PC Connection Inc (CNXN) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to PC Connection's Third Quarter 2010 Earnings Conference Call. (OPERATOR INSTRUCTIONS) As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host today, Steve Baldridge, Senior Vice President of Finance, and Corporate Controller. Please begin.

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 the PC Connection 2010 Third Quarter Earnings Call. If you haven't already seen our press release, you can contact Janice Rush at 603-683-2322, and she will 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 June 30, 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 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 results. Pat?

Again, good afternoon, everyone. Thank you for joining us to review the Company's financial results for the third quarter of 2010. As previously announced, net sales in the third quarter increased year over year by $130 million, or 32%, to $533 million, compared to the third quarter of 2009.

Net sales for each of our three major business segments grew significantly this past quarter, and for the second straight quarter both our large account and public sector segments reported record revenues. The IT demand environment continued to be very strong in Q3.

Net income for the three months ended September 30, 2010, increased by almost 200%, to $8.6 million, or $0.32 per share, compared to $2.9 million, or $0.11 per share, for the prior-year quarter.

As discussed in our Q1 and Q2 earnings calls, we formed a new company, PC Connection Express, Incorporated, to focus on the specialized needs of the 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 year-over-year comparisons, our 2009 operating results for the SMB segment are presented on a pro forma basis that excludes sales made through our inbound and Web channels. These sales are now reported under our new consumer SOHO segment.

Net sales for our SMB segment increased this quarter by 27% to $209 million, compared to the third quarter pro forma sales of 2009. SMB sales continue to benefit from the strengthening of IT demand and PC refresh. As I will discuss later, revenues increased significantly across almost all product categories.

Sales by our more direct subsidiary, recorded as our large account segment, increased this quarter by 54%, to $160 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.

New customer acquisitions have also contributed to the year-over-year increase. As reported earlier, Q3 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 25%, to $146 million. Federal government revenues increased by 41% year over year due to additional sales generated under federal contracts programs. Sales to educational institutions and state and local governments increased by 16% year over year due to larger contract sales as well as the acquisition of new customers.

PC Connection Express reported sales of $19 million for the third quarter of 2010, up slightly from the corresponding prior-year quarter. Strong Apple sales contributed to this sales growth. The Company's website, www.pcconnectionexpress.com, was launched in mid-January. Expanded marketing efforts continue to increase customer visits to the site.

Consolidated gross profit dollars in the third quarter of 2010 increased by $16 million, or 34%, to $62 million, compared to the prior-year quarter.

Gross margin, representing gross profit as a percentage of net sales, was 11.6% in Q3 2010, compared to 11.5% for Q3 last year. Both the SMB and public sector segments improved gross profit margins in the third quarter compared to the prior-year period.

Higher agency revenues in product margins in the SMB and public sector segments offset lower product margins in the large account segment in the quarter.

SMB expenses in the third quarter 2010 increased by 15%, to $48 million from the third quarter of 2009. The primary driver of the year-over-year dollar increase was higher variable compensation associated with our improved operating results. In addition, we added technical solution support personnel to improve our enterprise networking sales.

SG&A as a percentage of sales was 8.9% for the quarter, compared to 10.2 for the third quarter of 2009. This improved rate was due to higher 2010 sales as well as continued expense management.

Income from operations for the quarter was $14.3 million, or 2.7% of net sales, compared to $5.1 million, or 1.3% of net sales, for the third quarter of 2009.

Average annualized sale productivity for the third quarter of 2010 increased by 35% on a consolidated basis from the prior-year quarter.

Revenues for each of our three primary sales segments had significant gains compared to the prior-year quarter. Accordingly, sales productivity increased by 27% for SMB, 30% for the public sector, and 60% for large accounts.

The productivity increase was primarily revenue-driven, as sales representative headcount was largely unchanged from the prior-year quarter. We ended the quarter with 595 sales representatives, compared to 601 on September 30, 2009, and 588 on June 30, 2010.

Now, on to third quarter product sales trends. Notebooks and PDAs, historically our largest product category, grew year over year by 50%, due primarily to higher unit sales associated with large project rollouts and the PC refresh noted earlier.

Notebook and PDA sales accounted for 17% of net sales in the third quarter of 2010, compared to 15% in the prior-year period.

Software revenues grew by 49% year over year, and accounted for 15% in Q3 2010, compared to 14% in the prior-year quarter.

Desktops and servers grew by 45% during the quarter, and accounted for 15% of net sales in Q3 2010, compared to 14% in the prior-year quarter.

We also experienced healthy growth in both netcom products and memory and system enhancements. Customer demand for capital investment in our primary sales segments continued to strengthen as the economy continued to show modest improvement.

Average selling prices for ASPs for computer systems decreased 3% year over year in the third quarter this year. The decrease was attributable mainly to a 7% reduction in desktop ASPs. ASPs for both notebooks and servers increased by single digits in Q3 on a year-over-year basis.

We were pleased with PC Connection's performance in the quarter. We increased sales year over year by 32%. We have achieved sales growth of at least 25% year over year for three straight quarters. We also generated over $14 million in operating income and earnings of $0.32 per share.

