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PC Connection, Inc. (NASDAQ:PCCC)

Q1 2009 Earnings Call Transcript

April 30, 2009 11:00 am ET

Executives

Stephen Baldridge – SVP of Finance & Corporate Controller

Patricia Gallup – Chairman & CEO

Jack Ferguson – EVP, Treasurer and CFO

Tim McGrath – EVP, PC Connection Enterprises

Analysts

Brian Alexander – Raymond James

Operator

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

Stephen Baldridge

Thank you and good morning, everyone. This is Steve Baldridge, Senior 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 first 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 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 in the company's quarterly report on Form 10-K for the quarter-ended December 31, 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, 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?

Patricia Gallup

Good morning everyone, and again, thank you for joining us. The first quarter was a challenge for PC Connection as it was for many others, requiring us to carefully balance the short term and long term interests of our company and our shareholders. During the quarter, the overall economy and correspondingly our revenues decline at a faster pace than a anticipated. Net sales for Q1 2009 decreased $98 million or 23% to $326 million from $424 million for the first quarter of 2008. Sales declined in all three business segment and across all product lines. Loss from operations for the quarter was $2.6 million or 8% of net sales compared to operating income of $7.4 m million or 1.7% of net sales for the first quarter of 2008. Net loss for the first quarter of 2009 was $1.6 m million or $0.06 per share compared to net income of $4.8 m million or $0.18 for the prior year quarter.

As stated in a press release, the quarter ended March 31, 2009 included $0.9 million of special charges related to management restructuring and workforce reductions. Had these charges not been incurred, performance net loss for the quarter would have been $1.1 million – $1 million or $0.04 per share. We did not incur any special charges in the first quarter of 2008. Our press release includes a reconciliation of these pro forma amounts.

I will now comment on our SMB segment, our original core business. Net sales decreased by $68 million or 28% from the first quarter of 2008 to $172 million. Both commercial and consumer sales declined year-over-year. The increasingly sluggish demand seen in the quarter reflects the industry wide slowdown in purchasing patterns. On a positive note, web sales here were level year-over-year as a result of recent Internet marketing initiatives and improvements to our website. Sales to large corporate account customers reported as our large account segment decreased by $26 million or 23% to $91 million from the corresponding prior year quarter. MoreDirect continues to experience increased price competition as well as customers delaying purchases and customers redeploying excess equipment resulting from corporate layoffs.

Sales to government and education customers reported as our public sector segment decreased by $3 million or 5% from the first quarter of 2008 to $63 million. Our federal business decreased by 10% year-over-year due to lower contract sales and certain large orders that were deferred to Q2. Education sales and sales to state and local governments were down by 2% compared to the prior year in part due to state funding cutbacks. Consolidated gross profit dollars decreased year-over-year in the first quarter of 2009 by 21% or $11.1 million to $42 million. Gross margin representing gross profit as a percentage of net sales however increased to 12.8% in the first quarter of 2009 c compared to 12.4% in the first quarter of 2008.

Gross margin rates the past quarter increased slightly both year-over-year and sequentially. Lower invoice margins in the quarter were offset by increased vendor consideration, improved freight margins, and higher agency fee revenue, which are recorded on a net basis. SG&A expenses decreased by 5% to $43.3 million for the first quarter of 2009 compared to $45.4 million for the first quarter of 2008. 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 increased bad debt expense and increased investments in key strategic initiatives in sales system enhancements. SG&A expense as a percentage of sales was 13.3% for the quarter compared to 10.7% for the prior-year period. The rate increase resulted from both lower sales volumes and the previously mentioned cost increases.

Given the continuing decline in customer demand, management took actions at the end of the first quarter to reduce cost in line with lower sales volume as reported in our press release last month. We reduced approximately 8% of our workforce across all departments, including both sales and in sales support areas, and implemented various other operating cost reduction programs. The actions taken in Q1 will result in over $14 million in annual cost savings. We continue to review our operating costs to better align them with expected low sales volumes and we would implemented additional cost reduction as required.

