PC Connection Inc (CNXN) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the PC Connection 2010 Second-Quarter 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 may be recorded.

And now I'll turn the program over to our host, Steve Baldridge, Senior Vice President of Finance and Corporate Controller. Sir, please go ahead.

Thank you. 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 Second 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 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'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 the risk factors section of the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2010, 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 afternoon, everyone, and again, thank you for joining us to review the Company's financial results for the second quarter of 2010.

Net sales in the second quarter increased year over year by $100 million, or 27%, to $478 million compared to the second quarter of 2009. I am pleased to report that each of our three primary sales segments significantly grew sales this past quarter and that both the large accounts and public sector segments reported record quarterly revenues.

Net income for the quarter was $5 million, or $0.18 per share, compared to a net loss of $6.5 million, or $0.24 per share, for the prior-year quarter.

The second quarter of 2009 included $12.1 million of special charges related primarily to the write-off of a software development project. Had these charges not been incurred, pro forma net income for the second quarter of 2009 would have been $1.1 million, or $0.04 per share. We did not incur any special charges for the second quarter of 2010.

Our press release includes a reconciliation of last year's pro forma earnings.

During 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 or SOHO, market.

Prior to the formation of this new company, consumer and SOHO sales were included in our 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 exclude sales made through our inbound and Web channels. These sales are now reported under our consumer SOHO segment.

I'll now comment on our SMB segment, our original core business.

Net sales increased this quarter by 26% to $191 million, compared to the second-quarter pro forma sales of 2009. Similar to last quarter, SMB sales benefited from pent-up demand for IT products and PC refresh. As I will discuss later, we experienced significant increases in sales of notebooks and desktops, as well as netcom and storage products.

Sales by our more direct subsidiary, reported as our large account segment, increased this quarter by 36% to $149 million compared to the corresponding prior-year quarter. We continued to experience strong demand from our large account customers primarily for desktops, notebooks, and enterprise solutions.

As reported earlier, Q2 revenues were at record levels for both the large account and public sector segments.

Sales to government and education customers, reported as our public sector segment, increased year over year by 33% to $121 million.

Federal government revenues increased by 48% year over year due to additional sales generated under federal contract programs.

Sales to educational institutions and state and local governments increased by 26% year over year due to increased enterprise product sales and larger contract sales, as well as the acquisition of new customers.

PC Connection Express reported sales of $17 million for the second quarter of 2010 compared to pro forma sales of $25 million for second quarter of 2009.

As stated earlier, 2009 consumer and SOHO revenues were previously reported within the SMB segment. This company's new website, www.pcconnectionexpress.com, was launched in mid-January, and expanded efforts continue to increase customer visits to this site.

Consolidated gross profit dollars in the second quarter of 2010 increased by $12 million, or 26%, to $56 million compared to the prior-year quarter.

Gross margins, representing gross profit as a percentage of net sales, was largely unchanged at 11.7% in Q2 2010; however, the SMB and large account segments improved gross profit margins in the second quarter compared to the prior-year period.

SG&A expenses in the second quarter of 2010 increased by 13% to $48 million from the second quarter 2009. The year-over-year dollar increase was primarily the result of higher variable compensation associated with our improved operating results.

SG&A expense as a percentage of sales was 9.9% for the quarter compared to 11.2% for the second quarter of 2009. This improved rate was due to the higher 2010 sales, as well as continued expense management.

Income from operations for the quarter was $8.5 million, or 1.8% of net sales, compared to pro forma operating income of $2.2 million, or 6% of net sales, for the second quarter of 2009.

Average annualized sales productivity for the second quarter 2010 increased by 33% on a consolidated basis from the prior-year quarter.

Revenues for each of our three primarily sales segments increased by double-digit percentages compared to the prior-year quarter.

Accordingly, sales productivity increased by 35% for the public sector, 36% for SMB, and 37% for large account. The consumer business is largely Web-based, and accordingly, we will not be reporting sales productivity for this group.

We ended the quarter with 588 sales representatives, compared to 603 on June 30, 2009 and 583 on March 31, 2010.

Now on to Q2 product sales trends.

