PC Connection Inc (CNXN) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the PC Connection first-quarter 2010 earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator instructions.) As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Steve Baldridge, Senior Vice President of Finance and Corporate Controller. You may begin.

Steve Baldridge. Thank you, and good afternoon, everyone. This is Steve Baldridge, Senior VP of Finance and Corporate Controller. Patricia Gallup, Chairman and CEO; Tim McGrath, President and COO; and Jack Ferguson, Executive Vice President and CFO, are also here with us today.

We're pleased to have you join us today for PC Connection's 2010 first-quarter earnings call. If you haven't already seen our press release, you can contact Janice Rush at 603-683-2322 and she will fax or email 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'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 annual report on Form 10-K for the year ended December 31, 2009, which is on file with the Securities & 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 afternoon, everyone, and again, thank you for joining us to review the Company's financial results for the first quarter of 2010.

Net sales in the first quarter increased year over year by $82 million or 25% to $408 million compared to the first quarter of 2009. I am pleased to report that our three primary sales segments achieved substantial year-over-year growth with our large account segment increasing their sales by 39%.

Net income for the quarter was $2.4 million or $0.09 per share compared to a net loss of $1.6 million or $0.06 per share for the prior-year quarter. The first quarter of 2009 included $0.9 million of special charges related to management restructuring and workforce reduction. Had these charges not been incurred, pro forma net loss for the first quarter of 2009 would've been $1 million or $0.04 per share. We did not incur any special charges for the first quarter of 2010. Our press release includes a reconciliation of last year's pro forma amount.

During the last quarter's conference call, we announced the formation of PC Connection Express, Incorporated, a new company focused on meeting the specialized product requirements of the consumer and small office/home office market. This Company launched its new website, pcconnectionexpress.com, in mid-January. Prior to the formation of PC Connection Express, consumer sales were included in the Company's SMB segment. In order to facilitate comparisons between 2010 and the prior-year period, our 2009 operating results for the SMB segment are presented on a pro forma basis that excludes consumer and small office/home office sales.

I'll now comment on our SMB segment, our original core business. Net sales increased this quarter on a pro forma basis by $41 million or 27% from the first quarter of 2009 to $192 million. SMB sales benefitted from pent-up demand for IT products, PC refresh, and the release of Windows 7. As we will discuss later, we experienced significant increases in sales of notebooks and desktops, as well as attachment products such as printers and memory.

Corresponding prior-year quarter, we experienced strong demand from our large account customers primarily for desktops, notebooks, and enterprise solutions. Sales to government and education customers reported as our public sector segment increased yea rover year by $16 million or 26% to $79 million. Federal government revenues increased by 30% year over year due to additional sales generated under federal contact programs.

Education sales and sales to state and local governments increased in the aggregate by 23% year over year due in part to growth attributed to higher education sales. PC Connection Express, which began operations in mid-January, reported sales of $11 million for only 75 calendar days compared to $22 million included in the SMB segment for the full first quarter of 2009.

Consolidated gross profit dollars in the first quarter of 2010 increased by $7 million or 17% to $49 million compared to the prior-year quarter. Gross margin representing gross profit as a percentage of net sales decreased to 11.9% in the first quarter of 2010 compared to 12.8% in the first quarter of 2009. The lower margin rates were due principally to continued aggressive price competition which impacted all of our sales groups.

SG&A expenses in the first quarter of 2010 totaled $44.5 million, an increase of less than 3% from the first quarter of 2009. The year-over-year dollar increase was primarily the result of higher variable compensation associated with our improved operating results partially offset by reduced headcount. SG&A expense as a percentage of sales was 10.9% for the quarter compared to 13.3% for the first quarter of 2009. This improved rate was due to the higher 2010 sales as well as cost savings implemented by management in 2009.

Income from operations for the quarter was $4.2 million or 1% of net sales compared to a pro forma operating loss of $1.7 million or 0.5% of net sales for the first quarter of 2009.

Average annualized sale productivity for the first quarter 2010 increased by 43% on a consolidated basis from the prior-year quarter. Revenues for each of our three primary sales segments increased by double digit percentages compared to the prior-year quarter. Sales productivity increased by 54% for SMB, 41% for large accounts, and 36% for the public sector.

The consumer business is largely web-based, and accordingly, we will not be reporting sales productivity for this group. We ended the quarter with 583 sales representatives compared to 629 on March 31, 2009 and 589 on December 31, 2009.

