PC Mall, Inc. (MALL) Q2 2010 Earnings Call Transcript August 5, 2010 9:00 AM ET
Frank Khulusi – Chairman, President and CEO
Brandon LaVerne – CFO
Kris Rogers – EVP, Sales and Marketing
Brian Alexander – Raymond James
Thomas [ph] – Northland Securities
Good day ladies and gentlemen and welcome to the second quarter 2010 PC Mall Incorporated earnings conference call. At this time, all participants are in listen-only mode. On the call with us today are Frank Khulusi, Chairman, President and Chief Executive Officer, Brandon LaVerne, Chief Financial Officer, and Kris Rogers, Executive Vice President.
At this time, I would like to refer to the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information, or expectations about the company's products or markets, or otherwise make statements about the future, which statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from statements made.
These risks and uncertainties are detailed in the company's filings with the Securities and Exchange Commission.
I would now like to turn the call over to Mr. Frank Khulusi, please proceed sir.
Thank you Derrick. And good morning and welcome, thank you all for participating on this call with PC Mall. Today, we will be discussing the company's financial results for the second quarter of 2010.
I would like to start by sharing a few of our second quarter 2010 highlights.
Consolidated net sales for Q2 2010 were $317 million, up 21% year-over-year. Consolidated gross profit for Q2 2010 was $40.6 million, up 13% year-over-year. Consolidated gross profit margin for Q2, 2010 was 12.8% down from 13.7 in Q2 2009 and diluted earnings per share for Q2 2010 was $0.11 versus diluted earnings per share of $0.06 in Q2 2009.
Adjusted EBITDA for Q2 2010 was $5.4 million, up 46% year-over-year. We purchased 101,521 shares of our common stock in Q2 2010 at an average price of $4.90.
I'm pleased with our second quarter consolidated results. Our year-over-year growth rate significantly accelerated from the first quarter.
Our consolidated sales grew 26% over Q2 last year, excluding sales of Sun Microsystems' solutions, which were negatively affected by Oracle's acquisition of Sun. Our commercial sales companies showed very strong year-over-year growth with SMB growing 26% year-over-year and MME growing 36% year-over-year.
We believe that this growth was driven by both an improving demand environment and by the investments that we have been making in our businesses, which are beginning to benefit our results.
I am especially pleased that our consolidated operating profit grew 46% over Q2 last year, driven primarily by large increases in both our SMB and MME segments. Additionally, our previously discussed strategy shift in our MacMall segment has continued to pay off as evidenced by a 130% sequential improvement in MacMall operating profit from Q1 to Q2, marking our second straight quarter of sequential operating profit growth in what is traditionally a seasonally down quarter.
In Q2, we also continued to invest in the growth of our service business and in late Q2 our SARCOM subsidiary acquired the assets of NSPI, a managed services provider located in Atlanta, Georgia. NSPI's area of focus complement our own very well, and include data center services, remote managed IT services, including support of desktops, servers, networks and VoIP telephony systems, and professional services.
Looking forward, our results in Q2 support our previously announced goal of achieving a 1.5 to 2% quarterly non-GAAP operating profit margin by the fourth quarter of this year, and we remain committed to that goal.
Now I'd like to turn the call over to Brandon LaVerne our CFO, who will present the financial results in a bit more detail, Brandon?
Thanks, Frank. All comparisons I make will be against Q2 2009 unless otherwise noted. As Frank highlighted earlier, consolidated net sales for Q2 2010 were $317 million, up 21% year-over-year. Gross profit was $40.6 million, an increase of 13% over last year. Gross profit margin for Q2 2010 was 12.8%, down from 13.7% last year. Q2 operating profit increased 42% to $2.8 million.
Consistent with what we saw in Q1, our Q2 2010 results included a $400,000 increase in costs due to an appreciation of the Canadian dollar relative to the US dollar and $0.5 million increase in depreciation expense over Q2 2009 reflecting our IT investments in systems and infrastructure upgrades.
Net income for Q2 2010 was $1.4 million, up 67% over last year, resulted in diluted EPS of $0.11 per share versus diluted EPS of $0.06 last year. Adjusted EBITDA for Q2 2010 was $5.4 million, up 46% over last year.
Adjusted EBITDA is a non-GAAP measure that looks at operating profit plus depreciation and amortization, non-cash stock based compensation and special charges, if any; however there were no special charges reported in either period.
Information about our use of non-GAAP financial information is provided in our current report on Form 8-K filed with the SEC earlier today and available on our website.
I will now speak about our Q2 2010 segment results. For our SMB segment, Q2 sales increased 26% to $107.7 million primarily due to an improvement in a demand environment and an increase in revenues from SMB's new sales office located in Chicago.
