PC Connection Inc (CNXN) 2010 Q4 法說會逐字稿

Good morning everyone, and welcome to the PC Connection fourth quarter 2010 earnings conference call. Today's call is being recorded. At this time, for opening remarks and introductions I would like to turn the conference over to Mr. Steve Baldridge, Senior VP and Corporate Controller. Please go ahead, Sir.

Thank you, and good morning, 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 are pleased to have you join us today for PC Connection's 2010 fourth quarter earnings call. If you have not 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 rebroadcasted without specific permission from the company. 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 the purpose 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 September 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 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?

Thanks, Steve. Good morning, everyone, and again thank you for joining us.

Today, we announced that consolidated net sales in the fourth quarter increased year over year by $92 million or 20% to $556 million, compared to the fourth quarter of 2009. Consolidated sales for this quarter were the highest in the Company's history. The IT demand environment continued to be very strong in Q4, especially in the Large Account segment and the SMB segment, which achieved quarterly year over year growth of 36% and 28%, respectively. Strong net sales, stable growth margins, and operating leverage increased net income by 73% to $6.9 million or $0.26 per share this quarter, compared to net income of $4 million or $0.15 per share for the prior year quarter.

Through our inbound and web channel, sales were the highest in the Company's history. The IT demand environment continued to be very strong in Q4, especially in the Large Account and SMB segments, which achieved quarterly year over year growth of 36% and 28%, respectively. Strong net sales, stable growth margins, and operating leverage increased net income by 73% to $6.9 million or $0.26 per share this quarter, compared to net income of $4 million or $0.15 per quarter for the prior year quarter.

As discussed in our previous 2010 earnings calls, we formed a new company, PC Connection Express to focus on the specialized needs of our loyal long-term consumer and small office/home office or SOHO customer base. Prior to the formation of this new company, consumer and SOHO sales were included in our SMB segment. Accordingly, we have presented on a pro forma basis the 2009 operating results for the SMB segment that excludes sales made through our inbound and web channel. These sales are now reported under our new consumer SOHO segment.

Net sales for the SMB segment increased this quarter by 28% year over year to a record $245 million. SMB sales also increased on a sequential basis by 17% over the third quarter, reflecting a strong demand environment primarily for notebooks, desktops, and software. Our SMB segment growth stems primarily from deeper sales penetration into existing customers, which we attribute to our focus on solution spelling.

Sales for our MoreDirect subsidiary reported as our large account segment increased this quarter by 36% to $168 million, compared to the corresponding prior year quarter. Topping it's previous quarter's record for largest sales performance. Q4 marked the third straight quarter that our Large Account segments set a new sales record. We continue to experience strong demand in this segment, primarily for desktops, notebooks, and net/com products. Average order size has increased over the past five consecutive quarters and new customer acquisitions have continued both of which contributed to this segments strong sales growth.

Sales to government and education customers reported as a public sector segment decreased year over year by 1% to $117 million, a slight increase in education sales were offset by a decrease in federal contract sales in the quarter. We plan to increase our education sales next year to offset an unexpected continued tightening of federal stimulus spending. Prior to this quarter, our public sector segments had experienced strong sales growth for six straight quarters.

PC Connection Express had it's strongest 2010 quarter with sales of $25 million in Q4. Increase seasonal consumer demand generated a 32% increase over third quarter sales. Sales were 16% lower than those previously reported under our SMB segment in the prior-year quarter as not all of our customers and consumers on the -- customers on SOHO and consumers have transitioned to the new site www.pcconnectionexpress.com. The Company was launched in mid-January 2010. Profitability and initiatives to increase traffic on their site, continue to be this segments primary focus into 2011, its first full year of operation.

Consolidated gross profit dollars in the fourth quarter of 2010 increased by $11 million for 21% to $63 million compared to the prior year quarter. Gross margin representing gross profit as a percentage of net sales increased to 11.4% in Q4 2010, compared to 11.3% for Q4 last year due to an increase in higher-margin agency sale.

Our Large Account segment improved its gross margin by 40 basis points year over year in Q4 with higher agency sales and invoice margin. Both SMB and the public sector, maintain their growth margins profitable to the prior year quarter.

SG&A expenses in the fourth quarter of 2010 increased by 12% to $52 million for the fourth quarter 2009. The primary driver of the year over year dollar increase was higher variable compensation associated with our improved sales performance and operating results. We added sales representative and technical solutions support personnel to increase our data center, net/com software and storage sale.

