great. And then lastly, you've mentioned that you're looking at some cost-cutting initiatives. I'm not sure I caught any specifics there, but are you looking to cut headcount, and would that include your sales force, or are you committed to keeping your sales force in place for when business does come back?

This is Jack. We do not expect to cut our sales force. We're really looking more to support activity, and looking to make them more efficient and more productive in light of the current sales levels, and anticipated sales levels.

So each group and department is certainly subject to that review, but sales people are not the place that we would want to cut them at this time. We have to balance between our short-term objectives and our longer-term growth objectives, and we don't want to make short-term decisions that's going to impede our longer term goals.

Okay. Great. Thank you.

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

Thank you, operator. In closing today's conference call, would like to first thank all of our customers and vendor partners for their business and support. I would also like to thank our dedicated co-workers, our investors, and everyone listening on the call this morning.

As noted earlier in the call, the company experienced softer demand in the second quarter. We believe revenues for the third quarter of 2008 will be in the same range as the third quarter of 2007. We are taking a number of actions to bring costs in line with anticipated sales level. We have implemented cost savings programs to better leverage our expense structure.

We will also continue to improve our internal processes through technology enhancements designed to increase productivity of our sales force. There is work to do, but we believe that our talented and experienced team will be successful in executing our plans and that we will continue to build long-term shareholder value.

We appreciate your time and your interest in PC Connection. Have a great day, everyone.

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