Notebooks and PDAs, historically our largest product category, grew year over year by 59% due primarily to higher unit sales associated with large project rollouts and PC refresh noted earlier.

Notebook and PDA sales accounted for 18% of net sales in the second quarter of 2010 compared to 14% in the prior-year period.

Desktop and servers grew by 36% during the quarter and accounted for 16% of net sales in Q2 2010 compared to 14% in the prior-year quarter.

We also experienced significant growth in enterprise products as both netcom products and storage devices sales increased substantially.

Netcom products grew by 28% year over year and accounted for 10% of net sales in both the second quarter of 2010 and 2009.

Storage devices grew by 26% year over year and accounted for 8% of net sales in both the second quarter of 2010 and 2009.

Our customers in our primary sales segments continue to make capital investments in IT products and solutions.

Average selling prices, or ASPs, for computer systems were largely unchanged in the second quarter 2010 on a year-over-year basis. ASPs decreased sequentially by 6%, primarily due to lower server and notebook pricing. ASPs for notebooks and PDAs increased by 4% on a year-over-year basis. Desktop ASPs were largely unchanged compared to the prior-year period.

Server sales grew year over year due to both higher unit sales and for the fifth straight quarter increased server ASPs.

We were pleased with our overall performance in this quarter. We achieved 27% sales growth year over year, and we generated over $8 million in operating income and earnings of $0.18 per share.

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, the cash flow. Cash flow provided by operations for the six months ended June 30, 2010 was $6.5 million compared to $25.1 million for the prior-year period.

Operating cash flow in the 2010 period was generated by increased earnings, offset in part by an increase in accounts receivable.

Capital expenditures in the six months ended June 30, 2010 were lower than in the prior-year period, amounting to only $1.4 million in 2010 compared to $4.4 million in 2009. This will likely change in the second half of the year, however.

Net cash used for financing activity in the six months ended June 30, 2010 was $1.6 million, compared to $400,000 in the comparable prior-year period.

In the first half of 2010, we purchased $1.4 million of our outstanding stock, whereas in the first half of 2009, our treasury stock purchases totaled less than $200,000.

Our cash balance increased in the six months ended June 30, 2010 by $3.5 million compared to a $20.3 million increase for the prior-year period. We did not [act as] our credit facility at all in the first half of 2010, and as a result, we had no outstanding bank borrowings at quarter end. We ended the quarter with a cash balance of $46 million.

Turning now to the balance sheet, accounts receivable as of June 30, 2010 increased by $11 million to $229 million compared to the balance at December 31, 2009.

Days sales outstanding, or DSOs, were 49 days as of June 30, 2010 compared to 47 days as of June 30, 2009 and 48 days as of March 31, 2010.

The increase in DSO days over last year resulted primarily from the increased sales in the public sector segment, whose customers generally have slower build to cash cycles compared to our SMB segment. The increase is also attributed to the high June sales this year.

We are continuing to monitor ongoing credit exposure from our customers given the current liquidity environment and to minimize credit from customers where appropriate.

Inventory levels were largely unchanged compared to the prior year end despite higher revenues in 2010. Inventory turns for the quarter increased to 27 compared to 23 for the prior-year period and 25 for the first quarter of 2010.

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 63% of total net sales in the second quarter of 2010 compared to 61% in the corresponding prior-year period.

We continue to focus on increasing drop shipments where appropriate and cost effective, which supports lower inventory levels.

In summary, the balance sheet remained very healthy.

We will now entertain your questions. Operator?

Thank you, sir. (Operator instructions)

Our first question in queue comes from [Nabill Hanno] with Raymond James. Your line is now open.

Hi, and thanks for taking my question. You had a very strong quarter, growing above normal seasonality. Can you talk about how demand progressed through the quarter?

Hi, [Bill]. This is Tim. I'll take that. So we're fairly typical, I think, of a Q2, but demand did steadily increase. June was the strongest month in the quarter and incidentally a record month for our enterprise group. April also came in a little strong, and that may have been about some of the backlog coming into the quarter, but overall, April and June were our strongest months, but it was a nice progression up.

I don't know if you can comment on this, but did that continue so far this quarter?

