PC Connection Inc (CNXN) 2009 Q4 法說會逐字稿

Good day, everyone and welcome to PC Connection's fourth quarter 2009 earnings conference call.

(Operator Instructions).

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

Thank you, and good afternoon, 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, PC Connection Enterprises, are also here with us today. We are pleased to have you join us today for PC connection's 2009 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. Additionally, this conference call is the property of PC Connection and may not be recorded or rebroadcast without specific permission from the Company.

I would like to inform our participants that any statement or references made during the conference call that are not statements of historic fact, and 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 of 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, 2009, 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 statement 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?

Thanks, Steve. Good afternoon everyone, and again, thank you for joining us to review the Company's financial results for the fourth quarter of 2009. Net sales in the fourth quarter increased year-over-year by $24 million, or 5% to $463 million compared to the fourth quarter of 2008. Increased sales in our public sector and large account segments were partially offset by a slight decline in SMB sales. Net sales increased by $60 million or 15% over the third quarter, representing the third straight quarter of sequential revenue growth. This was due in part to the seasonal growth in consumer sales, as well as increased sales to commercial customers in both our SMB and large account segments. Net income for the quarter was $4 million, or $0.15 per share compared to a net loss of $2.7 million or $0.10 per share for the prior year quarter.

The fourth quarter of 2009 included a small adjustment to special charges that increased earnings, whereas the fourth quarter of 2008 included a $8.8 million of non-cash special charges related to the write-off of goodwill. Had special charges not been incurred, pro forma net income for the fourth quarter of 2009 would have been $3.9 million or $0.14 per share, compared to $2.7 million or $0.10 per share in 2008. Our press release includes a reconciliation of these pro forma amounts. I will now comment on our SMB segment, our original core business. Net sales decreased this quarter by $4 million or 2% from the fourth quarter of 2008 to $221 million. A slight improvement in corporate sales compared to the prior year quarter, was more than offset by a decline in consumer sales.

However, net sales grew sequentially by 21% reflecting sales growth with our business and consumer customers. This represents this business's third straight quarter of sequential growth. Sales by our MoreDirect subsidiary, reported as our large account segment, increased by $10 million or 9% to $224 million in the quarter, compared to the corresponding prior year quarter. Similar to our SMB customers, we are experiencing stronger demand from our large account customers, primarily in desktops, licensing, server, and virtualization products. Sales to government and education customers, reported as our public sector segment increased year-over-year by $18 million or 18% to $119 million. Our federal business increased by 23% year-over-year, due to additional sales generated under federal contract programs. Education sales and sales to state and local governments increased by 13% year-over-year, partly due to the success of our South Dakota sales office open in Q4 of last year.

Consolidated gross profit in the fourth quarter of 2009 was $52.5 million, up slightly from the prior year quarter. Gross margins representing gross profit as a percentage of net sales, decreased to 11.3% in the fourth quarter 2009, compared to 11.8% in the fourth quarter of 2008. The lower margin rates were due to continued aggressive price, competition, as well as increased public sector and large account sales, which generally have lower profit margins compared to SMB corporate customers. SG&A expenses in the fourth quarter of 2009 to $46 million, down slightly from the fourth quarter of 2008. SG&A expense as a percentage of sales was 9.9% for the quarter, compared to 10.5% for the fourth quarter of 2008, and 10.2% for the third quarter of 2009. Variable compensation increased in the fourth quarter of 2009, due to improved operating results, but was offset by reduced headcount, as well as other cost savings implemented by management in the past year.

We continue to review our operating costs to better align them with sales volumes, and we will implement additional cost reductions as required. Income from operations for the quarter was $6.6 million, or 1.4% of net sales, compared to an operating loss of $3.2 million or 0.7% of net sales for the fourth quarter of 2008. Net income for the fourth quarter of 2009 was $4 million, compared to a net loss of $2.7 million for the fourth quarter of 2008. Our effective income tax rate in the fourth quarter of 2009 was 40%, compared to 12% tax benefit in the prior year period. We expect our effective tax rate will continue to vary in future quarters, given the complexities of financial reporting requirements and state income taxes. On an annual basis, sales declined in 2009 by 10%, to $1.6 billion. On a segment basis, SMB and large account sales declined in 2009 by 18% and 10% respectively, from 2008 levels. However, public sector sales increased by 8% in 2009, over 2008. Annual gross profit dollars decreased by 14% to $185 million in 2009, compared to 2008. And gross profit margin in 2009 was 11.8%, compared to 12.3% in 2008.

