PC Connection Inc (CNXN) 2008 Q4 法說會逐字稿

Good day, everyone and welcome to the PC Connection Fourth Quarter 2008 conference call. This call is being recorded.

At this time, I would like to turn the call over to Senior Vice President of Finance and Corporate Controller, Mr. Stephen Baldridge. Please go ahead, sir.

Thank you and good morning, everyone. This is Stephen Baldridge, Senior Vice President 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're pleased to have you join us for PC Connection's 2008 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 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 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 December 30, 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 am now going to turn the call over to our CEO, Patricia Gallup, for her remarks on our quarterly and annual results. Pat?

Good morning, everyone. Again, thank you for joining us. Our results for the quarter reflected the downturn in the economy and the associated decline in demand for IP products. The weakness in the economy resulted in more conservative buying patterns on the part of our customers, ordered deferrals and longer sales cycles. Net sales for the fourth quarter of 2008 decreased $50 million or 10%, to $439 million from $490 million for the fourth quarter 2007. Sales declines experienced in the SMB in large account segments were partially offset by increased public sector revenues. We are preliminarily reporting net income for the fourth quarter, 2008 at $1.9 million or $0.07 per share compared to $6.2 million or $0.23 per share for the prior year quarter. As stated in our press release, the quarter ended December 31, 2008 included $1.2 million of special charges related to goodwill impairment in our SMB segment. Had these charges not been incurred, pro forma net income for the current quarter would have been $2.7 million or $0.10 per share, compared to pro forma net income of $6.5 million or $0.24 per share for the fourth quarter of 2007. Our press release includes a reconciliation of these pro forma amounts.

In addition, the Company is not yet completed its impairment review of goodwill attributed it's public sector and large account segments. We expect this review will be completed in time for filing our annual report on form 10-K in mid March and that any additional non-cash impairment charge would recognized at that time. Thus, net income and earnings per share for the quarter and year ended December 31, 2008 reported today are preliminary and subject to change based upon the results of this review.

I'll now comment on our SMB segment, our original core business. Net sales decreased by $39 million or 15% from the fourth quarter 2007 to $255 million. Our corporate outbound sales to small and medium-sized businesses for the quarter decreased by 19% year-over-year, reflecting the industrywide slowdown in purchasing patterns from our SMB customers. Additionally, large sales of video products to three customers in the previous year quarter were significantly less this year, contributing to the sales decline. However, Q4 consumer sales grew year-over-year by more than 14%, as a result of a recent expanded internet marketing initiative and improvements to our website. Sales to large corporate account customers, reported as our large account segment, decreased by $27 million or 19% to $113 million from the corresponding prior year quarter. More direct experience decreased revenues from further softening of large corporate spending, as well as increased price competition. Both our SMB and large account segments continue to be challenged in this uncertain business environment.

On the other hand, sales to government and education customers, reported as our public sector segment, continue to be a highlight of our business. Revenues for a public sector segment increased by $15 million or 18% from the fourth quarter of 2007 to $101 million. Our federal business increased by more than 25% year-over-year due to additional sales realized under federal contract programs. This represents the seventh consecutive quarter of double-digit year-over-year growth for our public sector business.

Consolidated gross profit dollars decreased year-over-year in the fourth quarter of 2008 by 10% or $5.5 million to $52 million. Gross margin, representing gross profit as a percentage of net sales, was 11.8% in the fourth quarter of 2008, compared to 11.7% in the fourth quarter of 2007. Gross margin rates this past quarter increased slightly year-over-year due to improved invoice profit margins, only partially offset by lower agency C revenues.

SG&A expenses decreased slightly to to $46 million for the fourth quarter of 2008, compared to $47 million for the fourth quarter of 2007. The dollar decrease was attributable to reduced variable compensation associated with lower sales volumes, as well as cost reductions implemented by management. These decreases were partially offset by a charge of $600,000 related to a fixed asset disposal and increased bad debt expense. We also continued this past quarter to make investments in key strategicnesses and sales system enhancements. SG&A expense, as a percentage of sales, was 10.5% for the quarter compared to 9.5% for the prior year period. Their rate increased resulted from lower sales volumes and previously mentioned costs.

As discussed on last quarter's call, given the softness in customer demand, management took actions in the third quarter to reduce cost in line with lower sales volumes. We reduced head count and sales support areas and implemented various operating cost reduction programs that are expected to result in annualized sales savings of $6 million. We continue to review our operating costs to better align them with expected lower sales volume.

Our affected income tax rate for the fourth quarter of 2008 was 57% compared to 38% for the corresponding prior year quarter. The increased rate, which reduced earnings per share by $0.02, was due primarily to an increase in valuation allowances associated with certain state tax credits.

Preliminary income from operations for the quarter was $4.5 million or 1% of net sales compared to $10.1 million or 2.1% for the fourth quarter of 2007. We are preliminarily reporting net income for the quarter of $1.9 million, subject to possible adjustment for further non-cash goodwill adjustment compared to $6.2 million for the fourth quarter of 2007.

