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PC Connection, Inc. (NASDAQ:PCCC)

Q4 2008 Earnings Call Transcript

February 5, 2009 11:00 am ET

Executives

Stephen Baldridge – SVP Finance & Corporate Controller

Patricia Gallup – Co-Founder, Chairman & CEO

Jack Ferguson – EVP, Treasurer & CFO

Tim McGrath – EVP, Enterprise Group

Analysts

Nabil Hanano – Raymond James

Matt Sheerin – Thomas Weisel Partners

Operator

Good day everyone and welcome to the PC Connection fourth quarter 2008 conference call. This call is being recorded. At this time I would like to turn the call over to the Senior Vice President of Finance and Corporate Controller, Mr. Stephen Baldridge. Please go ahead, sir.

Stephen Baldridge

Thank you, and good morning, everyone. This is Steve Baldridge, Senior Vice President 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 2008 fourth 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 Web site. Today's call is also being webcast and will be available from PC Connection's Web site.

I would like to inform our participants that any statements or references made during the conference call that are not statements of historical facts 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 in the company's quarterly report on Form 10-Q for the quarter-ended September 30, 2008, 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. 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 and annual results. Pat?

Patricia Gallup

Good morning everyone and thank you for joining us. Our results for the quarter reflected the downturn in the economy and the associated decline in demand for IT products. The weakness in the economy resulted in more conservative buying patterns on the part of our customers, order deferrals and longer sales cycles.

Net sales for the fourth quarter of 2008 decreased $50 million or 10% to $439 million from $490 million for the fourth quarter 2007. Sales declines experienced in the SMB and large account segments were partially offset by increased public sector revenues. We are preliminarily reporting net income for the fourth quarter of 2008 at $1.9 million or $0.0 7 per share compared to $6.2 million or $0.23 per share for the prior year quarter. As stated in our press release, the quarter ended December 31, 2008 included $1.2 million of special charges related to goodwill impairment in our SMB segments. Had these charges not been incurred pro forma net income for the current quarter would have been $2.7 million or $0.10 per share compared to pro forma net income of $6.5 million or $0.24 per share for the fourth quarter of 2007. Our press release includes a reconciliation of these pro forma amounts.

In addition, the company has not yet completed its impairment review of goodwill attributed to its public sector and large account segments. We expect this review will be completed in time for following our Annual Report on Form 10-K in mid March and that any additional non-cash impairment charge would be recognized at that time. Thus net income and earnings per share for the quarter and year ended December 31, 2008 reported today are preliminary and subject to change based upon the result of this review.

I will now comment on our SMB segment, our original core business. Net sales decreased by $39 million or 15% from the fourth quarter 2007 to $255 million. Our corporate outbound sales to smaller and medium-sized business for the quarter decreased by 19% year over year reflecting the industry-wide slowdown in purchasing patterns from our SMB customers. Additionally large sales of video products to three customers in the previous year quarter were significantly left this year contributing to the sales decline. However Q4 consumer sales grew year over year by more than 14% as a result of recent expanded Internet marketing initiatives and improvements to our Web site. Sales to large corporate account customers reported as our large account segments decreased by $27 million or 19% to $113 million from the corresponding prior year quarter. More direct experience decreased revenues from further softening of large corporate spending as well as increased price competition, both our SMB and large account segments continue to be challenged in this uncertain business environment.

On the other hand sales to government and educational customers reported as our public sector segments continued to be a highlight of our business. Revenues for our public sector segment increased by $15 million or 18% from the fourth quarter of 2007 to $101 million. Our federal business increased by more than 25% year over year due to additional sales realized under federal contract programs. This represents the seventh consecutive quarter of double-digit year-over-year growth for a public sector business. Consolidated gross profit dollars decreased year over year in the fourth quarter of 2008 by 10% or $5.5 million to $52 million. Gross margin representing gross profit as a percentage of net sales was 11.8% in the fourth quarter of 2008 compared to 11.7% in the fourth quarter of 2007. Gross margin rates this past quarter increased slightly year over year due to improved invoice profit margins only partially offset by lower agency fee revenues.