SG&A expense, as a percentage of sales was 9.3% for the third quarter, I'm sorry, for the quarter , compared to 9.9% for the fourth quarter of 2009. Fourth quarter over fourth quarter.This improved rate was due to higher 2010 sales as well as our continued expense management.

Income from operations for the quarter was $11.7 million or 2.1% of net sales, compared to $6.6 million or 1.4% of net sales for the fourth quarter of 2009. On an annual basis, net sales increased by 26% to nearly $2 billion. Our three primary segments each achieved double-digit revenue increases over 2009. Our Large Account segment had an outstanding year with record-breaking sales that increased 41% over the prior year. SMB also have a strong year with a 27% increase in net sales. The public sector achieved record sales with a healthy increase of 19%, with sales peaking in the third quarter.

Annual gross profit dollars increased by 24% to $230 million in 2010 compared to 2009, although gross margin in 2010 decreased year over year by 13 basis points to 11.7%. Increased pricing pressures in 2010, offset an increase in higher margin agency revenues compared to 2009.

SG&A expenses increased by $18.6 million in 2010, compared to 2009, but decreased as a percentage of net sales from 11% in 2009 to 9.7% in 2010. The dollar increase was due primarily to increased variable compensation associated with our improved results. We also invested in key areas in the second half of 2010 to augment our sales support areas and technical solution selling. The rate decrease is attributable to higher net sales as well as improved expense management in 2010. Net income increased by $24 million from a net loss in 2009 of $1.2 million or $0.05 per share to net income of $23 million or $0.85 per share in 2010.

On a consolidated basis, average annualized sales productivity for the fourth quarter 2010, increased by 18% from the prior year quarter. Our two corporate sales segments brought significant revenue gaines compared to the prior year quarter. Accordingly, sales productivity increased by 45% for our Large Account segments and 22% for SMB. Despite a slight decrease in revenues, productivity for the public sector increased by 1%. We ended the quarter with 615 sales representatives compared to 589 on December 31, 2009 and 595 on September 30, 2010.

Now, moving onto fourth quarter product sales trends. Notebooks and PDAs historically our largest product category grew year over year by 38% due to an increase in both unit sales and average selling prices or ASP. Notebook and PDA sales accounted for 18% of net sales in the first quarter of 2010, compared to 15% in the prior-year period. Desktop and server sales grew by 48% during the quarter and accounted for 17% of net sales in Q4 2010, compared to 13% in the prior year quarter.

Software sales grew by 32% year over year and accounting for 15% of net sales in Q4 2010, compared to 14% in the prior year quarter. Sales of both notebooks and desktops have been strong all year as the rebound in corporate profits and related PC refresh continued to fuel business capital investments. Overall, ASP's, for computer systems increase in the fourth quarter by 9% year over year and by 6% on a sequential basis. ASP's for notebooks and desktops increased year over year by 11% and 17%, respectively, while server ASP's where largely unchanged.

We were pleased with our strong performance in the quarter. We increase sales year over year by 20% in Q4, and we have achieved quarterly year over year sales growth of at least 20% for four straight quarters. We also generated $12 million in operating income and earnings of $0.26 per share. This strong performance allowed us to report our 2010 annual earnings of $23 million or $0.85 per share. We will continue to strengthen our business, by making further investments in our own internal IT systems and in our professional services capabilities. While we experience additional expenses in 2010, as a result of these investments, we believe they 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.Operating cash flow for the year ended December 31, 2010, actually resulted in the use of cash of $900,000, compared to operating cash generated of $5.7 million for the prior-year period. Although we generated over $33 million from earnings and non-cash expenses in 2010, our strong sales led to a corresponding increase in accounts receivable and a seasonal increase in inventory. We also reduced our accounts payable which led us to the net use of cash for the year.

Capital expenditures in 2010 were higher than in the prior year amounting to $7.2 million, compared to $5.6 million in 2009. As we have reported previously, capital expenditures will likely increase in 2011 and the following years. Net cash used for financing activity in 2010 was $2.9 million, compared to $850,000 in 2009. We purchased $3.1 million of our outstanding stock for treasury, whereas last year our treasury stock purchases were only $425,000. We also generated $1 million from employee stock purchases and option exercises in 2010, compared to only $275,000 in 2009.