Our effective income tax rate for the first quarter of 2009 was 35%. We expect our effective tax rate will vary in future quarters given the complexities of FIN 48 reporting requirements and state income taxes. On a consolidated basis, average annualized sales productivity for the first quarter decreased by 21% from the prior year. On a segment basis, average sales productivity decreased year-over-year by 21% in the SMB segment. Sales productivity decreased by 16% in the large account segment and by 27% in the public sector segment. The public sector decrease was due to new hires late in Q4 and lower federal sales. We ended the quarter with 629 sales representatives compared to 689 on March 31, 2008, and 712 sales representatives at prior year end.

Now on to Q1 product sales trends. Our larger product category, notebooks and PDAs, accounted for 15% of total sales. Software and video, imaging and sound, each accounted for 14%. Desktop servers decreased to 12% of total sales, primarily due to a decline in unit sales. Although all product lines were down year over year for the quarter, Netcom products and accessories and others experienced the smallest decline. Average selling prices or ASPs for computer systems decreased year-over-year by 13% in the first quarter of 2009 and decreased by 6% compared to the fourth quarter of 2008. Q1 notebook and PDA revenues decreased by 26% reflecting a decline in ASPs as unit sales were level year-over-year. Software revenues decreased by 20% in the quarter and video imaging and sound decreased by 29%.

We will continue to monitor our operating cost and carefully review our spending plans and programs particularly in this market to enable the best profitable 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.

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

Jack Ferguson

Thanks Pat. First to cash flow. Cash flow provided operations by o operation for the three months ended March 31, 2009 was $23.1 million compared to $10.7 million for the prior year period. The majority of this decrease was due to a reduction in accounts receivables in 2009, which ultimately improved cash flow. Capital expenditures in the first quarter of 2009 were lower than in the prior year, amounting to 1.9 million in 2009 compared to 2.9 million in 2008. Last year's expenditures included and extensive desktop upgrade for our sales in (inaudible).

Financing activities in the quarter ended March 31, 2009 represented a $300,000 use of funds compared to a $1 million use of fund for the prior year period. In the first quarter of 2009, we purchased $100,000 of our outstanding stock for treasury whereas in Q1 of 2008, our treasury stock purchases totaled $900,000. Our cash balances increased by approximately $21 million in the quarter ended March 31, 2009. This compares to a $7 million increase for the prior year quarter. Our cash flow remained strong with no outstanding quarter end borrowings from our bank credit facilities. We ended the quarter with cash balance of $68 million representing 67% of our quarter end market capitalization.

Turning to the balance sheet, accounts receivables as of March 31, 2009 decreased by $30 million to $140 million compared to the balance at March 1, 2008. Days sales outstanding were 46 days as of the end of March 2009 compared to 44 days as of March 31, 2008, and 45 as of December 31, 2008. Given the current economic environment, we are taking additional steps to minimize credit risk from our customers.

Inventory balances decreased by $9 million compared to the balance as of March 31, 2008. Inventory turns for the quarter decreased only slightly to 20 turns compared to 21 for the prior year period. We believe inventories are in excellent condition, both in quantity and in quality. Net sales of products drop shipped by distributors and other vendors directly to our customers accounted for a record 61% of total net sales in this first quarter of 2009. This compares to 53% in the first quarter of last year. We continue to focus on increasing drop shipments where appropriate and cost-effective, which allows us to maintain generally lower energy levels.

In summary, despite the current economy, the balance sheet remained very healthy. We will now entertain your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We will go first to Brian Alexander, Raymond James.

Brian Alexander – Raymond James

Thank you. Good morning. Just if you could a little bit about demand trends quarter to date through the month of April, what have you seen out there, if you could talk about it by segment? I think a lot of companies have talked about stabilization, so could you comment on whether you're seeing that or whether you are actually seeing business improve or not improve? Thanks.

