PC Connection, Inc.
Q2 2009 Earnings Call Transcript

Published: 31 Jul 2009

[Operator:]

Good day and welcome everyone to the PC Connection's Second Quarter 2009 Financial Results Conference Call. This call is being recorded. At this time I'd like to turn the conference over to Senior Vice President of Finance and Corporate Controller, Mr. Steven Baldridge. Please go ahead sir.

[Steven Baldridge:]

Thank you and good morning everyone. This is Steve Baldridge, Senor VP of Finance and Corporate Controller. Patricia Gallup, Chairman and CEO, Jack Ferguson, Executive Vice President and CFO and Tim McGrath, Executive Vice President, PC Connection Enterprises are also here with us today. We're pleased to have you join us today for PC Connection's 2009 second quarter conference call. If you haven't already seen our press release, you can contact Janice Rush at 603-683-2322 and she will fax or E-mail a copy to you immediately. You can also view it on our website. Today's call is also being webcast and will be available from PC Connection's website. Additionally, this conference call is a 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 maybe 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 quarterly report on Form 10-Q for the quarter ended March 31, 2009 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 result, Pat.

[Patricia Gallup:]

Good morning everyone. And again, thank you for joining us, to review the company's financial results for the second quarter of 2009. Our results for the quarter continued to reflect the ongoing economic environment and related decline in demand for IT products and services. Net sales in the second quarter decreased, year-over-year, by $72 million or 16% to 377 million compared to the second quarter of 2008. Sales decline in our two corporate segments were partially offset by increased public sector sales. On a sequentially basis, however, net sales this quarter increased by 51 million or 16% over the first quarter. This was due in part to the seasonal growth in our public sector segment, which I will discuss later. Net loss for the second quarter of 2009 was 6.5 million or $0.24 per share compared to net income of 5.1 million or $0.19 per share for the prior year quarter. As previously reported and as referred to in our press release, the quarter ending, -- ended June 30th 2009 included $12.1 million of special charges related primarily to the write-off of a software development project. The non-cash portion of the charges totaled 11.6 million. Had special charges not been incurred pro-forma net income for the second quarter of 2009 would've been $1.1 million or $0.04 per share. We did not incur any special charges in the second quarter of 2008. Our press release includes a reconciliation of these pro-forma amounts. I'll now comment on our SMB segment, our original core business. Net sales decreased this quarter by $60 million or 25% from the second quarter 2008 to 177 million. Commercial sales declined year-over-year as the weak demand experienced in the quarter reflects the continuing industry wide slowdown in purchasing patterns. On a positive note, our consumer sales increased slightly year-over-year, as a result of recent internet marketing initiatives. Sales by our MoreDirect subsidiary reported as our large account segment decreased by $18 million or 14% to $110 million in the quarter compared to the corresponding prior year quarter. MoreDirect continues to experience aggressive price competition as well as customers delaying purchases. Sales to government and education customers recorded as our public sector segment increased year-over-year by $5 million or 6% to 91 million. Our federal business increased by 24% year-over-year due to additional sales realized under federal contract programs. Education sales and sales to state and local governments were generally unchanged compared to the prior year despite funding cut backs in many states. Consolidated growth profit dollars in the second quarter of 2009, decreased year-over-year by 22% or $12.5 million to 44.3 million but increased sequentially by $2.7 million. Gross margin representing profit as a percentage of net sales decreased to 11.8% in the second quarter 2009 compared to 12.7% in the second quarter of 2008. The lower margins rates were due largely to aggressive price competition. We reduced SG&A expenses in the second quarter of 2009 by $6 million or 13% to 42.1 million compared to the second quarter of 2008. The dollar increase was attributable to reduced headcount and variable compensation associated with lower sales volumes as well as other cost savings implemented by management during the first half of this year. As reported in our prior quarters' earnings release, we implemented various cost reduction programs at the end of Q1, which we expect to generate over $14 million in annual cost savings. SG&A expense as a percentage of sales was 11.2% for the quarter compared to 10.7% for the prior year period. The rate increase resulted from lower sales volumes in the second quarter. We continue to review our operating costs to better align them with sales volumes and we will implement additional cost reductions as required. Our affected income tax rate for the second quarter of 2009 was approximately 35%, we expect our effective tax rate will vary in future quarters given the complexities of financial reporting requirements and state income taxes. Loss from operations for the quarter was $9.8 million or 2.6% of net sales compared to operating income of 8.7 million or 1.9% of net sales for the second quarter of 2008. Excluding special charges pro-forma operating income would've been $2.2 million in the second quarter of 2009. Net loss for the quarter was 6.5 million compared to net income of 5.1 million for the second quarter of 2008. And as I mentioned earlier, our pro-forma net income for the second quarter of 2009 would've been $1.1 million. The average annualized sales productivity for the second quarter decreased on a consolidated basis by 8% from the prior year. On a segment basis, average sales productivity decreased by 10% in SMB, 4% in large account, and 13% in public sector. The public sector decrease was due largely to the timing of new sales hires, which were added in Q4 of 2008. We ended the quarter with 603 sales representatives compared to 667 at June 30th 2008 and 629 at March 31st 2009. Now on to Q2 product sales trends; for the first time, software was our largest product category accounting for 15% of net sales in the second quarter of 2009, compared to 13% in the prior year quarter. Increased sales in the public sector drove this percentage increase. Three product categories, Notebooks and PDAs, Desktop Servers, and Accessories/Other, each accounted for 14% of total sales this quarter. Increased sales of specialized communication and solution products contributed to the year-over-year revenue growth in the Accessories/Other category. Average selling prices or ASTs for computer systems decreased in the second quarter of 2009 by 14% year-over-year and by 6% sequentially. Q2 Notebook and PDA revenues decreased by 22% year-over-year reflecting a decline in ASPs. Corresponding unit sales were unchanged for the third straight quarter. Video, imaging and sound sales decreased by 28% reflecting certain large Apple product orders to three customers in the second quarter of 2008 that were not repeated in 2009. We will continue to monitor our operating costs and review our extending plans and programs particularly in this market to enable the best possible allocation of our resources. However we will also continue to invest in the sales, marketing, and technology programs that we believe are necessary to ensure our future growth and prosperity. We will also continue to improve upon our software applications currently in use as well as review commercially available software as part of our overall strategic plan. And now Jack Ferguson will discuss our financial results in more detail, Jack.

