PC Connection Inc (CNXN) 2011 Q2 法說會逐字稿

Thanks so much for holding, everyone. And welcome to the PC Connection Second Quarter 2011 Earnings Conference Call. Just a quick reminder -- today's call is being recorded.

And now at this time, I would like to turn things over to our host, Mr. Steve Baldridge, Senior Vice President of Finance and Corporate Controller. Please go ahead, sir.

Thank you. And good afternoon, everyone. This is Steve Baldridge, Senior VP of Finance and Corporate Controller. Patricia Gallup, Chairman and CEO; 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 2011 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 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 Risk Factors in the Company's Annual Report on Form 10-K for the year ended December 31st, 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 2011. Unless otherwise noted, all second quarter 2011 results are being compared to our second quarter 2010 results.

I am pleased to report that we achieved record second quarter sales of $513 million, an increase of $35 million or 7%. As previously discussed, we've been making investments to increase our solutions sales capabilities, including our recent acquisition of ValCom Technology. We believe this strategy has enabled us to capture an increasing share of our customers' IT spend.

We achieved quarterly gross margin of 13%, the highest in Company history. Net income for the quarter increased by 49%, to $7.5 million; and earnings per share for the quarter were $0.28, an increase of $0.10 per share. Consolidated gross profit dollars in the quarter increased by 19%, or $11 million, to $67 million.

Gross margin, representing gross profit as a percentage of net sales, improved by 130 basis points due to improved invoice selling margins, increased vendor considerations and higher agency revenues. All four of our business segments contributed to the gross margin increase as a result of their continued focus on margin improvements.

Consolidated SG&A expenses in the quarter increased by 15%, or $7 million, to $54 million. We attribute the increase to investments in our solutions sales capabilities, higher variable compensation associated with improved operating results, increased marketing expenditures, and the inclusion of ValCom's operating costs for the quarter.

Our investments in our solutions sales capabilities included technical services personnel, whom we added to support sales of datacenter, Netcom, software and storage products. SG&A expense as a percentage of sales was 10.6% for the quarter, compared to 9.9% for the second quarter of 2010, due primarily to these investments. We anticipate that our planned investments will continue at these levels through the remainder of this year.

Income from operations for the quarter was $12.4 million or 2.4% of net sales, compared to $8.5 million or 1.8% of net sales for Q2 of last year. The increase was due primarily to our increase in sales and gross margins.

We will continue to strengthen our business in 2011 by making further investments in our solutions sales capabilities and in our own internal IT systems, which Jack will review in more detail in his comments. While we will incur additional expenses in 2011, we have already realized some of the benefits of our investments. And we believe these enhanced capabilities will enable us to better serve our customers in the future.

And now, I will turn the call over to Tim McGrath to discuss our business segments and to cover sales and product trends. Tim?

Thanks, Pat. And good afternoon, everyone.

I'll first comment on our SMB segment -- our original core business. SMB sales increased this quarter by 14%, to $218 million. The increase was due to the improvements in SMB customer profits, as well as growth in emerging and advanced technologies. We also continue to see strong performance in Notebooks, as the trend toward the mobilized workforce continues. The PC Refresh continued, albeit it at a more moderate pace compared to 2010.

Sales by our large account segment increased this quarter by 8%, to $161 million. As announced last quarter, we've included the operating results of ValCom under our large account segment. Excluding ValCom sales for the quarter, large account sales would've increased by 2%. We experienced moderating demand this quarter from our large account customers. However, we expect the enterprise segment to continue to make investments in virtualization and cloud computing, and these technologies will drive purchases in hardware, software and solutions in the future.

Overall sales in our public sector segment, which includes sales to government and education customers, decreased slightly to $120 million. Sales to the federal government declined by 20%, primarily due to a decline in federal spending. However, sales to higher education customers grew by double-digit percentages, which we attribute to our investment in public sector sales representatives as well as our solutions sales capabilities.

PC Connection Express focuses on the specialized needs of consumer and small office/home office customers. This segment reported sales of $14 million for the second quarter of 2011, a decrease of $2.8 million. However, its gross margin improved by 90 basis points. This segment is continuing to focus on profitability and gross margin improvements in 2011.

Consolidated sales productivity, which is annualized quarterly sales divided by the average number of sales representatives in the quarter, was largely unchanged. We ended the quarter with 630 sales representatives, compared to 588 on June 30th, 2010 and 634 on March 31st, 2011. Sales of Notebooks and PDAs, our largest product category, continued to be strong. Although the commercial Refresh cycle is aging, the rebound in corporate profits continued to fuel technology investments by our business customers in the quarter. This product category grew by 10% and accounted for 18% of net sales, which is comparable to the prior year.

