PC Connection Inc (CNXN) 2011 Q4 法說會逐字稿

Good day, everyone, and welcome to the PC Connection Fourth Quarter 2011 Earnings Conference. As a reminder, today's presentation is being recorded. At this time I would like to turn the conference over to Mr. Jack Ferguson, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, and good afternoon, everyone. This is Jack Ferguson. Joining me is Tim McGrath, President and CEO. We're pleased to have you join us today for PC Connection's 2011 Fourth Quarter Earnings Call. If you haven't already seen our press release, you can contact Janice Rush at 603-683-2322 and she will email a copy to you. You can also view it on our website.

Today's call is 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 Annual Report on Form 10-K for the year ended December 31st, 2010, which is on file with the Securities and Exchange Commission, as well as in other documents that the Company files with that agency from time to time.

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, Tim McGrath, for his remarks on our quarterly results. Tim?

Good afternoon, everyone. Thank you for joining us to review the Company's quarterly and annual financial results. Unless otherwise noted, all of my fourth quarter 2011 comparisons are being made against our fourth quarter 2010 results.

Net sales for the fourth quarter were $553 million, which are comparable to the 2010 fourth quarter sales. The 2010 revenues included certain large sales of tablets and media players that did not repeat in 2011 due to a contractual change with one of our suppliers.

We continue to invest in our solution sales capabilities, including our Q1 2011 acquisition of ValCom, and expect that as we execute our business plan, we will capture additional market share.

Net income for the quarter increased by 8% to $7.4 million, and earnings per share increased from $0.26 in 2010 to $0.28 per share in 2011.

Consolidated gross profit dollars in the quarter increased by over $5 million, or 9%, to $69 million. Gross margin, representing gross profit as a percentage of net sales, increased by over 100 basis points due to our continued focus on margin improvement. All four segments improved their invoice selling margins and contributed to the overall margin increase.

Consolidated SG&A expenses in the quarter increased by 10%, to $57 million. SG&A as a percent of net sales was 10.3% for the quarter, compared to 9.3% for the prior-year quarter. We attribute the dollar and rate increase to investments in solutions sales capabilities, higher variable compensation associated with improved gross profits, and the inclusion of ValCom's operating costs for the quarter.

Investments in our solutions sales capabilities include the addition of technical services personnel to support our data center, net com, software, and storage products. Additionally, we incurred approximately $1 million in nonrecurring regulatory charges during the quarter. We are monitoring our SG&A expenses to ensure that additional costs will fuel future growth.

Income from operations was $11.8 million, or 2.1% of net sales, in 2011, compared to $11.7 million in 2010.

On an annual basis, 2011 net sales increase by 7% over 2010 to $2.1 billion, surpassing the $2 billion mark for the first time in Company history. Our three primary segments each contributed to the revenue increase.

Our Large Account segment had its strongest year, with 2011 sales increasing by 18% over the prior year. On an organic basis, Large Account sales increased year over year by over 13%.

SMB sales increased by 4% in 2011 despite the loss in tablet and media player sales referred to earlier.

Sales for the Public Sector increased by 1% as constraints from the 2011 federal budget were offset by higher sales to the education customers.

Annual gross profit dollars increased by 15% to $265 million in 2011, compared to 2010.

Gross margin in 2011 increased year over year by 95 basis points to 12.6%. Increases in both vendor consideration and invoice selling margins contributed to the overall improvement in gross margin.

SG&A expenses increased by $26 million in 2011 compared to 2010, and increased as a percentage of net sales from 9.7% in 2010 to 10.3% in 2011. The increase was due primarily to investments in our service, support, and solutions selling areas as well as higher variable compensation, increased advertising expenses, and the inclusion of ValCom expenses.

Net income increased by $5.8 million from $23 million, or $0.85 a share in 2010, to $28.8 million, or $1.07 per share, in 2011.

We are encouraged by the initial return on our investments, particularly our ability to offer expanded services and solutions.

And now I'll discuss the quarterly results for our business segments and cover our product trends.

Our overall commercial business, which is a combination of our SMB and Large Accounts segments, grew for the quarter by 2%. Sales for our SMB segment, which serves primarily small to medium-sized businesses, decreased this quarter by 9% to $224 million. Our largest product category, notebooks, decreased by 13% during the quarter due to lower sales of tablets. Sales of desktops and servers were level with last year. SMB experienced healthy growth in both storage and net com products due to our investments in Solutions Selling.

Gross profit dollars for SMB decreased by 1% in the quarter. However, gross margin improved by 112 basis points to 14.4% due to a focus on higher-margin enterprise products and services.

Sales by our Large Account segment increased this quarter by 17% to $197 million. Consistent with prior quarters, we have included the operating results in ValCom under this segment. Excluding ValCom's revenue, Large Account sales would have increased by 10.5% due to strong demand for enterprise solutions.

Gross profit dollars increased by 26% for the Large Account segment. Gross margin increased 74 basis points as higher invoice selling margins offset a decrease in agency fees.