Tim McGrath

Hi Brian. It is Tim. I will take that. So we were pleased that we saw slight consecutive growth through Q1 in terms of the calendarization, but obviously a very soft quarter. Into Q2 we have seen some stabilization. We remain guarded as there is a lot of uncertainties you know. But our enterprise and public sector businesses, when you look at our bookings, you look at the forecast, and certainly the backlog, we are seeing a lot of stabilization there. We are encouraged about what we're seeing in SMB but they did get off to more of a slower start. Overall I would say a very conservative stabilization is happening.

Brian Alexander – Raymond James

Does that imply Tim that if we were to model sequentially off of Q1 that you would expect to see normal seasonality off of a difference first quarter or would you expect to see a little bit better than seasonality given how bad Q1 was?

Tim McGrath

Brian, we really don't offer guidance as you know and I really can't predict that at this time.

Brian Alexander – Raymond James

Okay. Could you talk a little bit of about just the overall pricing environment? I know you guys – I guess two questions – you talked about vendor funding helping you or help you gross margin, so just what is driving that in such a weak environment? Are vendors just becoming much more realistic and setting goals or is there another story that? And related to that, the competitive pricing environment and how is that playing out right now?

Tim McGrath

Okay. So Brian, I think I will kind of answer that reverse order. If you look at the competitive environment, we would still characterize it as hyper competitive. We are pleased to say that we are not losing customers. However we're running into situations where we are asked to bid a lot more. There is a lot more competitive pricing pressure and I think you saw that in our overall margin rates. That said, when you look at our partnership with our vendors and our total vendor consideration, we as a percentage were fairly flat. But when you look at that, we were slightly down on a dollar basis. We're pretty proud of the partnerships we have and we think that overall that will continue.

Brian Alexander – Raymond James

Okay. You mentioned netbooks in the prepared remarks and I am just wondering to what extent have you seen netbooks getting traction in your non-consumer segment?

Tim McGrath

So we have some really good growth with our networks. As you know that does have an effect on ASPs. And interestingly enough we are seeing some good growth in our public sector division with netbooks as many of the state and higher ed agencies are adopting that product. So if you break that down, big part of the business would still be characterized, as a web and VSB business, and then the next largest segment would be our public sector.

Brian Alexander – Raymond James

Okay. To what extent are you seeing them gain Tim in SMB community?

Tim McGrath

In the SMB community in terms of share, we see that doubling quarter over quarter. But that is still in the single digits when you look at our overall notebook share.

Brian Alexander – Raymond James

And do you think most of that is cannibalistic of traditional notebooks or is that incremental?

Tim McGrath

It is hard to say on that one. We do think that cannibalistic of the ASPs. Obviously the average selling price on a netbook is $399 or below. So clearly that has its effect on the average selling price.

Brian Alexander – Raymond James

And then just finally, the inventories this quarter was down but not really down as much of your sales decline so I'm just wondering what your plans are for inventory in the June quarter? Are you looking to reduce that? Any target on turns would be helpful?

Jack Ferguson

This is Jack. I will take that one. The inventories level I think we continue to manage setting much on a quarter by quarter basis based on a variety of factors. Certainly buy ins, availability of those, but obviously the increase in drop shipments where it makes sense to do so, we would continue that trend, but I would expect that inventory levels may not go down much more than they are now. If we get an opportunity for a particular end of life product or other products, that level may go up. But we try to manage the inventory very closely, particularly looking at the sales volume of these product lines.

Brian Alexander – Raymond James

Okay, thank you.

Operator

(Operator instructions) And with no further questions in the queue at this time I would like to turn the conference back over to Ms. Gallup for any additional or closing remarks.

Patricia Gallup

Thank you, operator.

Our near-term strategies remain focused on initiatives to the restore profitable growth to our business. I would 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 on the call this morning. We appreciate your time and interest in PC Connection. Have a great day.

Operator

This does conclude today’s conference. We appreciate your participation.

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