Gross profit margins were impacted by competitive pricing pressures, as well as the increase in public sector sales that generally have lower margin rates, compared to corporate customers. We reduced SG&A expense by $14 million in 2009 to $173 million, compared to $187 million in 2008, largely due to the cost savings initiatives implemented by management during the year, and reduced variable compensation due to lower sales. Net loss for 2009 was $1.2 million, compared to net income of $10.4 million for 2008. Both 2009 and 2008 included special charges that reduced earnings, and earnings per share.

Had these charges not been incurred, pro forma net income for 2009 would have been $6.8 million or $0.25 per share, compared to $16.7 million or $0.62 per share in 2008. Average annualized sales productivity for the fourth quarter increased by 22% on a consolidated basis from the prior year period, as all three segments increased by double-digit percentages year-over-year. Sales productivity for the SMB segment increased by 22%. Large account increased by 11%, and the public sector increased by 21%. We ended the quarter with 589 sales representatives, compared to 712 on December 31, 2008, and 601on September 30, 2009.

Now on to Q4 product sales trends. Notebooks and PDAs, historically our largest product category, accounted for 15% of net sales, in both the fourth quarter of 2009 and 2008. Video and imaging product sales also accounted for 15% of total sales in both fourth quarters. In both 2008 and 2009, certain large video product sales to several commercial customers boosted sales in this product category. Software sales accounted for 14% of net sales in Q4 2009, compared to 13% in the prior year period. Strong federal government sales as well as virtualization, increased software sales by 11% in the fourth quarter of 2009.

Desktop and servers accounted for 30% of net sales in Q4 2009, compared to 12% in the prior year quarter. Our customers, across all segments are increasingly making capital investments in IT products and solutions. Average selling prices, or ASPs for computer systems decreased in the fourth quarter of 2009 by 15% year-over-year and by 5% sequentially. Q4 notebook and PDA revenues increased by 6% year-over-year, as higher unit sales were partially offset by a decline in ASP related to netbook sales. Desktop and server sales increased 15% from the prior year quarter due to pent-up demand for IT equipment.

Moving forward, we will continue to invest in the sales marketing technology programs that we believe are necessary to ensure our future growth and success. At the same time, we 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 a loyal following of customers who purchased from us for their personal and home office needs. To better serve that market, with last month we started a new company, PC Connection Express Inc. This company will focus on the specialized product requirements of the consumer and small office/home office market. And now, Jack Ferguson will discuss our financial results in more detail. Jack?

Thanks, Pat. First, the cash flow. Cash flow provided by operations for the year ended December 31, 2009 was $5.7 million, compared to $45.2 million for the prior year period. The majority of this decrease in cash flow was due to an increase in accounts receivable, resulting from stronger year-end sales, partially offset by an increase in accounts payable. Capital expenditures in 2009 were lower than in the prior year, amounting to $5.6 million in 2009, compared to $10.3 million in 2008. Financing activities in the year ended December 31, 2009 related to repayments on a capital lease obligation, as well as treasury stock purchases. Our cash balance decreased slightly in 2009, compared to a $33 million increase in the prior year period. We have no outstanding quarter end borrowing from our credit facility, and ended the quarter with a cash balance of $46 million.

Turning now to the balance sheet, accounts receivable as of December 31, 2009 increased by $32 million to $218 million, compared to the balance at December 31, 2008. Days sales outstanding were 47 days as of December 31, 2009, compared to 45 days, both as of December 31, 2008, and as of September 30, 2009. The increase in DSO days over last year, resulted primarily from the increase in public sector sales. Public-sector customers generally have longer bill to cash cycles. We are continuing to monitor ongoing credit exposure from our customers, given the current liquidity environment, and minimize credit risk from our customers. Inventory balances increased by $7 million, compared to prior year end balance, primarily due to inventory and transit from our vendors. Inventory turns for the quarter increased to 24, compared to 20 for the prior year period.

We continue to believe that 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 was 61% of total net sales in the fourth quarter of 2009, compared to 57% in the fourth quarter last year. We continue to focus on increasing drop shipments where appropriate and cost effective, which supports lower inventory levels. In summary, despite the current economy, the balance sheet remains very healthy. We will now entertain your questions. Operator?

Thank you.

(Operator Instructions).

And we will go first to [Neville Hanano] with Raymond James.

Can you hear me?

Yes.

Good afternoon.

Good afternoon. Thank you.

If I look on a sequential basis, your consolidated revenue was up 15%, which looks like you were well above normal seasonality. Can you comment on if the increase was more macro driven or simply year and budget flush from your commercial customers?