We will continue to strengthen our business in 2010 by making further investments in our 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. I will start with the cash flow. Cash flow provided by operations for the nine months ended September 30, 2010, was $900,000, compared to $24.4 million for the prior-year period. Operating cash flow in the nine months ended September 30, 2010, was generated by the increase in earnings. However, as anticipated, our strong sales have led to a corresponding increase in accounts receivable. This, and a seasonal increase in inventory, largely offset the increase in cash flow otherwise generated by earnings.

Capital expenditures in the nine months ended September 30, 2010, were lower than in prior-year period, amounting to $3.1 million to date in 2010, compared to $5 million through September 30, 2009. Capital expenditures will likely increase, as I will discuss shortly.

Net cash used for financing activities in the nine months ended September 30, 2010, was $3.5 million, compared to $700,000 in the comparable prior-year period. Through the first nine months of 2010, we purchased $3.1 million of our outstanding stock for Treasury, whereas for the same period in 2009, our Treasury stock purchases totaled $300,000.

Our cash balance decreased by $5.8 million in the nine months ended September 30, 2010, compared to an $18.7 million increase in the corresponding prior-year period.

While free cash flow, which is operating cash flow less capital expenditures, is negative this period due to the increase in receivables, we expect this condition to improve in the coming quarters as those receivables are collected.

We did not access our credit facility at all in the first nine months of 2010, and accordingly we had no outstanding borrowings at quarter end. We ended the quarter with a cash balance of $40.5 million.

As our recent SEC filings indicate, we are currently in the midst of a comprehensive review and assessment of our entire business software needs. That review and assessment includes the review of commercially available software that meets or can be configured to meet those needs better than our existing software.

In the third quarter of 2010, we completed the first phase of this review and purchased a comprehensive database management system for $3 million. Payment for that software was made in October 2010.

While we have not yet finalized any decisions regarding whether, or to what extent, additional software will be acquired and implemented, the capital costs of the entire project, if fully implemented, would likely exceed $20 million over a five-year period.

Turning to the balance sheet -- accounts receivable, as of September 30, 2010, increased by $39 million to $257 million, compared to the balance at September 30, 2009.

Days sales outstanding, or DSOs, were 49 days as of September 30, 2010, compared to 45 days as of September 30, 2009, and 49 days as of June 30, 2010. DSO days increased over last year largely due to the record monthly sales realized in June and September of this year. We are continuing to monitor ongoing credit exposure from our customers, given the current liquidity environment and to minimize credit risk from our customers.

Inventory levels increased by $14 million in the third quarter to accommodate the increased demand from our customers. Inventory turns were 26 for the third quarter, compared to 24 for the prior-year quarter, and 27 for the second quarter of 2010. While inventory levels normally increase this quarter, in preparation for our fourth quarter sales, Q3 inventory turns remained high due to our increased sales this quarter. 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 customers were 64% of total net sales in the third quarter of 2010, compared to 59% in the corresponding prior-year period. We continue to focus on increasing drop shipments where appropriate and cost-effective, which supports ultimate lowering of inventory levels.

In summary, the balance sheet remained very healthy. We will now entertain your questions. Operator?

Thank you. (OPERATOR INSTRUCTIONS) [Navile Hanano], Raymond James.

Hi, this is Navile in for Brian. Can you hear me?

Yes. Hi, Navile.

I just wanted to first ask you about your strong enterprise growth. What's driving that growth, as the market's certainly not growing that fast? And what's differentiating PC Connection in this segment relative to your peers? Because when I look at your gross margin in the segment, it doesn't look like you got overly aggressive with price, as it was about 10% this quarter.

Hi Navile, this is Tim. So thanks. Over all, we're very pleased with the performance from our enterprise team. We've done a number of things right with that group, and over all, we've benefited from what we're seeing out there in the economy. Over all, I think the team has executed against their plan really well. I think they've done a terrific job of maintaining and really fostering growth with complex solutions in our existing account base while we open new accounts. That's been a big driver of our growth in the quarter.

But we're also seeing the other things that the industry is seeing. Windows 7 was a driver. Corporate profits coming back has been a pretty good driver of growth. Of course, the technology refresh we're seeing has been very strong in desktops and in infrastructure products. And as you know, it's Microsoft's fiscal year end. So that combination, I think all together, really helped to drive our sales in the enterprise space.

In terms of the competitiveness of the market, we are seeing a market still that's very competitive, and I think the team has done a great job of delivering more complex solutions to help drive up those margins.

Okay. And then, just stepping back -- from a consolidated view, can you kind of walk me through how demand trended during the quarter? Was it linear and did you end on any particular strength or weakness?

Thanks. It was fairly linear. September was the strongest sales month for the quarter for all businesses segments. Sales per day was stronger in the end of the quarter for all segments; but as Pat mentioned, SMB and enterprise-- excuse me, the enterprise and the public sector had record quarters. They also had record Septembers. So it was a very strong end of quarter for us.