Desktop and service sales grew by 10% during the quarter and accounted for 16% of net sales in the second quarter of 2011 and 2010. Because IT departments are challenged to find new ways to reduce costs and improve productivity with advanced technologies, we are optimistic about the outlook for desktops and servers.

Software sales increased by 22%, accounting for 15% of net sales in the quarter, compared to 13% in the prior-year quarter. The continuing trends toward virtualization, security and cloud computing are generating increased software sales.

Accessories and other sales, which includes our services revenue, grew by 15% and accounted for 13% of net sales in the quarter, compared to 12% last year. The increase in the category was due largely to the inclusion of ValCom services revenue and increased sales of point-of-sale equipment.

Average selling prices, or ASPs, for computer systems decreased by low single digits in the quarter compared to the prior year. ASP for Notebooks decreased by 8%, while desktop ASPs were comparable to last year.

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

Thanks, Tim.

First, the cash flow -- cash flow provided by operations for the six months ended June 30, 2011 was $32.9 million, which represented an increase of $25.5 million over the corresponding prior-year period. Operating cash in the 2011 period was generated primarily by higher earnings and an increase in accounts payable. Our net cash investment for the ValCom acquisition was $4.7 million. This is net of approximately $4.8 million of cash acquired in that transaction.

You may recall from our first quarter earnings release that we had agreed to pay up to an additional $3 million in contingent consideration for this acquisition upon the achievement of certain milestones. The first of these milestones was successfully achieved during the second quarter. And as a result, we've paid $1 million of this contingent consideration. The remaining two milestones have measurement dates in 2012.

Other capital expenditures in the six-month period increased by $4.7 million, to $6.1 million. These expenditures related in large part to the first phase of our IT initiatives, which we expect to complete early next year. As reported in prior calls, we are continuing to make comprehensive upgrades to our IT systems. And this additional capital investment will likely exceed $20 million over the next three years.

Net cash used for financing activities in the first half of 2011 was $1.6 million, which was comparable to the prior year. We purchased $1.5 million of our outstanding stock for treasury this period, compared to $1.4 million of treasury stock purchases in the first half of 2010.

Our cash balances increased by nearly $20 million in the six months ended June 30, 2011, compared to a $3.5 million increase in the prior-year period. We did not access our credit facility in either six-month period. And as a result, we had no outstanding borrowings at quarter end. We ended the quarter with a cash balance of $55 million.

Turning to the balance sheet -- accounts receivable increased by $3 million during the first half of the year, to $241 million at June 30, 2011. Days sales outstanding, or DSOs, improved to 46 days as of June 30, 2011; compared to 49 days as of June 30, 2010 and 47 days as of March 31, 2011. The improvement in DSO days over last year resulted primarily from the decrease in the proportion of sales by the public sector segment, whose customers generally have lower bill-to-cash cycles compared to our SMB and large account segments. We are continuing to monitor outgoing credit exposure from all of our customers, given the current liquidity environment, in order to minimize credit risk from our customers.

Turning to inventory -- inventory levels increased only slightly compared to the prior-year end, despite higher revenues in 2011. Inventory turns for the quarter decreased from 27 turns in 2010 to 25 in 2011. Inventory turns were 24 for the first quarter of 2011. We continue to believe that inventories are in excellent condition, both in quantity and in quality.

Accounts payable increased by $21 million during the first half of the year, to $135 million at June 30, 2011. The increase was due primarily to the timing of inventory and drop shipment purchases late in the period. All payables are current. And we regularly take full advantage of all cash discounts where it's cost-effective to do so. Net sales of products drop shipped by distributors and other vendors directly to customers were 64% of total net sales in the second quarter of 2011, compared to 63% in the corresponding prior-year period. We continue to focus on increasing drop shipments where appropriate and cost-effective, which supports lower inventory levels. Even so, we will continue to make opportunistic buy-ins where it makes business sense to do that.

In summary, the balance sheet remains very healthy.

We will now entertain your questions. Operator?

(Operator instructions) Brian Alexander, Raymond James.

It looks like your SMB trends improved in the quarter -- 14% growth year-over-year -- while your large corporate growth decelerated. I think organically you said it was up 2%. I think it's the first time that SMB has outgrown large enterprise in some time. So just talk about kind of the relative trends that you're seeing there -- what you're hearing from customers in both segments, and whether you saw anything notable from a linearity standpoint, meaning -- did the large enterprise spend really tail off in the month of June? And maybe just catch us up for the month of July, and how those trends have continued.

Brian, this is Tim.