SMB gross profit increased 27% to $14.7 million, resulting primarily from the increased sales. SMB gross profit margin remained unchanged at 13.6%, reflecting improvements due to seasonally strong enterprise sales and a normalization of competitive pricing pressures offset by a 71 basis point decline in vendor considerations as a percentage of net sales.
SMB operating profit increased 32% to $7.6 million, primarily due to the increased gross profit, partially offset by a $1.1 million increase in personnel costs. This increase in personnel cost was primarily due to a $300,000 impact of a higher Canadian exchange rate, the investment in our Chicago office and our addition of account executives in that facility, and an increase in variable commission and bonus expenses due to the increased SMB gross profit.
Average account executive headcount during Q2 2010 in our SMB segment was 363, up 10 account executives or 3% compared to 353 in Q2 2009 and down 4 account executives compared to 367 during Q1 2010.
For our MME segment, Q2 2010 net sales increased 36% to $125.5 million primarily due to increased spending by customers in the mid-market and enterprise sector in the quarter, which included a few large transactions with enterprise accounts. Product revenues increased by 50% year-over-year, while service revenues decreased by 7% year-over-year. Service revenues represented 17% of MME net sales in Q2 2010 compared to 25% of sales last year.
The service revenue decline was primarily due to an 18% decline in MME's SARCOM branded professional and managed services in Q2 2010 compared to last year, resulting from certain large service projects in Q2 2009 that did not reoccur this year. The decline in service revenues was partially offset by a 14% increase in services performed under our Abreon brand, which is primarily focused on changed management and eLearning consulting.
MME's service revenue vehicles are primarily contract based and have longer lead times. MME gross profit increased 18% to $18.6 million on higher sales and MME gross profit margin decreased to 14.9% compared to 17.1% last year, primarily due to the impact of the few large transactions mentioned earlier that were sold at lower margins, combined with a relative decrease in mix of services sales during the quarter.
MME operating profit in Q2 2010 increased 29% to $6 million primarily due to the increased gross profit, partially offset by a $900,000 increase in personnel costs due in part to an increase in variable compensation costs and a $200,000 increase in bad debt expense and a $200,000 increase in telecommunication expense.
Average account executive headcount during Q2 2010 in our MME segment was 110, up 11 account executives or 11% compared to 99 in Q2 2009 and up 2 account executives from 108 during Q1 2010.
For our Public Sector segment, net sales increased 8% to $41.1 million due to a 34% increase in net sales of our state and local government and educational institution business driven by stronger demand and our aggressive public sector market share growth strategy. This increase was partially offset by a 7% decrease in our Federal government business due to reductions in sales of Sun Microsystems, substantially related to the acquisition of Sun by Oracle and resulting vendor program changes in connection with Sun solutions.
These changes also had a significant negative impact on Federal sales through a large contract vehicle. Sales in our Federal government business excluding Sun Microsystems increased 58% over the prior year.
Public Sector gross profit decreased by $1.2 million, or 32%, to $2.6 million in Q2 2010 and gross profit margin decreased to 6.3% in Q2 2010 compared to 10% last year. The decrease in Public Sector gross profit and gross profit margin was primarily due to the impact of the Sun changes mentioned earlier.
Gross profit margin also reflects our previously stated market share growth strategy in the Public Sector business, specifically on the Wintel platform in order to broaden our sales mix.
In Q2 2010, our Public Sector segment had an operating loss of $800,000 compared to an operating profit of $800,000 last year. The decrease in operating profit from Q2 2009 was primarily due to the declines in gross profit combined with an increased Public Sector personnel cost of $400,000 resulting from our investment in our Health Dynamix division and other incremental investments in headcount.
Average account executive headcount during Q2 2010 in our Public Sector segment was 101, up 25 account executives or 33%, compared to 76 in Q2 2009 and up 13 account executives from 88 during Q1 2009.
For our MacMall segment, net sales for Q2 2010 declined 7% to $42.7 million, primarily due to our previously announced intentional strategy shift we made in Q1 2010 to focus the MacMall brand on higher profit customer segments such as small businesses, creative professionals and high-end consumers. MacMall gross profit increased by 2% to $4.7 million and gross profit margin increased to 11.1% compared to 10.1% last year. These increases were primarily due to the aforementioned intentional strategy shift.
MacMall operating profit increased by 130% to $1.3 million, primarily due to a $700,000 decrease in advertising expenditures and the increase in MacMall gross profit mentioned earlier, each of which was facilitated by a strategy shift.
MacMall operating profit also increased sequentially from $600,000 in Q1 2010.
Average account executive headcount during Q2 2010 in our MacMall segment was 96, down 3 account executives or 3% compared to 99 in Q2 2009 and no change from Q1 2010.
Corporate and other operating expenses includes corporate related expenses such as legal, accounting, information technology, product management and other administrative costs that are not otherwise included in our other reportable operating segments.