On an annual basis, sales decreased year-over-year by $32 million or 1.8%, as sales growth in our public sector segment was offset by declines in our SMB and large account segments. Gross profit dollars decreased in line with sales, reflecting our ability to hold gross margin rates level in 2008.

SG&A expense increased in 2008 by $5.1 million or 2.8% over the prior year. SG&A expense, as a percentage of sales, increased by 40 basis points over the prior year to 10.6% of net sales.

Our preliminary annual operating income decreased by$ 11.3 million to $25.5 million in 2008. Operating income, as a percentage of net sales, was 1.5% in 2008 compared to 2.1% in 2007. We are preliminarily reporting net income of $15 million or $0.56 per share, subject to a possible non-cash adjustment for further goodwill impairment, compared to $23 million or $0.85 per share in 2007.

On a consolidated basis, average annualized sales productivity for the fourth quarter decreased by 14% from the prior year. Average sales productivity in the SMB segment decreased by 15% year-over-year. In the large account segment, sales productivity decreased by 16% from the fourth quarter of 2007. Due to the establishment of a new sales office in South Dakota and the hiring of associated sales personnel late in the fourth quarter, sales productivity for the public sector segment decreased by 5%. Excluding these new personnels, sales productivity for the public sector segment increased by 9%. We ended the quarter with 712 sales representatives, up 4% from 683 representatives at prior year end.

Now on to Q4 product sales trends. Our two largest product categories, notebooks and PDA's, and video imaging and sound each accounted for 15% of total sales. Software and desktop service sales accounted for 13% and 12% respectively. For the third consecutive quarter, our Netcom product growth showed the highest year-over-year growth at 24%. Average selling prices or ASPs for computer systems decreased year-over-year by 12% in the fourth quarter of 2008 and decreased by 4% compared to the third quarter of 2008. Q4 notebook and PDA revenues decreased by 9% and desktop and server revenues decreased by 17% year-over-year reflecting declines in both unit sales and ASPs.

In 2008, service revenues experienced double-digit growth. We continue to invest in our services initiative, ProConnection and ServiceConnection through increased levels of sales training, targeted promotions and additional certifications for products. We believe these investments strategically position PC Connection to capture a larger portion of the services market.

We will continue to monitor our operating costs and review our spending plans and programs to enable the best possible allocation of our resources. However, we will continue to invest in the sales marketing and technology programs we believe are necessary to ensure our future growth and prosperity.

As mentioned earlier, in late December, we opened a new sales office in South Dakota to support the continued success of our public sector segment. We expect the new call center will be accretive to earnings during the second half of 2009 and represent a 10% sales growth in our public sector business for 2009.

And now, Jack Ferguson will discuss our financial results in more detail. Jack?

Thank, Pat. First, the cash flow. Cash flow provided by operations for the year ended December 31, 2008, with $45.2 million, compared to $400,000 for the prior year. The majority of this increase was due to a reduction in accounts receivable and inventories in 2008, which ultimately improved cash flow. Capital expenditures in the year ended December 31, 2008, were higher than in the prior year amounting to $10.4 million in 2008 compared to $7.1 million in 2007. As noted previously, investments to enhance our customer relationship management systems accounted for much of this increase.

Financing activities in the year ended December 31, 2008, represented a $1.6 million use of funds compared to a $2.8 million source of funds for the prior year. In 2008, we purchased $1.5 million of our outstanding stock for treasury, whereas in 2007, the exercise of stock options provided $2.9 million in cash.

Our cash balance increased by approximately $33 million in the year ended December 31, 2008, compared to a $4 million decrease for the prior year. Our cash flows remain strong with no outstanding quarter end borrowing from our credit facility. Our borrowing capacity under our credit facility remains unchanged.

Turning to the balance sheet. Accounts receivable as of December 31, 2008, decreased by $16 million to $186 million, compared to the balance at December 31, 2007. Day sales outstanding were 45 days as of December 31, 2008, compared to 43 days as of December 31, 2007 and 45 days as of September 30, 2008. Given the current economic environment, we are taking additional steps to minimize credit risks from our customers. Inventory balances decreased by $15 million or 20% compared to the prior year end balance.

Inventory turns were down slightly at 20 this quarter compared to 21 turns at the prior year end. We still believe inventories are in excellent condition, both in quantity and in quality. Net sales of products dropped shift by distributors and other vendors directly to customers accounted for 57% of total net sales in the fourth quarter of 2008, compared to 51% in the fourth 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, despite the current economy, the balance sheet remains very healthy. We will now entertain your questions. Operator?

Yes. (Operator Instructions). Our first question comes from Nabil Hanano, Raymond James.

Hi, this is Nabil Hanano in for Brian Alexander. I was wondering if you can just talk about the linearity per quarter for each of the segments? To become progressively worse each month and if so, does that trend continue into January?