Now onto Q1 product sales trends. Notebooks and PDAs, historically our largest product category, grew year over year by 38% due to higher unit sales in Q1 2010 and accounted for 16% of net sales in the first quarter of 2010 compared to 15% in the prior-year period. Desktop and servers grew by 53% during the quarter and accounted for 15% of net sales in Q1 2010 compared to 12% in the prior-year quarter. We also experienced significant growth in attachment sales as both printers and memory sales increased substantially.

Printers and supplies grew by 28% year over year and accounted for 10% of net sales in Q1 compared to 9% in the prior-year quarter. Memory and system enhancements grew by 49% year over year and accounted for 4% of net sales in Q1 2010 compared to 3% in the prior-year quarter. Our customers in our primary segments are increasingly making capital investments in IT products and solutions.

Average selling prices or ASPs for computer systems were largely unchanged in the first quarter of 2010 on a year-over-year basis. ASPs increased substantially by 11% primarily due to higher notebook pricing. Notebook and PDA revenue growth in the first quarter was due to higher unit sales as ASPs were unchanged on a year-over-year basis. Desktop sales also increased year over year due to higher unit sales despite a 9% decrease in ASPs. The growth in server sales was due to increased ASPs driven by higher end server sales to certain large account customers.

We will continue to strengthen our business in 2010 by making further investments in our own internal IT systems and in our professional services capabilities. We believe these investments will enable us to better serve our customers.

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

Thanks, Pat. First, to cash flow. Cash flow provided by operations for the three months ended March 31, 2010 was $13.7 million compared to $23.1 million for the prior-year period. Operating cash in the first quarter of 2010 benefitted from decreases in both accounts receivable and inventory, partially offset by a decrease in accounts payable. We expect to continue to generate cash from operations as we have done in the past.

Capital expenditures in the first quarter of 2010 were lower than in the prior-year period amounting to only $700,000 in 2010 compared to $1.9 million in 2009. Financing activities in the first quarter of 2010 was generally unchanged from the prior year period, and in both periods, our use of cash related to repayment on a capital lease obligation as well as treasury stock purchases.

Our cash balance increased by $12.7 million compared to a $20.9 million increase for the prior-year period. We again had no outstanding quarter-end borrowing from our credit facility and we ended a quarter with a cash balance of $59 million.

Turning to the balance sheet, accounts receivable as of March 31, 2010 decreased by $22 million to $196 million compared to the balance at December 31, 2009. Days sales outstanding, or DSOs, were 48 days as of March 31, 2010 compared to 46 days as of March 31, 2009 and 47 days as of December 31, 2009. The increase in DSO days over last year primarily resulted from the public sector whose customers generally have slower bill to cash cycles. We are continuing to monitor ongoing credit exposure from our customers in all of our segments given the current liquidity environment in order to minimize credit risk from our customers.

Inventory balances decreased by $7 million compared to the prior-year end balance due primarily from lower inventory in transit from our vendors. Inventory turns for the quarter increased to 25 compared to 20 for the prior-year period and to 24 for the fourth quarter 2009. 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 were 61% of total net sales in both the first quarters of 2010 and 2009. We continue to focus on increasing drop shipments where appropriate and cost-effective which supports lower inventory levels.

In summary, even considering the challenges from the current economy, our balance sheet remains very healthy.

We will now entertain your questions. Operator?

(Operator instructions.) And our first question comes from Bob Sales for LMK Capital Management.

Hi. I feel like I'm going to have a lot of air time here because I pushed the button late and there's no one in front of me, so you either got some shy participants on the call or it's you and I. It's a nice quarter. I was just thumbing through your operating margins going back looking at '05, '06, '07, '08, and it looks like your operating margins have peaked at various times in the 2% range. Can you give me some sense of number one, are your operating margins -- is there any seasonality that you have seen in your business as you look back, and two, are there levers that you can manage to balance the top line with the operating margin percentage?

Hi Bill (sic). This is Steve Baldridge. Let me start by saying you're right when you look at 2007 and see 2% operating income and 160 basis points in 2006. During those timeframes, the gross margin rates were also higher, and I think that one of our challenges in this very price-competitive environment is in the gross margin area as we're all negotiating or competing for fewer sales. So, I think there's opportunities for us to improve our operating income by growing again our gross margin rate. I wouldn't necessarily say that there's something cyclical about it.

