PC Mall, Inc. Q2 2008 Earnings Call Transcript

| About: PCM, Inc. (PCMI)

PC Mall, Inc. (MALL) Q2 2008 Earnings Call July 29, 2008 4:30 PM ET

Executives

Frank F. Khulusi – Chairman, President and Chief Executive Officer

Brandon H. LaVerne – Treasurer and Chief Financial Officer

Kristin M. Rogers – Executive Vice President – Sales & Marketing

Daniel J. DeVries – Executive Vice President – Consumer

Analysts

Brian Alexander – Raymond James

Chris Krueger – Northland Securities, Inc.

Operator

Welcome to the second quarter 2008 PC Mall Incorporated earnings conference call. (Operator Instructions)

On the call with us today are Frank Khulusi, Chairman, President and Chief Executive Officer, Brandon LaVerne, Chief Financial Officer, Kris Rogers and Dan DeVries, Executive Vice Presidents. 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 Frank Khulusi.

Frank F. Khulusi

I will begin with an overview of PC Mall’s second quarter development. Consolidated net sales were a Q2 record $331.2 million which was up 26% on a year-over-year basis. Gross profit was a Q2 record $46.2 million which was up 36% on a year-over-year basis. Gross profit margin for the quarter was 14% versus 12.9% in Q2 2007. Non-GAAP operating profit for Q2 2008 was $6.6 million, up 14% year-over-year. Non-GAAP operating profit margin for Q2 2008 was 2%. Non-GAAP diluted EPS was $0.25 per share versus $0.22 per share last year and GAAP diluted EPS was $0.22.

Once again I am pleased to report another record second quarter for PC Mall despite continued softness in IT spending. In a challenging macroenvironment we performed well and as we enter the second half of the year with a main focus on executing our strategy to bring value to our customers and vendor partners across our market segment.

Now I’d like to turn the call over to Brandon LaVerne, our Chief Financial Officer who will present the financial results in a bit more detail.

Brandon H. LaVerne

In Q2 2008, consolidated net sales increased 26% to $331.2 million and consolidated gross profit increased 36% to $46.2 million over the prior year. Consolidated gross profit margin was 14% in the second quarter compared to 12.9% last year. GAAP operating profit increased 1% to $5.9 million and included an $800,000 charge related to a lawsuit settlement. GAAP operating profit margin was 1.8% versus 2.2% in the prior year. Excluding the charge, non-GAAP operating profit for the quarter increased 14% to $6.6 million and non-GAAP operating profit margin was 2%. GAAP net income for the quarter was $3 million flat with the prior year.

However, excluding the charge on an after tax basis, non-GAAP net income increased 17% to $3.5 million. GAAP diluted EPS in Q2 2008 was $0.22 flat with Q2 2007 but excluding the charge, non-GAAP diluted EPS was $0.25 per share. Now I will speak more about our Q2 2008 segment results. All comparisons are against Q2 2007 unless otherwise noted. Net sales for our SMB segment were $129.9 million, a $4.6 million or 4% increase over the prior year despite continued softness in our volume iPod sales for certain customers. Gross profit for SMB increased by $500,000 or 3% to $16.1 million in Q2 2008 compared to $15.7 million in Q2 2007 primarily resulting from the increased sales mentioned earlier.

Gross profit margin for SMB remain relatively flat at 12.4% in Q2 2008 compared to 12.5% last year. SMB operating profit was $7.6 million, a decline of 14% compared to $8.9 million last year. The decrease was primarily due to an increase in SMB personnel costs and bad debt expense partially offset by the increase in gross profit as discussed above. The decrease in SMB personnel costs was primarily due to our investment in SMB account executive headcounts in future growth, a reduction in our Canadian labor subsidy under a new program which began in 2008 and a weakening of the U.S. dollar.

Average account executive headcount during Q2 2008 in our SMB segment was 410 compared to 353 in Q2 2007. For our MME segment, net sales for the quarter were $104.4 million compared to $44.6 million in Q2 2007, an increase of $59.8 million or 134%. This increase was primarily due to the inclusion of Sarcom results in Q2 of 2008 and strong growth in our legacy MME business. Excluding the impact of the Sarcom acquisition in Q2 2008, net sales in our MME business increased 10% to $49 million from $44.6 million in the prior year.

Gross profit for MME was $18.8 million, an increase of $12.5 million or 196% compared to $6.3 million last year. Gross profit margin increased by 380 basis points to 18% in Q2 2008 compared to 14.2% last year. The increase in MME gross profit was primarily due to the increase in MME sales mentioned earlier. The increase in MME gross profit margin was due to a favorable increase in the mix of services in Q2 2008 and increase in sales of certain software licenses by Sarcom which are recorded on a net basis.