It's Tim, so if we look at the calendarization of sales in the quarter and then the demand trend leaving the quarter by sales segment during Q4 as noted from the call gear, our average daily sales were lower during the month compared to the previous year. November was the softest month in the quarter. We did see our public sector business demand was fairly solid throughout the quarter and in terms of the linearity we -- November was the softest month overall in the quarter. So, we did see it dip down in November.

So it's bounced back and you're seeing that trend continue into January?

No, it hasn't -- December was stronger than November but we have not seen that trend continue into January.

Okay.

January has been a little softer.

And then, what are you seeing in terms of customer retention? How much of the revenue decline is due to customer share loss or customer or share loss versus lower spending by your existing customers?

That is a great question. We have been following that very closely. We're pleased to say that we're retaining our customers and in fact, our acquisition strategy has been pretty solid. However, our existing customer base does have a lot of budget constraints and they just are not spending given this economic environment. Not spending as much.

Okay. And then in terms of your competition on the pricing front, are you seeing your competitors become more aggressive as demand continues to deteriorate or is demand staying steady? Sorry.

As you might guess, when the market contracts it is a highly volatile, highly competitive environment and I think we do tend to see in market conditions like this, we see folks really become ultra-competitive. I would describe it as a very competitive marketplace right now.

Okay. Just my last question. What are vendors doing in this environment in terms of rebates or other vender funding compared to the last down cycle and do you you think the goals for vender rebates are being reset to attainable levels the next quarter?

Overall, if you look at what happened with us in Q4, on a consolidated basis we actually improved our back end vendor rebates by 27 base points. However, the dollar volume was fairly consistent, was fairly flat. I think that our strategic initiative that we have with our key vendor partners have allowed us to maintain these historic levels of funding. So, where -- at this point, we have maintained and I would say that on a dollar volume basis, we are flat.

Okay that's it for me. Thank you very much.

Thank you. (Operator Instructions).

Our next question comes from Matthew Sheerin, Thomas Weisel Partners.

Thanks, good morning. I know that you don't normally give specific guidance for the March quarter, but you just stated that sounds like January got off to a slower start. Typically your revenues are down sequentially because of seasonality. Are you seeing normal seasonal trends or is it going to be worse than seasonal so far this quarter, based on what you have been seeing?

So this is Tim. We look at that, obviously, on a segment basis and overall, there is no doubt the demand is softer across all three of our segments. Public sector has maintained, I would say, the best overall but, no question we're in a light demand environment.

And I suppose both SMB and enterprise? Any stand out as being better or worse than the other?

I would say they're fairly consistent. We don't give guidance and all we can say is what we have seen so far is a softening year-to-date.

Okay. And you also mentioned in the statement about a margins being impacted somewhat by lower net agency fees. Could you be more specific about that? Does that have to do with software licenses being softer or other things?

Hi, Matt. This is Steve Baldridge. The reduction in agency fees -- fee revenue would relate to our public sector but also our commercial customers and software assurance would be part of that reduction for sure. So, sort of a combination of revenue, or agency revenues from both the public sector and software assurance-related fees.

Why do you think the software assurance fees would be down? Is that cycle related or customers basically cutting back there as part of their own budget cuts?

Well, the historic trend for us has been stronger, software assurance revenues in Q2 and Q3 with Q1 and Q4 being a little softer. But clearly, as you look at the software sales, you can also see the declines in softness and demand there which, of course, would also impact software assurance. Okay, great.

And just lastly, just in terms of your own expense structure, I missed the beginning and in terms of your own cost structure. Do you, based on the lower revenue run rate, do you have -- have you talked about cost-cutting programs, head count reduction or anything like that?

Yes, this is Jack Ferguson. We actually initiated a cost-reduction program in Q3, which we're beginning to see some of the impact in Q4, which we expect to generate a cost savings annualized of about $6 million. So as you can understand, this is the continuing process. As our revenues change, we have to continue to look at our cost structures and keep them in line with the revenue stream. And as in the past, all costs are subject to that review. Now, that having said, we are still maintaining the investments that we have to have to operate our business. We don't want to make short-term decisions that jeopardize our long-term ability and growth possibilities. So, it is a balancing exercise but we continue to look very closely at costs and, as I said, all costs are subject to a continuing review.

Okay, great. All right, thanks very much and good luck.

Thank you, Matt.

Thank you. (Operator Instructions). It appears we have no further questions on the phone at this time. I would like to return the call back over to Patricia Gallup for closing remarks.

Thank you, Operator. I would like to thank all of our customers and vendor partners for their businesses and support. I'd also like to thank our dedicated co-workers and those of you listening on the call this morning. We appreciate your time and your interest in PC Connection. Have a great day.

Again, ladies and gentlemen, this does conclude today's conference. We thank you for your participation, you may now disconnect.