Corporate and other SG&A expenses increased by $1.6 million, or 16%, to $11.3 million primarily related to an increase in personnel costs of $600,000, which included $200,000 of an increase in stock-based compensation expenses, and an increase in depreciation expense of $400,000 primarily related to the completed portions of our ERP and infrastructure upgrades. Results for the quarter also include approximately $200,000 related to legal costs associated with our acquisition of NSPI.
Accounts receivable at June 30, 2010 was $170 million and increased by $8.5 million from December 31, 2009, primarily due to the significant increase in our MME sales in the latter part of Q2 2010.
Our inventory at $52.9 million at June 30, 2010 represents a decrease of $15.7 million from year end, reflecting sell-through of seasonal purchases made in late 2009 as well as sell-through of our Public Sector backlog that existed at year end, offset by increases in inventory supporting our MME segment.
Accounts payable at June 30, 2010 was $103.3 million and decreased by $5.5 million from year-end.
Outstanding borrowings under our line of credit increased by $11.7 million to $64.8 million at June 30, 2010 compared to year-end with the increase largely due to our acquisition of NSPI.
CapEx for the quarter was approximately $2.3 million reflecting continued investments in our IT infrastructure projects.
Now I would like to turn the call over to Kris Rogers. Kris?
Thanks, Brandon. I'll spend a few minutes on our segment specific results as well as other key performance indicators for our consolidated business to give you more color on our performance in the second quarter. I'll review product mix, manufacturer and category concentration and growth rates, all of which are on a gross basis. I'll start by discussing the results of our segments.
For SMB business, PC Mall sales had year-over-year growth of 26% in Q2 2010 over Q2 2009. As indicated, when we closed Q1 of this year, we continued seeing improvement in the demand for technology products and solutions across the SMB customer segment.
Our new buying customer accounts, which we define as new or reactivated customers who purchase for the first time in at least 12 months and spent more than $1000, grew by 13% in Q2 2010 over Q2 2009, an addition to growth in existing buying customer accounts.
In addition, our average order value for SMB customers grew 17% to $1755 from $1503 a year ago. Average order sizes were up consistently throughout the quarter, which we believe represents a stronger product mix for SMB.
Gross profit for the SMB business also grew by 26% with gross margin at 13% for Q2 2010. While the Q2 2010 gross profit percent of 13.63% is only slightly higher than Q2 2009 is up sequentially by 120 basis point from Q1 of 2010. As indicated in our conference call for Q1 2010 results, we did see competitive pricing pressures normalize during the quarter and also benefited from a strong close to Q2 2010 in our Enterprise Licensing category.
Operating margins and profit grew in our SMB business over the prior year, with operating profit growing by 32% and operating margins improving by 31 basis point. The improvement in operating profit and margins were driven by the incremental gross profit offset by our investments in our Chicago SMB call center.
As we've indicated in earlier calls, we made a decision last year to invest aggressively to facilitate future growth in SMB, primarily for the opening of a large new call center in Chicago.
This investment in headcount and an increase in personnel costs driven by the US/Canadian exchange rate partially offset the increase in operating margins in SMB. However, the Chicago call center is on track for strong sales growth in 2010 and we are pleased by the stronger ramp of account executive productivity we have seen in our prior experience.
As of the end of Q2, we had 74 SMB account executives in our new Chicago office and we intend to continue hiring in that location.
Our SARCOM business, which targets the mid-market and enterprise base, grew 35% year-over-year with product sales up 50% but service sales down 7% from Q2 2009. The growth in product revenue was driven by accelerating demand across the mid-market and Enterprise Customer segment but also by a few large refresh projects, which spiked volume in Q2 2010. We also saw the impact of these types of projects on the accelerated growth of our notebook and desktop revenues year-over-year.
The decline in the mid-market and enterprise service sales is due to a decline in SARCOM branded service revenues, with the decline a function of several large service engagements in Q2 2009, which did not reoccur.
However, SARCOM branded services did grow by 2% in Q2 2010 sequentially, Abreon branded services for change management and eLearning services grew by 14% in Q2 2010 over Q2 2009, marking the first quarter of year-over-year growth for Abreon since Q3 2009.
Abreon has a strong presence in supporting the healthcare vertical, which is contributing to their increasing engagements, and we are encouraged that Abreon also grew sequentially in Q2 2010 by 31%.
Gross profit for the mid-market enterprise segment grew by 15.2% with gross margins at 14.6%. Gross margins declined from 17.1% in Q2 2009 as a result of a few large transactions during the quarter for the refresh projects mentioned above, as well as the lower mix of services revenues to product revenue.
We did see service revenue in pipeline trend up through the quarter and service margins were modestly up across service categories. In Q2 2010 services represented 17% of SARCOM revenues versus 25% in Q2 2009.