I think [entering] in the quarter, as you know, we don't give guidance, but I think we are expecting a fairly typical ramp in Q3 in terms of the calendarization. As you know, it's our public sector's largest quarter.

Okay. So looking at gross margin, it was down, albeit modestly, on a sequential basis. Can you talk about the current pricing environment? Is it stable? Has it deteriorated? Or was the decline all mix driven?

Hi, Nabill. This is Steve Baldridge. As you noted, the consolidated gross profit margins in the second quarter at 11.72% were virtually flat to the prior-year quarter. And what we experienced in Q2 were higher software referral agency fee revenues that were largely offset by lower product invoice margins. So the competitive pricing environment was clearly in play during the second quarter as we've seen for a number of quarters now.

On a sequential basis, our gross margin rate was down approximately 20 basis points, again, a reduction in invoice product margins, partially offset by higher software agency referral fees in Q2, which is typically our highest quarter for those sorts of software referral fees.

Shifting to the public sector, you gave the growth rates for your fed and sled business. Can you remind me what your mix is, and also, what is your outlook on the sled business given (inaudible) constraints.

Hi, Nabill, Steve Baldridge. I'll take the first part of that question, and Tim McGrath will respond to the second part.

So our federal sales were in excess of $40 million during the quarter compared to our sled sales that approximated $80 million in the quarter, to give you some sense in terms of mix between our sled and fed business.

Our federal sales during the quarter grew year over year by 48%, and our sled sales grew year over year in the quarter by 26%. I'll let Tim respond to our outlook on our sled business for the remainder of the year.

Well, thanks. So as you know, in Q2, we had record revenues for our GovC business. Going into Q3, the government's year end, we are looking for solid growth I think more in line with historic growth trends. We are seeing some positive impact from the equipment refresh and for the larger project rollouts. We're also seeing some good growth from our federal contract vehicles. So, overall, we're anticipating a fairly consistent Q3.

Okay, that's helpful. And switching to operating line, your leverage was quite impressive this quarter. You had 6% sequential contribution margins and SG&A was well managed with expenses growing a little over a third of that sequential increase in revenue.

Given your commentary on how demand progressed through the quarter, is that how we should be thinking about SG&A going forward, or do you think you're going to have to add more going forward (inaudible)?

This is Jack Ferguson. I'll take that question. On a longer-term basis, we generally try to maintain a leverage of about 50% increase in expenses versus increase in sales and gross margins. And as you know, probably 70% of our SG&A costs are personnel costs. The primary reason for the increase in dollar amounts for SG&A this quarter was, of course, due to variable compensation associated with the higher gross margin.

But as you pointed out and as Pat mentioned in her comments, we did get very good leverage, both sequentially and year over year. If you looked at year over year, our total SG&A went up just under 13% with a gross margin increase of about 26%. Likewise, in Q1 [to] Q2, our operating expense went up about 7% versus roughly 15% increase in gross margin.

Looking forward, we will continue to make the investments that we need to sustain our business and grow. This will include [selected to hire] with certain skill sets that we feel we need to fill out our solutions initiatives, so clearly, we'll be doing that, as well as adding sales personnel. Tim, do you have anything, any further [there]?

No.

Okay. Looking at your product breakout, can you talk about your PC growth, which was again very strong, and especially in the notebooks, was any of the notebook growth a result of the iPad? And, also, how do you see commercial PC refresh playing out in general over the next several quarters, and what are you hearing from your customers?

So I think I'll take that in reverse order, but clearly, we're seeing a lot of PC refresh. There are a lot of drivers for that, as you know. Windows 7 continues to be a good generator of demand for us. Large project growth has been very solid. And with regard to our notebook business, as you saw, we grew 59% there, as Pat mentioned, so that's the very strong growth. Within that, we are seeing some good growth. I'd say double-digit growth is coming from our iPad business.

And can you break out how much of your notebook sales were iPad?

Nabill, so what Tim indicated is of the $54 million we did in that category last year, we had double-digit -- lower double-digit growth year over year from the sale of iPads. We really would prefer not to break that out specifically, but at least a good percentage of that 59% growth came from iPad sales.