Other than perhaps in the public sector which Q1 tends to be its lowest quarter. It will increase in Q3 -- Q2 and Q3. And I think the other aspect is that there's a certain level of our costs that are relatively fixed in nature and, of course, our operating margin is guided by not only the gross profit margin but by the sales volume. And so while we continue to manage our costs where we can, there will be swings from quarter to quarter.

And a follow-up if I might. What would you say is different now versus those timeframes? Is it the weakness of the end market, therefore people are more price-sensitive, or has there been some sort of secular change that will be different for this upturn versus 2006 and 2007?

This is Tim. So, I think in general there are some differences in the market. If we look at the last economic downturn, clearly it was a much longer downturn, much more prolonged and much more gradual. This economic downturn, as you know, things kind of fell steeper, but they also climbed back a little quicker. So in that process, we are seeing our customers starting to come back. We're starting to go into more of a recovery here as you know. But the marketplace is still very competitive. So, many of our competitors are with us and we say we end up in these opportunities and we are all there battling it out together. Overall, we're pleased with our value proposition. We're pleased with our growth, and we think that over time we're going to continue to see recovery in this market.

Thank you. What I'm going to do is I'm going to leave it there and get back in queue in case there are other people waiting for questions.

Okay. Thank you.

(Operator instructions.) And we have a follow-up from Bob Sales.

The next question I wanted to understand on the same topic was operating margins. Can you, to the extent you're willing to talk about the margins along the various end markets that you cover, I guess since you mentioned it, perhaps, contrasting the public sector sales with some of the corporate sales?

You're referring to our operating income?

Well, I'm referring to ultimately the operating martin, but I think it's going to manifest -- the variability will probably manifest itself at the gross margin level.

Sure, so maybe we could start with just as we looked at our Q1 performance, our consolidated gross profit as a percent of net sales was 11.9% in the first quarter of 2010, and that compared to 12.8% in the prior-year quarter.

And again, the continued aggressive price competition really in all the segments led to the lower invoice product margins, but also increased sales to large account customers who have a lower margin rate, so some mix from our enterprise customers. It also contributed to a lower consolidated gross margin year over year. So, typically, as you look historically at the gross margin rates, your SMB segment has higher margin rates within your public sector and your enterprise customers having lower margin rates.

And I'm just looking at the growth rate. Would -- it looks like your SMB sector grew -- what was your large account growth during the quarter, year over year?

It was 39%, the large account.

39%? I'm actually surprised by the growth of your SMB business. I thought that would be lagging the other businesses. But is it fair to say that if that comprises a bigger percentage of your revenue that would positively impact your gross margins?

Yes, from a mix basis, it would positively impact the consolidated gross margin rate.

Okay. And then it looks like the categories you cited -- your biggest categories, notebook PDA, desktop and servers, printers and supplies and memory, all went up as a percentage of revenue. The total's a little less than 50%. What was the -- what were the laggers in terms of product categories during the quarter?

Bob, this is Tim. I'll take that. So, to begin with, I think if you look overall at some of the product categories, we're very pleased to see there were some real drivers of growth and those drivers of growth tended to expand the categories. I'll give you an example. We had tremendous growth in network servers and that was driven by some of the green initiatives and energy saving, some of the virtualization, and of course, Windows 7. So overall, many of the categories we saw terrific growth. Some of the categories that were a little bit lighter were the categories that were peripheral to that and some of the adjunct and add-on categories. But the mainstream categories we saw very solid growth.

Okay, and as I look at the product segment, can you help me understand, maybe rank order, the profitability by product area at the gross margin level, if you're able to?

So, Bob, your question is gross margin by product by segment?

Well, gross margin by product. So, whether or not desktops are more profitable for you than notebooks, printers, and supplies versus those two. If you're able to do that on a general sense.

Well, from a general sense, a high level, a lot of the networking and higher-end servers and -- may have higher margin rates, but historically we've not provided a lot of information by product categories so I'd prefer not to go there.

Okay. Thank you. You're -- looks like you're doing a great job. I mean, by these numbers, it looks like you've got to be taking share relative to your competitors, so tremendous job. You've done a great job through the whole downturn.

Thank you very much.

Thanks.

Thanks, Bob.

And at this time, I'd like to turn the call over to Patricia Gallup for any closing remarks.

Thank you, Operator. In closing, we're encouraged by the improvement in our overall performance in the first quarter. We achieved 25% sales growth year over year and we generated over $4 million in operating income and earnings of $0.09 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 effort. 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.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day.