Our public sector segment, PC Mall Gov, which sells to state, local, educational and federal customers, had a challenging Q2 2010 as a result of program changes with our largest manufacturer partner on the Federal side. Sun Microsystems, after its acquisition by Oracle announced changes during Q2 2010, which resulted in significant disruption in the selling motion of Sun's products and services by PC Mall Gov. These changes included changes in pricing policy in certain programs, which adversely affected – impacted customer's behavior relative to Sun Oracle hardware products, exacerbated by uncertainty around support, delivery, maintenance and pricing changes.
Overall, our Public Sector segment grew by 18% in Q2 2010 over Q2 2009. However, our state, local and education business was up 34% over Q2 2010 while the Federal business was down 8% year-over-year. However, excluding sales of Sun products to Federal business, sales were up 58% over last year.
The growth in our SLED business was the result of strong performance in new and existing SLED contracts. We also saw strong growth in gross profit and gross margins in our SLED business with gross profit growing by 87% and gross margins improving significantly. The improvement in SLED gross profit and margins is attributed primarily to a stronger product mix and the growth of service revenues within SLED in Q2 2010.
The declines in the Federal business are directly related to the changes mentioned earlier with Sun Microsystems. In addition to the revenue declines, gross profit declined by 62% resulting in a significant decline in gross margins.
With the changed (inaudible) from Sun Microsystems we have adjusted our selling models in order to improve gross profit margins going forward. We have also seen customers start to open up (inaudible) again and expect to see standard sell-through in Q3 2010.
Stepping apart from our Sun business, other manufacturer sales grew by 58% in Q2 2010 over Q2 2009 in our Fed business and we expect to continue to ramp our non-Sun business in the Federal space. Sun product sales were down 65% in Q2 2010 from Q2 2009.
Overall, operating profit and margins for the Public Sector declined significantly in Q2 2010 with PC Mall Gov reporting a loss of $821,000 as compared to a profit of $782,000 in Q2 2009. The loss was driven primarily by the loss of gross profit in our Federal business as well as our continuing investment in Health Dynamics, our healthcare initiative announced late last year. While Health Dynamics contributed modestly to revenue in Q2 2010, we expect to see a stronger ramp on that business in the second half of 2010.
Sales in our MacMall segment, which is primarily focused on small business, creative professionals and high-end consumers declined by 7% in Q2 2010 from Q2 2009 where the year-over-year revenues declined margin improvement from the 21% year-over-year decline in Q1 2010 over Q1 2009.
Our revenues from this segment also grew sequentially from Q1 2010 by 3%, contrary to normal seasonal pattern, we attribute the improved performance in the MacMall segment to our previously disclosed strategic initiative to reposition the MacMall segment on the more profitable small business, creative professionals and high-end consumer markets. Also contributing to the improved revenue performance was the successful launches at MacMall for the Adobe Creative Suite 5, the iPad and the new MacBook, all of which performed strongly during Q2 2010.
Gross profit in our MacMall segment increased by 2% with a 95 basis point improvement in gross margin. The improvement in gross profit and gross margin is due to the execution of our strategic shift as well as strong performance in the higher margin Mac product categories.
Operating profit in MacMall was up almost threefold, which is due to both improved gross margins and tight operational expense control combined with a reduction in advertising costs that our new strategy allowed us to make. Although we've been aggressive about moderating our cost where we do not see strong ROI we have invested in key areas of the MacMall segment where we do see a strong return and we'll continue to do so.
Those areas include our retail stores, our marketing to the creative professional segment and our leadership team.
At this time I'll review the product category results, which are all calculated on gross billed revenue. With the strong revenue growth in Q2 2010 we saw most product categories return to year-over-year growth. While some of the growth was driven by larger opportunities, we did see growth across the more traditional product categories, which we believe is a function of a more normalized demand environment.
Our largest category for Q2 2010 was software at 20% of revenues, slightly down from 21% of our mix in Q2 2009 with revenue growth of 12% over Q2 2009. We saw solid growth results with all leading publishers as a result of improved demand coupled with our large and successful launch of Creative Suite 5 from Adobe.
Our strongest growth came from the categories of security and virtualization was significant growth from publishers, VMware, Symantec, (inaudible), McAfee and others. We also saw return to growth in our Microsoft business, which we believe is primarily a function of a recovery in commercial markets. While the growth was modest to this business over Q2 2009, we did see strong sequential improvement in the Microsoft business.
Our second largest product category was Notebooks, 17%, compared to 15% of our revenues for Q2 of 2009. Notebook sales increased 39% over Q2 2009, reflecting resurgence in commercial demand.
We saw a solid growth of greater than 69% across Wintel brands. So, strong gains in average selling prices, which we believe reflects the mix of larger corporate clients increasing demand for corporate notebook standards.