All right. And then just last question. There still seems to be a lot of product shortages going around, but it seems to have -- improving now. Are you having any problem acquiring any product? Your inventory was flat. Are your customers getting everything they need?

Actually, we are going into Q3 with a larger backlog than we had both year over year and sequentially, so we're a little bit encouraged at the start of the quarter with the backlog. Some of that is driven off some product shortages I'd say primarily in the netcom space.

Okay, that's very helpful. Thank you again, and I have no further questions.

Thank you, Nabill.

Thank you, sir. (Operator instructions)

Next in queue comes from Bob Sales with LMK Capital Management. Your line is now open.

Hi. Great quarter.

Thank you.

Several of my questions were just answered. I had -- the question about the government, the federal -- fed and sled business, you know, there haven't been a lot of reports of a growing market as it relates to those two areas, and my question is do you feel like there is market growth or that your success is a result of share gains or something different?

Well, thanks. That's a terrific question. We'll give you our best estimate.

To begin with, we've all read a lot, heard a lot. Analysts have commented a lot about the effect of the stimulus plan and some of the changes that have happened around that. Also, a lot of our competitors and suppliers do classify healthcare in the public sector, which tends to skew the numbers.

But to the best of our abilities to predict the future, we've been very focused on acquiring new accounts. We've had great success there. We've been very focused on garnering a greater share of wallet within our existing account base by offering up solutions that help solve their problem, and to that extent, we've been pretty successful. So we're fairly confident we can continue that trend.

Okay, and can you one more time just describe the gross margin percentage difference between the large account and SMB business and your government business? And I realize you may not want to go -- you may not want to be precise in your quantification, but give us some sense of the delta.

Hi, this is Steve Baldridge, and in fact, I think on page three of the earnings release, we summarize what those gross margin rates are for Q2 for the current quarter and year over year by segment. But basically, our SMB segment had margin rates in the quarter at 14.4%, and you asked about our large account segment was at 10.5%, to just show the difference between those two segments. And our public sector is around 9.5%. So that's the difference from a margin rate perspective, so obviously some quarters in Q3 will have a higher mix of public sector sales, which will lower our consolidated margin rate.

Okay, I see it now. And then I'm still a little bit confused about the performance with the PC Connection Express, both in top line and with respect to the margins. So help me understand the plan going forward with that business or what you all are thinking.

Sure. So, overall, the consumer's been a big part of our business for the last 28 years, and we really wanted the ability to showcase consumer products to consumers and business products to businesses. So by breaking out this business, it allows us to focus on specific needs of each segment and it also enables us to really develop a further and specific focus as we look at consumer products and we go deeper into a consumer product for the consumer. So, overall, it really was a natural extension for us.

In addition to that, we've already had relationships with our key suppliers for many years. We've had the infrastructure that we need to support the business, and overall, by having an additional website, an additional catalog, or I should say a separate catalog business, it should enable additional leverage over the future.

So that said, the sales are down in Express, but if you look at the origin and the year-over-year comparison, again, many customers have been loyal to the PC Connection brand, so moving them to the PC Connection Express brand will take some time.

Understood, understood. Okay, that's it for now. I may get back into queue if there's additional questions after me, but once again, that's excellent performance.

Thanks. Thank you for your question.

Thank you. Our next question in queue comes from David Berman with Berman Capital. Your question, please.

Hi, guys. Those are great, great numbers.

I was wondering if you could just run us through the cash flow year over year. I'm trying to see where the cash went because you still have -- the way I look at it, you've got $1.84 a share in cash, and I'm surprised it's down from $2.51 last year. So forgive me; I may have missed out on some acquisitions or things you may have had from the last 12 months, but I'm just wondering where it's gone.

I feel a lot of it's tied up in -- because your inventories are pretty well controlled, so it's not like there's that much in inventory, and your accounts receivables, there's a lot there. You've got quite a lot there. But I was just wondering what's happening to the cash flow.

This is Jack. I'll try to answer that.

We continue to generate cash flow with operating activities. As you can appreciate, operating cash flow is really that balance between receivables, inventories, and payables, and that's going to continue to change. Of course, if you have good earnings, that will be -- and earnings and depreciation gives you a positive start with cash flow. If you invest heavily in receivables, particularly if you have sales in the last month where receivables' balance goes up, that shows a decrease in the income related to cash, and that shows up as a negative number in the cash flow from operations.