Our cash balance decreased by $11 million in 2010, compared to a $700,000 decrease in the prior year. Nonetheless, we had only minimal drawings on our credit facilities. We had no outstanding borrowings at year end and ended the year with a cash balance of $35 million.

Turning now to the balance sheet. Accounts receivable as of December 31, 2010, increased by $20 million to $238 million, compared to the balance at December 31, 2009. Date sales outstanding or DSOs were 44 days as of December 31, 2010, compared to 47 days as of December 31, 2009, and 49 days as of September 30, 2010.

We continue to monitor ongoing credit exposure from our customers, given the current liquidity environment, in order to minimize credit risks from our customers. We increased our inventory by $7 million in 2010 compared to the prior year end balance. Inventory turns were 23 for the fourth quarter compared to 24 for the prior-year quarter and 26 for the third quarter of 2010. Inventory turns decreased sequentially, as expected, due to seasonal demand trending in the last two quarters. We continue to believe that inventories are in excellent condition both in quantity and in quality.

Net sales for products drop shipped by distributors and other vendors directly to our customers were 63% of total net sales in the fourth quarter of 2010, compared to 61% in Q4 of 2009. We continue to focus on increasing drop shipments where appropriate and cost effective, which ultimately supports lower inventory levels. In summary, the balance sheet remains very healthy.

We will now entertain your questions. Operator?

[ Operator Instructions ]

(Operator Instructions)

Brian Alexander, Raymond James.

Thanks. Good morning and nice job.Pat, you alluded to four straight quarters of 20% growth through 2010, and we're starting to face some tougher comparisons. So I was just wondering if you guys can talk about the demand environment and just how you're thinking about growth in 2011 and within that what customer and product segments do you expect to outperform?

Thanks for the question. Tim, why don't you start of the answer to that one?

Sure. Thanks, Brian, and Brian we appreciate the compliment. I think our thinking is very consistent with what we've read from you and others. We still have a lot of positive drivers for the demand environment going forward. No doubt there is a very strong correlation between corporate profit and our business and we expect corporate profits to continue. We also are still getting a tail wind from the aged install base and the desktop refresh. And the whole movement toward the cloud is generating some demand for us and many of our product lines, especially as we think about access, networking access and some of the other technologies related to that. Our software business has been strong and although we do not give specific future guidance, I think that our feelings are very consistent with what you and others have said about the space.

So is it fair to assume that you expect the business to behave relatively seasonally on a sequential basis for the next few quarters and if you run out those assumptions does it suggest growth is more in the mid- to high-single digits for 2011 versus the double -- the 20% growth we saw in 2010? Or do you think it's going to be much different than how I just described?

I think Brian, how you just described it, certainly the single-digit growth projections -- given that the comparables that we're working off seems to make a whole lot more sense.

Okay, great. You might have addressed in your prepared remarks, I'm sorry if I missed it. But the gross margins for the Company have come down throughout 2010. Some of that is a mix driven but specifically in the fourth quarter, it looks like your SMB gross margins dropped down to 13.3% I think from 14% and change in the second and third quarter. So can you just address the gross margin change in the SMB segment?

Sure. Hi, Brian, this is Steve Baldridge. In the SMB segment really for both SMB and public sector, the fourth quarter year-over-year gross margin rates were relatively unchanged, fairly flat compared to the gross margin rate performance in Q4 of 2009. For SMB sequentially, we did see a reduced gross margin rate of around 95 basis points. And the sequential reduction in SMB gross margin rates was due primarily to both lower invoice margins and lower agency fees sequentially. But on a consolidated basis, we were very pleased to have a slight increase in our gross margin in Q4 year-over-year and pleased with the large account segment that realized almost a 40 basis points improvement in gross margin rate resulting from both higher agency fees and higher invoice margin.

Okay. So within SMB specifically, and to your point, it's not unusual for gross margins to fall from Q3 to Q4. I just thought it was a little bit steeper than normal. Would you expect that to recover in the first half of 2011 back up to that 14% level?

Yes, which sort of follows the historic trend. So I think historically we would have a little higher margin rates in the first half and there is no reason to believe that that historic trend will continue in SMB for the first half of 2011.

Okay. And then on OpEx another positive, I think, is you guys have been able to really control OpEx throughout 2010 and growing it at basically less than half the rate of sale growth. We have talked about some investments that you are making going forward so what it's the right way for us to think about OpEx growth relative to sales grow if we assume let's say 7% or 8% top-line growth. Can you grow OpEx at half that rate or less or should we expect it to be more similar to revenue growth?