Okay. And then, switching to inventory -- I know you said they were up seasonally, they were up 20%, 21% quarter over quarter, which was twice the rate of sales growth, and it looks like it's well above normal seasonality, in the mid single digits over the past five years. What drove the decision to aggressively build that inventory? And does that signify your confidence in at least a normal 4Q budget for us? I realize on a day's basis they aren't that abnormal.

No. As you saw, as we reported, the inventory turns even stayed high even this quarter, due to our high sales. Some of the things that were driving inventory in Q3 over and above what typically is our quarter to build up inventory for the year-end quarter, we had some opportunistic buys for the quarter. And we also have some planned customer rollouts that will happen in Q4. I think those three factors were the biggest factor in our inventory increase this particular quarter.

So you still expect at least a normal 4Q budget flush, I'm guessing from your comments.

I would expect so. I mean, that typically is what happens in our Q4.

And then just in particular, your products. Notebooks are strong again. I know last quarter you said some of the growth was attributable to the iPad. Can you kind of break out how much of the growth was in iPads versus core notebooks?

And then also, software was up 33% sequentially; it looks to be well above seasonality. And I know that you said Windows refresh is driving that, but it seems-- it was more than I would have expected.

I think that, again, we mentioned the fiscal year end for Microsoft has really helped to drive that. I think that our focus on stronger in [cache] and more solutions helped to drive that.

And we did see, with the year end of our federal business-- excuse me, with the end of the federal buying season in September, we did see an upturn there for virtualization software -- again, consistent with solutions-based approach for the business. So that was also a big driver.

Then just my last question before I get back in line. Your operating leverage remains very strong, your operating expenses as a percentage of sales dipped below 9%, which it looks like for the first time in nearly a decade. How should we think about operating expenses going forward, given the growth that you expect to see and the fact that you're running at such an efficient level, it appears?

Well, as you probably know, in this model a good part of our spend was our relatively fixed over any particular sales level. So we tend to try to keep any increase in SG&A at about 50% of any sales increase. And that way, we can get leverage going forward. Absent any particular initiative that we might have for a quarter, that's what I would expect -- that we would try to keep the SG&A expense within this particular range.

All right. Thank you for your time, and congratulations on the quarter.

Thank you.

(OPERATOR INSTRUCTIONS) Bob Sales, LMK Capital.

Hi, congratulations. I have two questions. One, can you talk about-- for the systems cost, the $20 million over five years, how much of that will be capitalized versus expense?

Typically in a project like that, probably, while I can't be held to a particular percentage, the vast majority, probably in the 80-plus percent, would be capitalized. As you typically have in an IT project, there will be certain costs such as training and things that cannot be capitalized in any project. But that's probably a good rule of thumb to think of to be capitalized. And then once that is placed in service, as they get placed in service over the period, they would be then depreciated over probably a five- to seven-year period after that.

Okay. And from a trading standpoint, it sounds like that's down the road a bit because the systems-- even the components of the system would take time to install.

Yes, Bob. I'll take that. Certainly we don't expect to start training for that system for quite a few quarters out. So you're right, it's a long-term plan for us.

And these are in components, too. It's not like we have committed now to go the full distance. We will be making decisions as we go as to whether it makes sense for us from a return on investment point of view. So each step along the way, we'll be making those decisions.

We have bought the first block of software, and we will be implementing that. But subsequent decisions will depend on what the ROI would show us.

Okay, great. And then, you mentioned that the sales per day was stronger at the end of the quarter than at the beginning of the quarter. Can you talk about -- without providing guidance, because I know you don't -- but some level of how we should look at that with respect to seasonality or strength of the business as we kind of look over the next three months, towards the end of the year?

Sure, Bob. We've all been agonizing over that question. And I think our view is very consistent with what our suppliers, our partners, and really even the analyst community is saying -- and that is that the technology refresh, the desktop refresh, we think a lot of that has already happened but there's more to come. We think Windows 7 has been a driver, is going to continue. And we think that the uptick in corporate profits is going to help.

That said, it's really not clear that we're going to be able to continue to maintain these growth rates. What I think is clear is that we're going to maintain a growth rate above the industry; and clearly, that's what we're driving toward.

Right. And my point is only that with these kind of earnings, you don't have to grow a lot to justify a meaningfully higher stock price. And so I wasn't looking for your confidence in growth as much as I was just your sense of being able to sustain this kind of revenue level.

Bob, there is a seasonality to our business, as you know. Q3 is the largest quarter for our public sector. We are hoping that in the enterprise sector, we will see the Q4 budget -- [plots] show traditionally very strong Q4 in the enterprise. And SMB has been very consistent in Q4. So we're optimistic about that but we really don't give guidance.

Understood. But congratulations on the business. You're executing very, very well.

Thank you, Bob.

I am not showing any other questions at this time. I'd like to turn it back over to management for closing comments.

Thank you, Operator. In closing, we achieved record quarterly sales and significant increases in both operating income and earnings per share. Everyone in the Company worked hard in support of our strategic objectives to obtain these results. We believe we can continue to increase market share and expand our business as we help our customers meet their needs for IT solutions.

I would like to thank all of our customers, vendor partners, and shareholders for their continued support. I would also like to thank all of you listening to our call. Your time and interest in PC Connection are appreciated. Good evening, everyone.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.