Nonetheless, we still generated positive cash flow, including the investing activities, which is relatively small in the first six months, and our financing activities, which were primarily treasury stock purchases. So I'm not sure that I understand where you said the cash is going. It's going to fluctuate from quarter to quarter depending on --

Yes, but what's interesting is that your accounts receivables have been consistent at 40 days roughly, as I work out, 40 days -- 43 days, in fact, for this last quarter. And your payables are consistent, as well, 27, 28 days. So I'm just trying to -- so there were no acquisitions or anything like that. I'm trying to understand where the cash went for the last 12 months. There's nothing that's purely coming out of the growth of the business, is that right?

I believe so. It's primarily -- there's not a whole lot of depreciation adjustments here.

Right. So really --

(Inaudible - multiple speakers).

So, really, it's actually tied in -- it's tied in -- basically if you do the math, it looks like it's tied into the accounts receivable, right?

Receivables, and then you have to look at the balance of those payables.

Right.

(Inaudible) look at the balance sheet as well as the cash flow to see how that changes.

Right. So the accounts receivables were up 61 million and the payables were up only 25 million.

So that would tell you that there's a --

There's [$26] million there in excess tied up -- you've got $36 million of tied-up money in receivables, right? And 35 million shares, so that's like really an extra $1.30 or something like that, correct, and sitting in excess including receivables?

That's right, and that's a temporary situation, of course, as we --

Yes, same (inaudible) you get paid. Right, but now your 43 days, what is the situation with regard to potential bad debts? I know you have a lot of government stuff, all that, but 43 days -- it's gone up from 40 days. Is that all good, or what's your provision for bad debts, and how is that an issue?

We've generally been very close to managing credit exposure very tightly, and we've had a very small amount of bad debt expense over the year.

As you said, government, there's very little or no bad debts experience. Our enterprise accounts primarily are Fortune 100 companies, Fortune 500 companies. Very small exposure there. Our SMB group is probably the biggest bad debt exposure, but we've taken steps to really manage those credit exposures very tightly, and we will -- we have actually reduced credit in cases, and we've been right on the phone with collection efforts the 31st day, and so we haven't had a big write-off of bad debts. We've taken steps purposefully because of this economy to really draw in some of the credits.

So there's no [worry there] -- they're provided for. You feel very comfortable with the hedging?

Very much so, yes.

And the inventory is up only 16%, which is really well controlled, but when you look at the aging of the inventories, especially in your field where they can sort of become [off you] very quickly, can you just lead us through a sense of how we can feel comfortable with that inventory?

Steve, do you want to talk about that?

Sure. From an inventory perspective, we've had an increase. Part of the increase in the inventory levels would be in transit inventory. That means inventory that's on its way to the customer but because it hasn't reached the destination of the customer, we have to reverse those sales and put that back on our balance sheet in the form of inventory. So that inventory is as good as sold.

We look at our inventory on a quarterly basis and perform an overstock analysis on all of our inventory to do sort of a slow moving inventory review and really have diminimus -- we have diminimus amounts of inventory in excess of 90 days. For that inventory that is slower moving than others, we have generally price protection from most of our key vendor partners who help us move that inventory out.

So we feel very comfortable with our inventory obsolescence reserves and have seen an improvement in both the aging of our inventory in addition to the customer returns inventory, this at very low levels and very current.

Right, okay. Well, guys, this is some really impressive results. We hope we see these in the next three quarters going forward the next few years.

All right. Thank you for your [questions].

Thank you.

Thank you. At this time, I'm currently showing no additional questioners in the queue. I'd like to turn the call over to Patricia Gallup for any closing remarks.

Thank you, Operator.

In closing, during the quarter, PC Connection achieved its highest Q2 sales level in history and second highest quarterly level overall. The Company also achieved significant increases in both operating income and earnings per share.

We believe we can continue to increase market share and as the economy improves grow our business and enhance long-term shareholder value.

I'd 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 great evening.

Thank you. Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may now disconnect.