This is Jack. On a run rate basis, our target has always been to try to limit the SG&A growth to roughly half of the revenue growth. Having said that I think you have to overlay what additional investments we might make -- that we will be making. I think we have previously reported that we are going to make significant IT investments. And as you make those, there is a certain portion of investments that are going to be operating in nature. So you would expect some increase and while we haven't given specific guidance on the dollar amounts. I think it's safe to say that given those additional initiatives that we are planning both in the IT area and in the sales area that that 50% level may be a little low in the next couple of years. I think it may be a little higher.

But still you should be able to get some expense leverage it sounds like?

Oh, yes. I think we will be.

And then maybe just a couple of questions on some of the segments. I noticed that networking and storage were sort of weaker on a year-over-year basis relative to some of the other segments and your largest vendor has some new offerings there through a couple of acquisition that it's made.I guess, what can you say about those new offerings and how much traction are you seeing there and why do you think the networking and storage segments were as weak as they were on a relative basis?

Hi, Brian. This is Tim. I will take that, overall if you think about our largest vendor, we actually exited their year with extraordinary growth with them. We're a leader for them in the DRC channel and we expect to maintain a leadership position going forward. We did have some large net/com sales and a year-over-year comparable that I think affected the category growth. But as we look at our drive into solution, there is no doubt that these are categories that are mission critical for us and that you are going to see continued emphasis and improvement in.

Okay. Is there any sort of story underneath the networking segment specifically where you just saw things fade throughout the fourth quarter and you are just seeing lower overall demand for networking? Or do you think it was more an issue specific to PC Connection? I am just kind of looking at the trends here and it looks like we were down a couple percentage points year on year after growing strong double digits in the first three quarters.

Right. I think the majority of that decline is based on a year-over-year comparison and some of the large orders that we had in Q4 of '09.

Okay, fair enough. Then the last sort of comments or questions I would have would just be to get your perspective on where we are in the PC refresh cycle, you had very strong desktop growth throughout the year, also pretty good notebook growth. Where do you think we are in that upgrade cycle? And would you characterize it any differently between SMB and large enterprise and then on top of that, sorry for all the questions, but on top that commercial adoption of tablets? Where are we with there?

First, Brian. There's a lot there. We're really have been very fortunate based on the strength that we have seen in the demand around the aged install base and the desktop and notebook refresh. As you know, it was very strong in 2010 and we are seeing signals that, that is not going to let up in 2011 at least for the first couple of quarters. We do not have great visibility into the exit 2011 but our customer base is indicating that demand is going to be very strong for those products so we are optimistic that that will continue. We're also seeing a great uptick in our tablet business, as you know. Many of our key suppliers will be introducing new tablet this quarter and we are optimistic about what that will bring. I'm not sure what I might have missed there. If there is anything you want me to clarify, I'm happy to do that.

I guess it sounds like at least early you are seeing a fair amount of interest from your commercial customers in the tablet space?

Yes, as a matter of fact we are up 34% sequentially and that is at a pretty good margin and pretty good 6% growth in the ASP. So there's no doubt that the tablets are making a real impact on our business and on our customer's business.

You don't know off the top of your head what number of units you're actually selling per quarter, do you?

I don't in aggregate. I have it by vendor but I don't want to give you bad data.

Fair enough. I will get back in the queue. Thank you.

(Operator Instructions)At this time, there are no further questions. I will turn the conference back over to Ms. Gallup for any additional or closing comments.

Thank you, operator. In closing due to the hard work and commitment of many, the Company executed very well this quarter and took advantage of an improving economy. We achieved a 73% increase in net income year-over-year and had record-breaking sales for both the fourth quarter and the year while maintaining cost disciplines in a high-growth mode. I am pleased with PC Connection's consistent year-over-year quarterly growth sales and earnings. We'll also continue to look for acquisition opportunities that complement our strategic plan. PC Connection remains committed to making the investments necessary to continue to grow our business and improve operating performance. We believe the momentum we have built has positioned us well to continue our growth in a recovering economy.

I would like to thank all of our customers, vendor partners, and shareholders for their continued support. I would also like to thank those of you listening to our call, your time and interest in PC Connection are appreciated. Have a nice afternoon.

That conclude today's teleconference. Thank you all for your participation.