I think we'll start with a consolidated view. And clearly, we think that sales growth and demand is going to normalize to more historic rates. Obviously, with the events of the market with the past couple of weeks, I think there's a lot of uncertainty. But we're overall fairly optimistic. And I'll try to break that down by segment.

You're right that our SMB team really did perform very well in the quarter. And they've actually had a few quarters of very good growth. We're seeing there that our value proposition is being well-received by our customers. As you know, technology is more complex. And while the SMB profits came back, I still don't think, in SMB or in the enterprise space, companies are adding a lot of headcount. But there is a real need to be more efficient, to improve productivity into lower cost. And so technologies like virtualization and cloud, and some of the other offerings that we have, enable that.

As I mentioned, the trend in SMB around the mobilized workforce has been very strong. And of course, that leads into other areas, like accessories -- or in particular, securities -- that goes along with mobilization. So I think SMB has been strong. I think it's going to continue to be fairly strong for us.

When we talk about the enterprise -- as you know, the enterprise did several quarters of very strong growth. And again, the value proposition well-received there. However, with our large enterprise, like with all of the large enterprise competitive landscape out there, the business tends to be project-dependent. And we look at large project rollouts. And I think we did see a more modest pace for rollouts in Q2, but we've already recovered very nicely in Q3. So a lot of that was a timing issue.

So overall, we're pretty confident that we have the right strategy -- certainly the right operating, the right business plan, and the right people -- to drive that business forward.

I think --

In terms of --

Yes. Go ahead, I'm sorry, Tim.

In terms of linearity -- I think it's about what you'd expect. June was the strongest sales month in the quarter in both SMB, enterprise and -- actually for all segments -- gov, and for the consumer segment. We did exit the quarter with a little stronger backlog. But sales per day were stronger toward the back half of the quarter in all segments.

In terms of your comment about the project-based work perhaps being a little bit softer in Q2 but recovering in July -- any more context you could put around that in terms of what types of projects? Was that specific to any particular vertical, like financial services or maybe another industry? And when you say that it's recovered in July, is that a pretty significant snapback? I'm just trying to get a little bit of color around what exactly happened, and maybe why it happened. And it sounds like maybe what was a pause last quarter has kind of returned to normalcy this quarter.

Yes, I think we're seeing what the competitive landscape is seeing and saying about the enterprise space. And I think we've got a really good cross section of customers that cover the gamut of industries. So there isn't one vertical, other than healthcare, that I would put above another vertical specifically. I think we're seeing good growth there.

We did see a little bit of a pause on some of the projects. And as I mentioned in enterprise specifically, we have already recovered in Q3.

Does that suggest that your July -- sorry to get so granular -- but that your July in enterprise is performing better versus June than it normally would? So what we lost in June or shifted from June has been recovered in July? And if you kind of average the two months, it's basically a normal trend? Or is it still a little bit softer than that?

As you know, one month doesn't make a quarter. And again, given these markets, there is some question. But we absolutely did recover in the enterprise in July. We snapped right back.

Okay.

And on the federal side -- I think you said it was down 20% or so?

Yes.

And that was year-over-year. Could you remind us what that looked like in Q1, just to get the trend line there? And then, more importantly as we enter into the months of August and September -- which are typically associated with the strongest months of the federal spending season -- what's your expectation for federal spending in Q3 relative to what you would normally see?

That's a difficult question to answer with any certainty. I'm going to start, and I'll let Steve finish with some of the actual data.

But in general, as you know, the federal business is about these large contract-buying vehicles. And they're very closely correlated with the federal budgets. And there's absolutely been a pullback there. So we do expect that the federal business is going to be challenged certainly for the balance of the quarter. And as you know, Q3 is the strongest quarter for our public sector business.

So Steve, you want to comment on Q1 specifically?

Sure. As you remember, our federal business represents approximately 30% of our public sector business overall. And the federal business for calendar year 2010 left the year up 22% year-over-year. So federal has been doing quite well. In Q1, our federal team had a year-over-year sales increase of around 16%. And as we've mentioned in the release, federal was down 20% in Q2. And I think Tim provided a little more color on federal going forward.

One of the other components, though, to the business plan, really, is the focus -- the discipline around our margin plans and our margin enhancement. And the public sector has done a very nice job there, as has the whole company.

Okay.

And then, within your commentary around mobility, which sounded like it continued to be strong -- anything to point out there for Tablets specifically within the commercial space, and whether you're seeing Tablet adoption accelerate and potentially cannibalize traditional Notebook sales?

We are seeing great acceleration with Tablets. As you know, one vendor in particular has about 64% market share out there in the industry. But there's a lot of optimism from some of the other vendors. We are seeing some products that look encouraging. We're excited about some of the alternatives that we see out there. And clearly, this is a category that's going to grow for us and for the competitive landscape. Right now, we still don't believe it has cannibalized our Notebook markets, but clearly there's that potential for the future.