We also saw a solid increase in Apple Notebooks with 17% year-over-year growth, primarily as the result of the launch of the iPad. Contributing to the notebook growth was the launch of the tablets for Apple, which sold well into all commercial markets.
We continue to see significant upside with other tablet manufacturers and believe that this category will be accretive to the notebook sales overall.
Our next largest category was desktops at 12% sales versus 10% of revenue in Q2 2009, with a very strong growth of 51% over Q2 2009. The high growth in desktop sales was a function of strong growth in SMB coupled with several very large desktop refreshes in the enterprise space.
Desktop sales were up in all customer segments and across all platforms with the exception of the Apple platform.
Networking was 8% of sales in Q2 2010 versus 8% in Q2 2009 with sales increasing 27% year-over-year. We believe that growth could have been even stronger in Q2 2010 given that we exited the quarter with significant backlog for leading manufacturers in this category. We continue to add technical and selling resources for this category to accelerate our growth and are currently working to ramp with the new networking offering from Hewlett-Packard as they incorporate 3Com into their portfolio.
Our overall delivered services, excluding packaged services right next to our largest product category had 6% of total sales in Q2 2010, down from 7% of total sales in Q2 2009. While we're showing overall decline, we are encouraged during the quarter to see Abreon services return to year-over-year growth and also saw sequential improvement in SARCOM branded services.
We saw a modest benefit during the quarter from the acquisition of NSPI. And we are gratified to see pipeline develop immediately for NSPI services across our other commercial subsidiaries.
Storage was 5% of revenue in Q2 2010, down from 7% of revenue in Q2 2009 with year-over-year decline of 23%. While we had growth across our traditional enterprise storage partners, the growth was offset by the substantial declines in the Sun Microsystems storage business on the Federal side. We did see strong sequential improvement in our storage revenues over Q1 2010.
Manufacturer package services came in at 3% of our sales in Q2 2010 versus 4% in Q2 2009, and we are down 28% over Q2 2009, primarily as a result of the decline in the Sun Microsystems warranty services.
Displays and printers represented 5 and 3% respectively of sales. Printer sales were up with 9% growth over Q2 2009, although continued to reflect slight product shortages, so we believe that going forward there should be no more material supply issues.
Printer ASPs grew during the quarter, which we see as a function of the accelerated growth of color printers with cost of color becoming more competitive with black and white. We are seeing better traction in the managed print services area with more print manufacturers introducing program options that can scale across both enterprise accounts as well as public sector and SMB accounts.
In displays, we saw a strong growth of 56% over Q2 2009, a piece of the growth was driven by the large desktop refreshes so backing those out we still saw strong growth in the category. Increasing LCD prices are partially driving the growth as is the growing category of digital signage where a number of solid wins during the quarter contributed to revenue growth.
Server sales were 3% of sales in Q2 2010 with a 35% increase from Q2 2009 with growth coming across all manufacturer partners with the exception of Sun Microsystems. This resulted in very strong growth in service sales on the Wintel platform offset by the decline in the Sun Microsystems server business.
With growth of 31% year-over-year is the power category, which represents 2% of revenues and continues to reflect the ongoing trends for virtualization.
Memory, also at 2% of revenues grew at 63% year-over-year with prices currently stable for DRAM, the decline is expected as we head into the end of the year and we expect supply to outstrip demand.
A few highlights on the emerging technology areas include our full authorization during Q2 2010 for Intermec, a strategic partner of Health Dynamics as we round out our portfolio up for solutions for healthcare. Sales for Intermec during the quarter grew 140% year-over-year.
In the mobile space, we saw very high growth in our relationship with BlackBerry, primarily focused on businesses with less than 99 employees.
We held several successful webinars during the quarter, which contributed to a 558% growth year-over-year although it's still a young category for us.
Rounding out, our emerging technology partner, which is Meraki, supervise the networking services through the cloud where we had 156% year-over-year growth. While the numbers are still small we expect to see strong growth in small business in state, local and education markets for these types of services.
From a manufacturer concentration standpoint, on a gross consolidated basis, our top five manufacturers for Q2 2010 were Hewlett-Packard, Apple, Cisco, Microsoft and Lenovo respectively, so in aggregate represented approximately 54% of our total revenues.
As a point of reference, the top five manufacturers for Q2 2009 were HP, Apple, Microsoft, Cisco and Sun Microsystems who represented approximately 48% of our total revenues.
At this point I will turn the call back over to Frank Khulusi. Frank?
Thanks, Kris. Now I'd like to take a moment to provide you some additional detail and also update you on a few of our strategic initiatives.
In Q2 we and other Sun channel partners were negatively impacted by program changes precipitated by the acquisition of Sun by Oracle. However, we are hopeful that some of the issues started by these program changes will be resolved in the coming months and regardless of whether they are resolved we expect that PC Mall Gov will be profitable in Q3 this year.