Overall quarterly sales in our Public Sector segment, which include sales to government and education customers, decreased in 2011 by approximately 2%. Sales to the federal government were generally comparable to the prior year, whereas sales to state, local, and education customers decreased by 3%.

However, gross profit dollars for the Public Sector increased in the quarter by 10%, with both government and education showing improvements. Gross margin increased significantly, by 130 basis points, due to higher invoice and selling margins.

Sales to consumer and small office home office customers were $17 million in the quarter, compared to $25 million in the prior-year quarter. However, gross profit dollars increased by 7% as gross margins improved by 324 basis points. This segment was focused, in 2011, on gross margin and operating improvements. Moving forward, this group will focus more on small business customers.

On a consolidated basis, we ended the quarter with 646 sales representatives, compared to 615 on December 31, 2010.

Notebook and PDAs, our largest product category in the quarter, decreased by 2% and accounted for 17% of net sales compared to 18% in 2010. The decrease was the result of a decline in ASPs as unit sales increased.

Sales of desktops and servers decreased by 7% and accounted for 16% of net sales.

Software sales were nearly level, accounting for 15% of net sales in the quarter, in both 2011 and 2010.

We continue to experience strong demand for advanced technologies like virtualization, security, and cloud computing.

Video imaging and sound sales decreased by 25% due to several large sales in Q4 that did not repeat in 2011.

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

Thanks, Tim. In summary, our operating results for the quarter were positive, especially considering the continuing uncertainty in the economy.

Consolidated sales for the quarter remained relatively constant on a year-over-year basis as the declines in SMB and consumer sales were offset by strong Large Account sales. There were significant gross margin improvements in all four business segments and earnings per share increased from $0.26 to $0.28 in the quarter.

We continue to invest in long-term growth strategies in order to produce strong operating results. We also manage our resources and liquidity to maintain a strong financial base. Even though our cash balance decreased by $31 million in 2011, we believe our balance sheet demonstrates a continuing strength.

Cash flow used by operations for the year ended December 31, 2011, was $5.3 million, compared to a $900,000 use of cash in 2010. The primary use of operating cash in 2011 relates to a $57 million increase in accounts receivable. This increase was only partially offset by increased earnings and an increase in accounts payable.

Cash used for investment activities in 2011 was $16 million, compared to $7.2 million in 2010. Our net cash investments in 2011 for the ValCom acquisition was $4.7 million. We have agreed to pay an additional $2 million in contingent considerations in 2012 for this acquisition upon the achievement of certain revenue milestones.

Cash used for other capital expenditures in 2011 increased by $4.5 million. These expenditures relate in large part to the first phase of our IT initiative, which we expect to complete in late 2012. As reported in prior calls, we are continuing to consider comprehensive upgrades to our IT systems, and if these are implemented, our additional capital investment will likely exceed $20 million over the next three years.

Net cash used for financing activities in 2011 was $9.4 million, compared to $2.9 million in 2010.

The Company paid a one-time special cash dividend of $10.6 million, or $0.40 per share, during the last quarter of 2011.

We also purchased $4 million of our outstanding stock or treasury at an average price of $8.28 per share. We consider block repurchases directly from larger stockholders, as well as open market purchases, in carrying out our ongoing stock repurchase plan.

We borrowed a net of $5.3 million from our line of credit in December to take advantage of trade discount and to pay other short-term obligations. Accordingly, our cash balance decreased by $30.8 million in 2011, compared to a $10.9 million decrease in 2010. We ended the year with a cash balance of $4.6 million.

We are out of our line of credit now and expect to remain out in the remainder of this quarter through our normal cash conversion cycle.

Turning to the remainder of the balance sheet, accounts receivable, as stated before, increased by $57 million during the year to $295 million at December 31, 2011.

Day sales outstanding, or DSOs, increased to 53 days as of December 31, 2011, compared to 44 days as of December 31, 2010.

We experienced more liquidity pressure from our customers as they sought to preserve their own year-end cash balances. Additionally, more customers have been requesting extended payment terms as a condition of doing business.

DSO days increased across all segments. However, we do not believe the increased DSOs at year end indicate any general weakening of credit in our overall customer base. Nonetheless, we are continuing to monitor ongoing credit exposure from all of our customers given the current liquidity environment in order to minimize that credit risk.

Our year-end inventory levels increased year over year by $3.1 million, primarily as a result of additional buy-ins of constrained product lines.

Inventory turns for the fourth quarter 2011 increased to 25, compared to 23 turns in Q4 2010. We continue to believe that inventories are in excellent condition, both in quantity and quality.

Net sales of products drop-shipped by distributors and other vendors directly to customers were 67% of total net sales in the fourth 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 so.

Accounts payable increased during the year by $16 million to $131 million at December 31, 2011. The increase was due primarily to the timing of product 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 stockholders' equity was 58% of total assets at December 31, 2011, compared to 61% at December 31, 2010. Accordingly, our overall leverage ratio remains relatively low.

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

Thank you, Mr. Ferguson. (Operator Instructions) Brian Alexander, Raymond James.