SG&A expenses decreased slightly to $46 million for the fourth quarter of 2008 compared to $47 million for the fourth quarter of 2007. The dollar decrease was attributable to reduced variable compensation associated with lower sales volumes as well as cost reductions implemented by management. These decreases were partially offset by a charge of $600,000 related to a fixed asset disposal and increased bad debt expense. We also continued this past quarter to make investments in key strategic niches and sales system enhancements. SG&A expense as a percentage of sales was 10.5% for the quarter compared to 9.5% for the prior year period. The increase resulted from lower sales volumes and previously mentioned cost.

As discussed in the last quarter’s call, given the softness in customer demand, management took actions in the third quarter to reduce cost in line with lower sales volumes. We reduced headcount in sales support areas and implemented various operating cost reduction programs that are expected to result in annualized sales savings of $6 million. We continue to review our operating cost to better align them with expected lower sales volumes. Our effective income tax rate for the fourth quarter was 57% compared to 38% for the corresponding prior year quarter. The increased rate which reduced earnings per share by $0.02 was due primarily to an increase in valuation allowances associated with certain state tax credits. Preliminary income from operations for the quarter was $4.5 million or 1% of net sales compared to $10.1 million or 2.1% for the fourth quarter of 2007. We are preliminarily reporting net income for the quarter of $1.9 million subject to possible adjustment for a further non-cash goodwill adjustment compared to $6.2 million for the fourth quarter of 2007.

On an annual basis sales decreased year over year by $32 million or 1.8% as sales growth in our public sector segment was offset by declines in our SMB and large account segments. Gross profit dollars decreased in line with sales reflecting our ability to hold gross margin rates level in 2008. SG&A expense increased in 2008 by $5.1 million or 2.8% over the prior year. SG&A expense as a percentage of sales increased by 40 basis points over the prior year to 10.6% of net sales. Our preliminary annual operating income decreased by $11.3 million to $25.5 million in 2008. Operating income as a percentage of net sales was 1.5% in 2008 compared to 2.1% in 2007. We are preliminarily reporting net income of $15 million or $0.56 per share subject to a possible non-cash adjustment for further goodwill impairment compared to $23 million or $0.85 per share in 2007. On a consolidated basis average annualized sales productivity for the fourth quarter decreased by 14% from the prior year. Average sales productivity in the SMB segment decreased by 15% year over year. In the large account segment sales productivity decreased by 16% from the fourth quarter of 2007. Due to the establishment of a new sales office in South Dakota and the hiring of associated sales personnel late in the fourth quarter sales productivity for the public sector segment decreased by 5%. Excluding these new personnel sales productivity for the public sector segment increased by 9%. We ended the quarter with 712 sales representatives up 4% from 683 representatives at prior end.

Now on to Q4 product sales trends, our two largest product categories notebooks and PDAs and video imaging and sound each accounted for 15% of total sales. Software and desktop server sales accounted for 13% and 12% respectively. For the third consecutive quarter our netcom product growth showed the highest year-over-year growth at 24%. Average selling prices or ASPs for computer systems decreased year over year by 12% in the fourth quarter of 2008 and decreased by 4% compared to the third quarter of 2008. Q4 notebook and PDA revenues decreased by 9% and desktop and server revenues decreased by 17% year over year reflecting declines in those unit sales and ASPs. In 2008, service revenues experienced double-digit growth. We continued to invest in our services initiatives ProConnection and ServiceConnection through increased levels of sales training targeted promotions and additional certifications for products. We believe these investments strategically position PC Connections to capture a larger portion of the services market. We will continue to monitor our operating cost and review our spending plans and programs to enable the best possible allocation of our resources; however we will continue to invest in the sales, marketing and technology programs we believe are necessary to ensure our future growth and prosperity. As mentioned earlier in late December we opened a new sales office in South Dakota to support the continued success of our public sector segment. We expect the new call centre will be accretive to earnings during the second half of 2009 and represent a 10% sales growth in our public sector business for 2009.