The changes we have mentioned primarily impacted our Fed business, while our SLED business continued to grow and contributed nicely. Additionally our growth rate in Fed with manufacturers other than Sun was 58% in Q2 versus Q2 last year.
We also have several strategic initiatives underway that we feel will benefit both sales and profits in our Gov business going forward, including selling our growing portfolio of services into our Gov accounts, the continued growth of our Health Dynamics team, which we expect will contribute in a more meaningful way going forward, and our market share growth initiative in the Wintel space.
We believe that these initiatives along with prudent cost management will contribute to improving results in the Gov business in the months and quarters to come.
As I mentioned above, we continue to invest in Q2 in the growth of our Health Dynamic division of PC Mall Gov, which is dedicated to providing IT solutions to clients in the healthcare marketplace. Health Dynamics combined our sales, service and technical capabilities to provide a unique value proposition to its clients. While, Health Dynamics contributed modestly to our Q2 results, we are very pleased with the traction they continue to gain in both new and existing accounts and expect that they will be an increasingly meaningful part of our results in future periods.
As I mentioned in our Q1 conference call, during Q1 of 2010 MacMall shifted resources away from less profitable consumer work transactions to the more profitable high-end consumer, small business and (inaudible) professional segment. And starting investing late in Q1 in incremental out bound business headcount to capitalize on the demand for Apple products in the commercial space.
While we are still executing on that strategy shift, we continue to derive incremental benefits from these efforts in Q2, with our second straight quarter of sequential operating income growth as operating income more than doubled in Q2 from Q1. We are convinced that our strategy with the MacMall business will be successful and are very pleased with our results to that and thus far.
In late Q2, we announced that our SARCOM subsidiary completed this acquisition of NSPI, a managed services provider based in Atlanta, Georgia. NSPI generated approximately 75% of its revenues from services in the first half of 2010, and it focuses on providing its customers with solutions including data center services, remote managed IT services including support of desktops, servers, networks and VoIP telephony systems, and professional services.
NSPI was recently certified as a Cisco Managed Services Advanced Channel Partner worldwide. The certification served as a recognition for NSPI's accomplishments in the delivery of managed IT services and its recent investment in the build out of a new data center to supplement its existing space.
Although the acquisition occurred less than two months ago, we have already seen strong interest in NSPI services from our embedded customer bases at SMB, SARCOM and Gov. We believe that our customers in these segments have a need for the solutions that NSPI can provide and we intend to market aggressively for those customers going forward.
In Q2, we continue to grow our presence in social networking, specifically through the small business network powered by PC Mall, which we launched late last year as a social media community for small businesses. We believe that our unique approach with the social media platform gives us a cost effective way to market to and engage these small businesses and give these businesses an efficient and cost effective way to research, assess and ultimately procure solutions that support their IT needs.
Our initial goal for the small business network were focused on building the community, and we have surpassed our near-term goals for active members with over 18,000 active users, up 80% from Q1.
We continue to be pleased with the trajectory of our Chicago office including account executive productivity as well as sales growth. We have a long-term plan for our Chicago office to be our largest revenue producer and believe we are tracking well towards that goal.
In closing, we are pleased that we were able to grow significantly from both a revenue and profitability standpoint. The investments that we have continue to (inaudible) despite challenging economic conditions are beginning to pay off.
We look forward to leveraging these initiatives going forward and we believe those investments will provide us a significant competitive advantage, as we are better able to anticipate, identify and serve the needs of our customers across our markets.
In short, we are very well positioned heading into the second half of 2010 and beyond.
Now I would like to open up this call for any questions you may have. Operator?
(Operator Instructions). The first question comes from the line of Brian Alexander with Raymond James. Please proceed.
Brian Alexander – Raymond James
Thanks. Good morning guys.
Good morning, Brian.
Brian Alexander – Raymond James
Could you just comment about what the demand trends look like thus far in third quarter I realize it's only been a month but just have you seen any change in just the overall turnout there in the buying cycles and just how does your backlog look at this point relative to last quarter?
Demand continues to be very strong across the segments where we're strong, which is for us all segments except for Gov. Gov is experiencing the seasonal uplift that we normally experience and SLED continues to do well.
On the services side, we have some recent wins and our pipeline continues to be strong, so it bodes well for the second half. As you know, we did experience a sequential increase in services sales from Q1 to Q2 and we are optimistic that that kind of bodes well for the second half of the year as well.
If you recall, we said previously that services are contract based and as a result they lag the decline as a result of the economic issues, but they are also lagging the return to increases that the product[ph] business is experiencing.
Brian Alexander – Raymond James
So, when do you think services will get back to 20, 25% of your MME business, which I think is kind of where they were a year ago?
Well, we think that services should grow – I would rather just have that – quote that those targets based on increases in revenue both on a sequential and year-over-year basis, which our hope is to accelerate into next year.