Yes. Could you guys talk about the DSO issue again? I'm not sure I understood what you were referencing, Jack, when you talked about customers demanding longer payment terms. I haven't heard this from your peers and I don't think you guys have talked about this in the past, so what's different in this environment that's causing that because it sounds like this is across your customer base. That's my first question and I have a few follow-ups.

Okay. We did experience that across all the business segments, particularly in Q4. If you compared DSOs to the previously reported DSOs in the other quarters, you saw the significant increase. And that had to do with, as we attempted to collect, we found that more and more customers were intentionally trying to preserve their own cash balances and advising us they will pay us after the first of the year, which many of them have -- that DSO has come down considerably. But at year end, that was pretty high.

Additionally, we are increasing the number of customers who are getting extended payment terms. Now, these are larger companies and so they have very good credit ratings; it's not a case where we're being forced into giving bad credit. But that is a significant increase in extended payment terms.

Additionally, in this quarter there was what I would call a nonrecurring issue with respect to the Public Sector payments, in which we had a delay of receipts coming from one of our teaming partners in the federal government. Those payments had been inadvertently paid to the teaming partner instead of us so we've spent January basically getting those payments back. That probably artificially raised the Public Sector.

But it's clear that this year end is the first time that we've experienced that the DSOs were higher because of the customer delays in payment. Yes, go ahead.

For the larger customers, are you looking to securitize those receivables at all to improve your cash flow, or is that something where you're going to carry the credit risk on your balance sheet?

I think we would carry the credit risk on our balance sheet. So far, we don't feel that there's -- I think the cost of securitizing it would outweigh the borrowing costs right at this point, considering our low borrowing rate.

Okay. And then your revenue, relative to my expectation, was a little bit less but your gross margin was better for sure. So how much of this is a conscious decision on the part of the Company to either prune revenue or sacrifice some revenue due to competitive environment and preserve margin? I'm just trying to get a sense for whether you think your revenue trends were more reflective of the demand environment or more reflective of decisions that you made to preserve profitability in a potentially increasingly competitive environment.

Hi Brian, this is Tim.

Hi, Tim.

Thanks. Over all, I think we had kind of a mixed bag. Let me start by saying our Large Account sales grew by 17% and alternately in the quarter, the big offset really was in the SMB segment, and to a lesser degree in the Public Sector. In SMB, it really is all about certain low-margin sales of tablets in Q4, and media players. As a result of a contractual change in our supplier agreement, we stopped taking those sales. So accordingly, top-line sales were hurt because of that.

However, we have several initiatives under way in our solutions selling arenas and in the enterprise product lines to improve margins, and our plans are working. So clearly I don't expect that contractual change and that supplier agreement change to affect us going forward; we had to move thorough that in the past.

How much do you think product availability hurt top line in the quarter and potentially helped margins?

That's a tough question. We have our estimates; and of course it varied by product line. But it's really tough to pin that down, as you know, to an exact answer. Ultimately I think with our larger suppliers, our constraint issues and our inability to deliver as a result [this time] of the hard drive were fairly consistent with what our suppliers are seeing. So we really don't have an exact number we can call out.

Do you have any meaningful backlog that spilled over into Q1?

We do have a backlog that did spill over -- it was about $5 million higher exiting the quarter. But that said, we do anticipate, as I know you know, that the hard drive constraint issue -- we're not out of the woods yet. We see that as lasting potentially through the first half of the year.

And were you more constrained on PC-related products or enterprise-related?

Clearly, it was the desktop and notebook product that we had a little heavier constraint on. It did affect some of our servers. But ultimately, it was the desktop-notebook line.

And just a final one from me -- you called that a regulatory charge, I think, in the prepared remarks. Can you elaborate on what that was for and whether you expect that -- I think you called it nonrecurring so I assume we won't see that in Q1, but what was that for? Thanks.

That had to do with the regulatory audit. As you know, we tried to anticipate what we think a probable assessment might be and so we made that accrual in the fourth quarter. That audit will take place in this current quarter and so we had to estimate what we think the likely exposure would be. That's one case.

There was another case in which a state audit -- this is non-income tax -- there was some additional interest charges for past assessments there which we recognized in Q4 at that time. So all of those really relate to a nonrecurring --

And then there was a -- one of my favorites was a special fee in the District of Columbia for a ball park that happened to be built there a few years back. We had to make an assessment for that fee and we called that in Q4.

All right; thank you.

Thanks, Brian.

(Operator Instructions) As there are no further questions at this time, I'll turn the call back to Mr. McGrath for any closing or additional remarks.

Thank you, Operator. I'm pleased with our overall performance in 2011. PC Connection achieved record annual sales while attaining the highest annual gross margins in over a decade. We remain committed to making the investments necessary to continue to grow our business and improve our operating performance.

We believe that the strategies we have put in place will position us well to gain market share 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 co-workers for their efforts. I'd 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.

Ladies and gentlemen, that does conclude today's presentation. We thank you for your participation.