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 year ended December 31, 2008 was $45.2 million compared to $400,000 for the prior year. The majority of this increase was due to a reduction in accounts receivable and inventory in 2008 which ultimately improved cash flow. Capital expenditures in the year ended December 31, 2008 were higher than in the prior year amounting to $10.4 million in 2008 to $7.1 million in 2007. As noted previously investments to enhance our customer relationship management systems accounted for much of this increase.

Financing activities in the year ended December 31, 2008 represented a $1.6 million use of funds compared to a $2.8 million source funds for the prior year. In 2008, we purchased $1.5 million of our outstanding stock for treasury whereas in 2007 the exercise of stock options provided $2.9 million in cash. Our cash balance increased by approximately $33 million in the year ended December 31, 2008 compared to a $4 million decrease for the prior year. Our cash flows remained strong with no outstanding quarter end borrowing from our credit facility. Our borrowing capacity under our credit facility remains unchanged.

Turning to the balance sheet accounts receivable as of December 31, 2008 decreased by $16 million to $186 million compared to the balance at December 31, 2007. Days sales outstanding were 45 days as of December 31, 2008 compared to 43 days as of December 31, 2007 and 45 days as of September 30, 2008. Given the current economic environment, we are taking additional steps to minimize credit risks from our customers. Inventory balances decreased by $15 million or 20% compared to the prior year end balance. Inventory turns were down slightly at 20 this quarter compared to 21 turns at the prior year end. We still believe inventories are in excellent condition both in quantity and in quality. Net sales to products dropped chips by distributors and other vendors directly to customers accounted for 57% of total net sales in the fourth quarter of 2008 compared to 51% in the fourth quarter of last year. We continued to focus on increasing dropped shipments where 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?

Question-and-Answer Session

Operator

(Operator instructions) We will pause for a moment to assemble our roster. Our first question comes from Nabil Hanano, Raymond James.

Nabil Hanano – Raymond James

Hi this is Nabil Hanano in for Brian Alexander. I was wondering if you could just talk about the linearity during the quarter for each of your segments they had become progressively worse each month and if so is that trend continued into January?

Tim McGrath

This is Tim. So if we look at the calendarization of sales in the quarter and then the demand trend leaving the quarter by sales segment during Q4 as noted from the call here our average daily sales were lower during the month compared to the previous year. November was the softest month in the quarter. We did see with our public sector business as demand was fairly solid throughout the quarter in terms of the linearity, November was the softest month overall in the quarter so we did see a dip down in November.

Nabil Hanano – Raymond James

So it has bounced back and you are seeing that trend continue into January –

Tim McGrath

No it has not. December was stronger than November but we have not seen that trend continue into January.

Nabil Hanano – Raymond James

Okay.

Tim McGrath

January has been a little softer.

Nabil Hanano – Raymond James

Then what are you seeing in terms of customer retention, how much of the revenue decline is due to customer share loss or customer or share loss versus lower spending by your existing customers?

Tim McGrath

That is a great question. We have been following that very closely so we are pleased to say that we are retaining our customers and in fact our acquisition strategy has been pretty solid. However our existing customer base does have a lot of budget constraints and they just are not spending given the economic environment, not spending as much.

Nabil Hanano – Raymond James

And then in terms of your competition on pricing products, have you seen your competitors become more aggressive as demand continues to deteriorate or is demand the same, steady?

Tim McGrath

As you might guess, when the market contracts it is a highly volatile, highly competitive environment and I think we do tend to see in market conditions like this we see folks really become ultra competitive. I would describe it as a very competitive marketplace right now.

Nabil Hanano – Raymond James

Okay. Just my last question, what are vendors doing in this environment in terms of rebates to other vendor funding compared to the last down cycle and do you think that goals for vendor rebates have been reset to attainable levels for the next quarter?