Are you seeing any traction with any Tablets beyond the leading vendor, which I assume is Apple?

[Yes.] We're seeing great promise with webOS and great promise with some of the other Android operating systems.

And when you say -- just make sure I understand -- when you say "promise," is that actual sales, or is that interest?

Well, the webOS product really has been out on the market just about a month, and is really just starting to ramp up. And we expect more enhancements to come there. And another one of the competitive products that we've all been waiting for isn't out yet; it'll be out in August. But I think that combination is going to be a force in the business market space.

Okay.

Just a couple other ones -- storage was down year-on-year. Most would call storage a relatively hot category in the context of technology hardware spend. So I'm just wondering -- is that something that is unique to PC Connection -- that your storage sales were down? And what's kind of the reasoning behind that?

As you know, especially as we look out at the second half of the year, storage offers great promise for us. We're making a lot of inroads. And with our solutions capability, our forecasts are pretty strong. I think the whole storage and server infrastructure market is going to be strong for us in the back half of the year. That said, I think the challenge in Q2 really was an enterprise challenge and a timing issue.

And is that part of the snapback you saw in July -- that storage, for whatever reason, was weak in June and strong in July?

Not specifically. We're referencing the enterprise sales overall, when I was looking at the return to what we'll call normal trends.

Okay. Any commentary from customers or anecdotes you could share behind why storage might've been weak in the second quarter?

I think more so than ever, customers are asking us to help them navigate through all of these technological changes. And again, I think our strategy by going deeper and wider with solutions in our customer base is one that really is on the right track. So we've been helping our customers navigate through all that. I think with the data doubling and the growth in data, there is going to be a very strong demand for that. But I think when you look at cloud and some of the other offerings, customers are really taking time to evaluate.

And as I mentioned, customers, I think, are going to do that without necessarily adding headcount or adding seats, but investing in technology that's going to help them improve productivity and reduce costs.

Great.

Final one -- just in terms of product availability -- any issues that you had in the quarter that you could point to with respect to specific categories that were in short supply? And I noticed your inventory was up year-on-year a little bit more than sales. So if you could help us understand where maybe you had some excess inventory?

The inventory was really customer-driven. It's where we're doing large project rollouts, and we're doing a record number of custom configurations. And so the inventory -- and I'll let Jack comment a little more on the overall inventory balance -- but that really was the driver of inventory.

Did you want to comment on inventory, or --?

Other than the increase [in] inventory from the year end was only about $1 million. So I think in total -- Steve, you may have the breakdown as to how much of that was really on hand versus in-transit.

Sure, Jack.

To your point, Brian -- inventory was up June year-over-year. And I think a little bit of that increase we saw June year-over-year was a result of some opportunistic buys later in the quarter. But as Jack mentioned, from a year-end level, our inventories were only up slightly. And we continue to believe, both in quantity and quality, that inventories are in very good shape.

Brian, the front end of your question was -- I'm sorry, could you repeat that?

Just in the areas of potential shortages, I guess primarily I'm concerned about the printing space, as one of your large suppliers there might've been constrained related to the earthquake in Japan.

Actually, we've worked through those issues, so we don't have any particular constraints there. We were absolutely constrained on our Tablets in Q2. And there's no doubt that that did have an impact on Tablet sales. But other than that, we didn't see anything that would have a real impact on our performance.

Okay.

Maybe one last one, competitive pricing -- obviously, your gross margins were very strong. I think the SMB gross margins look to be a record. And I know you called out a couple of different reasons for the gross margin strength. So just trying to get some sense for whether you're seeing anything in the competitive pricing environment that concerns you.

As you know, Brian, because we've discussed it -- we've had a business plan to focus on margin improvement. And for last couple of quarters, I think the team has executed pretty well against the plan. So we've gained some traction there.

However, I think as you also know, we are seeing a lot of highly competitive opportunities now in public sector, and in the enterprise space in particular. So it has not been as competitive in the SMB space.

Okay. Thanks so much.

(Operator instructions)

Ladies and gentlemen, it appears we have no further questions today. Ms. Gallup, I'd like to turn the Conference back to you, ma'am, for any closing comments.

Thank you, operator.

In closing -- during the quarter, the Company achieved its highest Q2 sales level in its history, while also achieving record gross margins. The Company also realized significant increases in both operating income and earnings per share. We believe we are driving the right balance of growth, profitability and strategic capital investments to position us well for future success.

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 good evening.

Ladies and gentlemen, that will conclude today's Conference Call. We'd like to thank you all for joining us, and wish you all a great evening.