Good afternoon. I will take that. I think there were a competition of factors in play. Earlier we did see a little bit of a refresh happening, a technology refresh happening. And we did see some year-end budget and project work start moving through the business. And naturally, the macroeconomic environment in December especially, I think really helped that. Overall, I think it points back to execution of our strategy.

Thank you. When I look at your gross margins by segment, I see that you're SMB and Corporate were both down a year-over-year and sequentially. Can you speak to the pricing pressures that you're seeing in the market in each segment? I do understand that the decline in SMB will be partially attributable to your seasonal mix of products.

Hi, Neville, this is Steve Baldridge. I will make a couple of comments and let Tim elaborate. But our commercial customer sales segment did experience year-over-year sequential declines in their gross margins. The lower margin rates were due largely to the aggressive pricing competition that we have mentioned in previous quarters, and that pricing competition continued in Q4.

That's right, Steve. As a matter of fact, we see hyper competitive pricing pressures out there in the competitive landscape. But we also did make an investment in new account acquisitions in the quarter.

And did that pricing pressure, did it accelerate, decelerate or is it pretty much flat from the last quarter?

I would say that as the activity started to heat up, and we found ourselves competing in more project work, the competition was very strong. I think it accelerated toward the back end of the quarter.

All right. That's helpful. Thank you. Now that the environment is clearly improving, I would expect you would add back some cost at a measured pace. Can you remind me what the historical variable cost, either for revenue dollar or GP dollar is? And do you think the historical relationship will be any different going forward, given the action you have taken during the downturn.?

This is Jack Ferguson. As you can appreciate, we have a substantial portion of our expenses as relatively fixed over certain ranges. The highest percentage of our costs are, of course, personnel costs. So it depends on the range that you're speaking, as to whether increases in revenue is going to, what percentage of increase in cost that is going to generate. As you have undoubtedly read, we have taken out a fair amount of our costs in 2009, structural changes, to try to make the operations more efficient. But we have historically had a target of generally figuring each margin dollar increase, we would try not to increase SG&A over 50% or less than that increase. And that's over a longer period. I'm not sure I can be more specific than that. It depends on the range of increase that you might be looking at.

No, that's helpful. I appreciate it. Now if I may switch to your product mix, your servers and enterprise networking were up 25% year-over-year to over $180 million quarterly run rate. That is as highest that I can recall. Can you walk me through on what drove that growth which is nearly four times your large enterprises segment, where I imagine most of the business is?

Thanks, Neville. I think there were a number of factors in play. We focused on kind of landing and expanding our business, driving our solution business within our accounts. That certainly played a role, and you'll note that our average order size that increased nicely. So we are doing a better job connecting and making a more robust server offerings. And finally, as I mentioned, a number of new buy accounts, and I think again we have been involved in more opportunities. So we are very pleased with the solution focus, and the rise of enterprise sales. Our enterprise products, excuse me.

And is that -- are those products significantly higher margin or just a little bit higher margin than what you normally ship your enterprise customers?

Again, in this competitive environment, its tough to beat definitive there. But the enterprise, you know the Blade server products and the virtualization products tend to be higher margin.

Okay. And just my last question, looking at software, too, was up in the double digits. Microsoft, two weeks ago, I believe had a blowout quarter with their Windows 7 products, albeit that was consumer driven. What has been the customer feedback so far on the software? Are they still waiting for the Service Pack 1, and then related to that, what are your comment on the PC upgrade cycle, given the nature of the installed base? Thank you.

Thanks. We certainly hope there is a correlation there. We are seeing our customer base being a little more enthusiastic about Windows 7, certainly a little more than they were about Vista. And we are seeing some encouraging signs that there will be a desktop refresh, to go along with the Windows 7 refresh. So overall, we are positive with the response to Windows 7, and we do anticipate that point upward trend to continue.

Great. Thank you very much. That doesn't for me.

Thank you.

(Operator Instructions).

And at this time, we have no further questions. I will send the call back over to Ms. Patricia Gallup, for any closing or additional remarks.

Thank you, operator. In closing, despite the challenging business environment, our fourth quarter sales grew by 15% sequentially. And we generated over $6 million in operating income and earnings of $0.15 per share. I would like to thank all of our customers, vendor partners, and shareholders for their continued support and our dedicated coworkers for their efforts. I would also like to thank those of you listening to our call this afternoon. Your time and interest in PC connection are appreciated. Have a good evening.

That concludes today's conference. We thank you for your participation.