However, we will not manage the business mix because we will take all the product revenue that we can get our hands on and take all the services revenue that we can get our hands on. So that's really tough to quote what the percentage of services revenue is going to be.
Brian Alexander – Raymond James
Sure. In terms of Sun, could you just walk through sort of what changed in the relationship and where are we now in terms of Sun as a percentage of your business and how much more of a drag do you think that will be going forward? It sounds like it was mostly in the public sector side. And then I think, Frank, you mentioned that you expect to be profitable in the Public Sector in the third quarter? I just wanted to confirm that.
Yes, that's right. And just a minor correction, the Sun business for us is Federal so it does not have an impact on the SLED side and our SLED business did as a result perform extremely well in the second quarter.
On the Fed side, I think you recall we stated previously that we were depending on the quarter at the time and the top two or three resellers forced on in the Federal space and that did hurt us in the second quarter as Oracle completed an acquisition of what was an un-profitable business by Sun and made the changes that they thought necessary for the long-term viability of that business. And sometimes with a pendulum they tend to swing more in one direction then they should, and there is an opportunity that some of that gets corrected and partially swing back and we're hopeful that, that would take place.
But regardless of whether or not that takes place we are adjusting and taking whatever action we need. We were prudent enough to start changing our mix in the direction of Wintel and have been acquiring customers and business that way and as a result, our growth rate on the Wintel side, on the Federal side although unfortunately it wasn't a large enough piece of our overall Federal business to mitigate against the loss of Sun revenue and margin. It was – the Wintel growth was very significant at 58%.
However, one of my favorite lines is “with chaos comes opportunity” and we, of all companies are, really one of the best to take advantage of that and one of the things that could take place as a result of the chaos in the Sun market is that some of the weaker players will drop out of that business and as we plan on remaining committed. We want to grow our Wintel businesses as fast as we can but we remain committed to our relationship with Oracle and Sun and we will capitalize on whatever changes that they make and try to use those to our advantage to make that business more profitable for us going forward.
Brian Alexander – Raymond James
But, just as to confirm, I know Q3 is a seasonally strong quarter for Fed, and typically your public sector operating margins are generally strong in that quarter. So, beyond Q3 are we expecting the Public Sector business to be profitable even if this business doesn't come back?
Brian Alexander – Raymond James
Okay. And just in terms of –.
However I caution you – I mean profit is from zero to infinity, right? I mean as we go forward we expect modest profitability, so it's not used profitability and probably by this time next year is when we will see our – the greatest part of our efforts pay off.
Brian Alexander – Raymond James
Okay. And maybe just a couple of product related questions. First of all, on the HP networking business, Kris, when do you expect to see more meaningful traction there and just talk about how aggressively you see them trying to drive growth through the channel?
Well, I think relatively seeing, I mean just in terms of revenue contribution, my hope is that we actually get – start to see something in Q4, calendar Q4. We actually have for example, our engineers are going through their certifications in August that was the first opportunity we had to participate in the actual training.
HP has skewed up products, so I think between the combination of having products available, getting the engineers trained and then the next step is really getting in front of the sales forces, I actually think we will start to see (inaudible) and sell-throughs start to happen in late Q3, Q4. So I am – we are actually pretty bullish about the opportunity with HP networking as we add 3Com to the portfolio.
Brian Alexander – Raymond James
And then on the PC refresh it sounded like you guys saw some pretty strong results there on the desktop side and the notebook side. Where do you think we are in terms of the commercial refresh, and maybe put it in kind of baseball terms, what innings do you think were – your customers are in from a refresh perspective at this point?
I think we are in the beginning stage. I mean I think the pent-up demand impact is a little and the top of that is we feel and hopefully we are right is a little exaggerated. I think that more of what we are seeing is the fact that not only is there a pent-up demand but also Windows 7 is being adopted, had a much faster, better taste than any other operating system in the history of Microsoft and recent history anyway. And we are not even scraping the surface yet.
So with all that activity very, very few of the overall percentage of the machines has completed the upgrade and we think where – there is much more opportunity to come.
Brian Alexander – Raymond James
Okay. And then finally with respect to Apple, I guess how material do you think some of their new product announcements can be for your business, particularly the iPad?
Well, we think that, you know how – with the iPhone that was a halo effect in terms of increasing Apple's adoption in the overall consumer space as a mainstream player and they have been very successful with that. But with the iPad, our early indication, we kind of predicted that and our predictions are coming to bear. There is a very rapid and good adoption on the commercial side of the iPad and it's a commercial halo effect that I think bodes very well for PC Mall.
It further solidifies us and justifies our relationship and our commitment to Apple and the fact that we are as large as we are with them on the direct marketing side. So, we – and they need us there more than they would need us say on the consumer side where they do have a very large footprint with their retail stores and their website.