[Jack Ferguson:]

Thanks Pat. First the cash flow. Cash flow provided by operations for the six months ended June 30, 2009 was $25.1 million compared to 33.6 million for the prior year period. As Pat mentioned earlier, the charge we incurred for the writing off of the software development project did not impact our cash flows. Operating cash flows in the first half of 2009 were positively affected by a decrease in accounts receivable. Capital expenditures in the first half of 2009 were lower than in the prior year amounting to $4.4 million in 2009 compared to 5.5 million in 2008. Such expenditures are expected to remain below last year's level for the remainder of 2009. Financing activities in the six months ended June 30, 2009 resulted in a $400,000 use of funds compared to $1 million use of funds for the prior year period. In the first half of 2009, we purchased $180,000 of our outstanding stock where as in Q2 of 2008, our treasury stock purchases totaled $900,000. Our cash balance increased by approximately $20 million in the six month ended June 30, 2009. This compares to a $27 million increase for the prior year period. Our cash flows remain strong with no outstanding quarter end borrowing from our credit facility. We ended the quarter with a cash balance of $67 million representing 48% of our quarter end market capitalization. Turning to the balance sheet, accounts receivable as of June 30, 2009, decreased by $25 million to $169 million compared to the balance of June 30, 2008. Days Sales Outstanding or DSO's were 47 days as of June 30, 2009, compared to 45 days as of June 30, 2008, and 46 days as of March 31, 2009. The increase in DSO days resulted from the increase in public sector sales particularly in the last month of the quarter. Public sector customers generally have slightly longer bill to cash cycles. We're continuing to take the necessary steps to minimize credit risks from our customers given the current liquidity environment. Inventory balances decreased by $7 million compared to the balance of June 30, 2008. Inventory turns for the quarter decreased only slightly to 23, compared to 24 for the prior year period. We continue to believe that inventories are in excellent condition both in quantity and in quality. Net sales of products dropped ships by distributors and other vendors directly to our customers for approximately 61% of total net sales in the second quarter of 2009, compared to 56% in the second quarter last year. This represents only the second time that the percentage has exceeded 60%. We continue to focus on increasing dropped shipments for appropriate and cost effective which allows us to maintain lower inventory levels. In summary, despite the current economy, the balance sheet remains very healthy. We will now entertain your questions, operator.

[Operator:]

Thank you. (Operator Instructions). And our first question today comes from Brian Alexander of Raymond James.

[Unidentified Analyst:]

Good morning. This is Nabil Hanano (ph) in for Brian Alexander. I was wondering if you could speak about linearity for Q2 by customer segment. We've seen a lot of signs of stabilization in the North American market and if those trends have continued into July.

[Timothy McGrath:]

Good morning this is Tim. I'll take that question. So overall our sales grew consecutively throughout the quarter for each of our sales segments. June was the largest sales month for the quarter and that was very similar to last year. Our large accounts, more directly, our public sector business did show greater backlog at the June end of quarter than the previous year. So ultimately, the seasonality and the linearity are just about what we'd expect.

[Unidentified Analyst:]

And what about going into Q3, have those trends continued?

[Timothy McGrath:]

As you know historically, we don't provide guidance. However I think that in general terms, we're planning for moderate growth and we do expect the seasonality lift from our public sector business.

[Unidentified Analyst:]

Okay, that's helpful Thank you. And what are your thoughts on PC upgrade cycle into next year given the aged install base and the imminent release of Windows 7?

[Timothy McGrath:]

So the question there with Windows 7, we're encouraged in particular for our S&P segments. If you look at the effect that Window will have on the ecosystem overall, I think it's very positive. However, we're conscious because we saw with Microsoft Vista, in many cases, it really didn't live up to the demand expectations. So we have a positive outlook. We're cautious. We think that the enterprise segments will be a little slower to adopt given their requirements.