Tim McGrath

Overall, if you look at what happened with us in Q4, on a consolidated basis we actually improved our back-end vendor rebates by 27 basis points. However the dollar volume was fairly consistent, was fairly flat. I think that our strategic initiative that we havc with our key vendor partners have allowed us to maintain these historic levels of funding. So, at this point we have maintained and I would say that on a dollar volume basis we are flat.

Nabil Hanano – Raymond James

Okay, that is it from me. Thank you very much.

Operator

(Operator instructions) Our next question comes from Matt Sheerin [ph], Thomas Weisel Partners.

Matt Sheerin – Thomas Weisel Partners

Yes, thanks, good morning. I know that you don’t normally give specific guidance for the March quarter but you just stated that it sounds like January got off to a slower start, typically your revenues are down sequentially because of seasonality, are you seeing normal trends or is there going to be worse than seasonal so far this quarter based on what you have been seeing?

Jack Ferguson

So this spend, we are looking back obviously on a segment basis but overall there is no doubt the demand is softer across all three of our segments. Our public sector has maintained I would say it has fared the best overall but no question we are in a light demand environment.

Matt Sheerin – Thomas Weisel Partners

I suppose both SMB and enterprise any standout has been better or worse than the other.

Jack Ferguson

I would say they are fairly consistent as you know we don’t give guidance and all I can say is what we have seen so far is a softening year to date.

Matt Sheerin – Thomas Weisel Partners

Okay. And you also mentioned in your statement about margins being impacted somewhat by lower net agent CCs, could you be specific about that? Does that have to do with software licenses being softer or other things?

Stephen Baldridge

Hi Matt, this is Steve Baldridge. The reduction in Agent CCs fee revenue would relate to our public sector but also our commercial customers and software assurance would be part of that reduction for sure so sort of a combination of revenue, our agency revenues from both the public sector and software assurance related fees.

Matt Sheerin – Thomas Weisel Partners

Why do you think the software assurance fees would be down? Is that cycle related or the customers basically cutting back there as part of their own budget cuts?

Stephen Baldridge

The historical trend for us has been stronger software assurances revenues in Q2 and Q3 with Q1 and Q4 being a little softer but clearly as you look at software sales, you can also see the declines in softness and demand there which of course would also impact software assurance.

Matt Sheerin – Thomas Weisel Partners

Okay great and just lastly just in terms of your own expense structure, I missed the beginning in terms of your own cost structure, do you based on the lower revenue run rate do you have – you talked about cost cutting programs, headcount reduction or anything like that?

Jack Ferguson

Yes, this is Jack Ferguson, we actually initiated a cost reduction program in Q3 which we are beginning to see some of the impact in Q4 which we expect to generate a cost saving annualized of about $6 million but as you can understand this is a continuing process. As our revenues change, we have to continue to look at our cost structures and keep them in line with the revenue stream and as in the past all costs are subject to that review. Now that having said, we are still maintaining the investments that we have to have to operate our business. We don’t want to make short-term decisions that jeopardize our long-term ability and growth possibility. So it is a balancing exercise but we continue to look very closely at cost, and as I said, all costs are subject to a continuing review.

Matt Sheerin – Thomas Weisel Partners

Okay great. Thanks very much and good luck.

Jack Ferguson

Thank you Matt.

Operator

(Operator instructions) It appears we have no further questions on the phone at this time; I would like to turn the call over to Patricia Gallup for closing remarks.

Patricia Gallup

Thank you operator. I would like to thank all of our customers and vendor partners for their business and support. I would also like to thank our dedicated coworkers and those of you listening on the call this morning. We appreciate your time and your interest to PC Connection, have a great day.

Operator

And again, ladies and gentlemen, this does conclude today’s conference. We thank you for your participation, you may now disconnect.

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Source: PC Connection, Inc. Q4 2008 Earnings Call Transcript

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