I mean we continue to serve a purpose there even on the retail side and consumer side with our increased product offerings on integration, our multi vendor approach, our ability to install Windows on machines et cetera, et cetera. But on the commercial side, you can take that and multiply it exponentially, a lot of customers find extreme value in dealing with it and we feel that that can aggregate. They continue – those customers and companies continue to be predominantly Wintel so, for them to be on a direct basis with somebody that just has Apple solutions is not right for a lot of them, they would rather deal with someone that can integrate the Apple platform in their predominantly Wintel environment and we do a very good job of that.
Brian Alexander – Raymond James
Okay. Thank you very much.
Probably better than anyone in the industry. Thanks, Brian.
(Operator Instructions) your next question comes from the line of Chris Krueger with Northland Capital Markets, please proceed.
Thomas – Northland Securities
Hi, guys. Good morning, this is Thomas [ph] for Chris. Thanks for taking my questions. Just first, how did month-to-month sales trends progress throughout the quarter and can you shed some light on how the first month of Q3 was?
Sure, this is Kris Rogers. So sequentially through the quarter, we actually saw what I would consider to be a pretty consistent seasonal Q2. We traditionally see a little bit of a down tick in May, kind of a combination of sort of a holiday and so, was very typical Q2 for us. Good start for the quarter with April, a little bit down in May and then very strong finish in June and that's pretty consistent.
And I think your question was the start of Q3 so, if we look at July, which we finished out about a week ago, we saw really demand continue pretty consistently into July. So, if I look at a start to the quarter, July was consistent with the short start that we had in Q2, so we don't really see any interruption[ph] to the demand patterns.
Thomas – Northland Securities
Okay. Related to the Chicago office, how did your experience ramping up large sales force several years ago play a role in ramping up the Chicago office? I mean are the Chicago sales personnel getting off to a better start than others in the past?
Yes. And it's a start up, so when you have a start, you can only slide so many seasoned managers and seasoned personnel and whatever, a lot of the hires are new including management et cetera. So to have that already be the case at this early stage of the game is very encouraging and bodes very well for when we do get critical mass and critical knowledge in that office.
Thomas – Northland Securities
Okay. If you meet your Q4 operating margin goal, can we expect or would you expect operating margins to stay at that level throughout 2011 or move higher or what is that going to look like?
We are not able to and will not make any commitment on a quarter-by-quarter basis, however our goals are to grow our operating margins from that level, but that's not to say that there won't be quarterly dip on an otherwise favorable trend line.
Thomas – Northland Securities
Okay. So in –
And, just to add to that we will, as I said earlier, take sale in whatever area that are accretive to our overall operating profit that may be at the expense of our operating margin, however there does exist significant leverage in our SG&A as our sales grow the primary way that our operating margin grows and from a trend line perspective subject to quarterly dip is our topline growing.
If you look at our SG&A as a percentage of sales, it did dip from Q1 to Q2. So it shows you that our sales grow there is leverage in our SG&A. We think that there is more leverage in our SG&A as our sales grow and we've pretty much started all the initiatives and begun our path in those areas and we don't have any major new initiatives that we contemplate on taking or making in the near future, just continue the execution on the initiatives that we have already announced.
So as those unfold and as our sales grow, the leverage does exist in our SG&A, which will facilitate our cap on that trend line that I talked about earlier.
Thomas – Northland Securities
Okay. Any operating margin outlook for the MME segment for Q3, Q4, is it similar to 1Q, 2Q or is it – can we expect it to ramp up?
We are not giving operating margin target by segment.
Thomas – Northland Securities
Lastly what kind of visibility do you have into sales growth in the public sector?
We – probably of that business we have the least visibility on because it tends to be very seasonal with respect to Q3 and within Q3 it tends to be very seasonal towards the end of Q3.
So, what I will tell you is that management, as I mentioned earlier, optimistic about the changes that they are making. We are very pleased with the trends of 58% growth on our Wintel side, we are hopeful that some of the changes that Oracle made will be readjusted. We are also hopeful that we can take advantage of some of the uncertainty and market vacuum that could be created as a result of that. What that ends up being in terms of overall sales growth I cannot quote as a result of what I mentioned earlier being the hockey stick.
Thomas – Northland Securities
Okay. Thanks guys.
At this time I am showing no further questions in queue. I would like to turn the call back over to Mr. Frank Khulusi for any closing remarks.
Thank you Derrick. I would like to thank everyone on the PC Mall team for your continued effort, dedication and good work. In addition, thank you all very much for spending some time with us on this call and for your interest in PC Mall.
We appreciate your support and look forward to speaking with you again on our third quarter conference call. In the meantime, please contact us with any questions or if you have any for IT solutions we'd love to help you. Have a great day.
Ladies and gentlemen that concludes today's conference. Thank you for your participation, you may now disconnect. Have a great day.
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