[Unidentified Analyst:]

Okay and then also regarding PCs, what are you seeing with Netbooks. Your total Notebook revenue declined 22% year-over-year. Your PC ASP relation I believe was up. How much is Netbooks contributing to that?

[Timothy McGrath:]

So, we are seeing good growth in our Netbooks and as a matter of fact, specifically the Netbook category was 7% of our Notebook category in Q2 '09. That compares to about 1% in Q2 '08. And compared to about 5.5% for Q1 '09. So we are seeing a positive growth in the Netbook category. And as you might expect, that does reflect in the ASP component for Notebooks overall as a category.

[Unidentified Analyst:]

Are you seeing Netbooks gain any traction in the Enterprise?

[Timothy McGrath:]

We're seeing less traction there but much more traction in the public sector, specifically the SLED segment.

[Unidentified Analyst:]

Okay. And then finally, have you seen any product availability suppliers used across your lines and then specifically in kind of hardware given some commentary from other suppliers?

[Timothy McGrath:]

We are seeing, as you know, one of our largest suppliers has changed their supply chain methodology and they are moving their hard copy visit out to distribution. And I think there was a little bit of the hiccup with that process. We've great confidence in that vendor. We saw a little bit of a delay in the beginning of the quarter and then again little bit of a supply chain interruption at the backend of the quarter. But I would not say that it's significant to our sales overall.

[Unidentified Analyst:]

Okay. Thank you. That's all I have.

[Operator:]

(Operator Instructions). We'll go next to Matt Sheerin of Thomas Weisel Partners.

[Matthew Sheerin:]

Yes, thank you. Couple of questions, just expanding on the question regarding demand, it sounded like you're expecting normal seasonal uplift in your government business. Are you also seeing typical seasonal trends in the More business as well as your SMB business and could you tell me what the typical seasonality is?

[Timothy McGrath:]

Sure. I'll take the first part of the question and that's with the public sector, we do expect that we're going into the busy season for our SLED business with back to school and we do expect normal seasonality there. For our Enterprise segment, we have been challenged, it has been just a hyper competitive environment and we are seeing that in the Enterprise space as you know, CIO's and IT budgets are still constrained, people are still very cautious. So, we expect seasonality to be normal, however, we're very cautious about overall demand. And I think the same is true for SMB segment, as you noted, it's been the hardest hit, larger macro economic drivers including access to capital and of course SMB profits are still in place there. So seasonality on track, we're cautious about demand.

[Matthew Sheerin:]

Okay, and just following up on that, you talked about competitive pricing and that leads to my question on gross margin which was down for you in each segment sequential basis. How much of that was just pricing pressure from customers versus any changes in rebates or back-end dollars from your vendors?

[Steve Baldridge:]

Hi Matt, this is Steve Baldridge.

[Matthew Sheerin:]

Hi Steve.

[Steve Baldridge:]

As noted in the earnings release, our gross margin as a percent of sales did decrease to 11.8% in the second quarter compared to 12.7% in the quarter and the previous year. The 90 basis points decrease in margin rate was due largely to aggressive price competition as we mentioned earlier on the call. It was price competition that we noted in all three of our business segments and so the majority of the reduction in margin rate was truly related to the price competition. In terms of vendor consideration, though the vendor consideration in the second quarter was down slightly year-over-year, on a rate basis it was up approximately 5 basis points. So, therefore the aggressive pricing was clearly the result of the decline in margin rate.

[Matthew Sheerin:]

Okay. And then just operationally, how do you balance taking market share and bringing in volume versus a profitable opportunities in keeping that gross margin, where it is or even growing it.

[Jack Ferguson:]

Well this is Jack Ferguson. We always have to look at the balance between whether or not to take a lower margin sales opportunity. First is trying to keep our margin rates up. We obviously look for additional gross profit dollars but we're also looking at the longer term impact as well. So that's always a decision, pretty much on a case by case basis. We certainly are not going to try to be the lowest cost, lowest priced vendor in the market. But by the same token, we're going to remain competitive. Hopefully that gives you some...

[Matthew Sheerin:]

Yeah. But sir, what can you, what can you tell us, are our maintaining your share, market share in those three segments, as far as you can tell?

[Timothy McGrath:]

Hey thanks, this is Tim. We're, we believe that we're maintaining market share and we also believe to differ, just off of Jack's comment that to look at some of our professional services, growth along with our software growth, overall we'll call it a solution mix. Our solutions business is on the rise. And we're getting good traction there.

[Matthew Sheerin:]

Okay, thank you very much.

[Operator:]

And with no further questions in the queue, I' like to turn the conference back over to Patricia Gallup for closing remarks.

[Patricia Gallup:]

Thank you operator. In closing, we're pleased that in Q2, despite the challenging business environment, we made progress on restoring profitable growth to our business. Again, excluding special charges, we generated 2.2 million of pro-forma operating income in the second quarter. 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 morning, we appreciate your time and interest in PC Connection, have a great day.

[Operator:]

And that does conclude today's conference, ladies and gentlemen. Again we appreciate everyone's participation today.