MME operating profit in Q2 2008 increased 176% to $4.8 million compared to $1.8 million in the prior year. The improvement was primarily due to the increase in MME gross profit mentioned earlier partially offset by a $6.9 million increase in MME personnel costs which was primarily due to the addition of Sarcom personnel as well as an investment in sales account executives in our legacy MME business. Average account executive headcount during Q2 2008 in our MME segment was 153 compared to 84 in Q2 2007.

For our public sector segment, net sales for Q2 2008 were $37.3 million compared to $37.7 million last year, a decrease of $400,000 or 1%. This decrease was primarily due to a decline in our federal business which was impacted by the timing of service shipments at the end of the quarter largely offset by increases in our state and local business capitalizing on the close of the state and local budget year and recent contract wins in the sector. Gross profit for our public sector segment was $3.9 million, a decline of $400,000 or 9% compared to $4.3 million last year.

Gross profit margin decreased by 90 basis points to 10.5% compared to 11.4% last year. The decline in our public sector segment gross profit and gross profit margin was primarily due to the loss of a certain state contract under which we provide a contractual licensing products which we record on a net basis. Operating profit in Q2 2008 for our public sector segment decreased 10% to $769,000 compared to $850,000 in Q2 2007. The decline was primarily due to the decrease in gross profit mentioned earlier, partially offset by decreased bad debt expense and personnel costs. Average account executive headcount during Q2 2008 in our public sector segment was 101 compared to 83 in Q2 2007.

For our consumer segment, net sales were $59.5 million compared to $55.3 million last year, an increase of $4.2 million or 8%. This increase was primarily due to the overall strength in the Apple market and our aggressive consumer promotions partially offset by what we believe is general softness in the consumer market. Gross profit for our consumer segment was $7.4 million, a decline of $300,000 or 4% compared to $7.7 million in Q2 2007. Gross profit margin decreased by 140 basis points to 12.4% in Q2 2008 compared to 13.8% in Q2 2007.

The decrease in our consumer gross profit and gross profit margin in the current quarter was primarily the result of increased sales of lower margin consumer CPUs and increased promotional activities in the quarter. Operating profit in Q2 2008 for our consumer segment decreased 1% to $2.8 million compared to $2.9 million in Q2 2007, remaining relatively flat due to the decrease in gross profit largely offset by a decrease in advertising expense. Average account executive headcount during Q2 2008 in our consumer segment was 121 compared to 116 in Q2 2007.

SG&A within our corporate and other segment includes corporate related expenses such as legal, accounting, information technology, product management and other administrative costs that are not otherwise included in our reportable operating segments. Corporate and other SG&A expenses in Q2 2008 were $10.2 million, an increase of $1.7 million or 20% from $8.5 million in Q2 2007. The increase was primarily due to a $1.1 million increase in personnel costs resulting from investments in our marketing, information technology and credit departments as well as centralization of resources from our MME segment and the $800,000 lawsuit settlement charge described above, partially offset by a $200,000 decrease in telecommunication cost.

On our June 30, 2008 balance sheet, accounts receivable was $167 million, an increase of $7.7 million from year end primarily due to an increase in Sarcom receivables. Our inventory of $50.5 million in June 30, 2008 represents a decrease of $14 million from year end. Accounts payable decreased by $27.8 million from year end primarily due to the timing of vendor payables. Outstanding borrowings into the line of credit increased by $12.6 million to $66.5 million at June 30, 2008 from year end.


Now I would like to turn the call over to Kris Rogers.

Kristin M. Rogers

I’ll begin by discussing the results of our segments in more detail. As Brandon mentioned earlier, net sales for our SMB segment returned a positive year-over-year growth of 4% increase in revenues in Q2 2008 versus Q2 2007. The increase in sales resulted from continued increases in the productivity of the maturing sales force in SMB offset by continued softness in demand for volume iPod sales to certain customers. As part of our strategy for future growth in this segment we started off 2008 with an investment in headcount for SMB primarily in our Montreal cost center and the establishment of a new SMB cost center in the metropolitan Chicago area.


We continue to drive improvements and productivity of our SMB sales force with the ongoing development of our CRM capabilities and a continuing investment in solution strategy for higher end technologies. From a product mix perspective, the SMB business has strong year-over-year growth in the business software and enterprise licensing categories, server categories, storage and networking categories while demand softens for the desktop, notebook and printer categories. We also saw some early results in the ramp of sales with managed and professional services through our SMB segment. The number is not yet imperial but we expect to see continued growth in services as we evolve that strategy in 2008.

Our MME segment shows solid year-over-year growth with an increase in net sales of 134% in Q2 2008 over Q2 2007. On an organic basis, excluding the impact of the Sarcom acquisition, MME grew a solid 10%. Our MME, both managed services and professional services, remain a key focus. While we have seen some weakness in demand for traditional products such as desktops, notebooks and printers in this marketplace, we’ve seen an acceleration of demand for services. Services represented 20% of MME’s revenues in Q2 2008 versus 7% in Q2 2007 large driven by the incremental services volume from Sarcom and Abreon.

Both Sarcom and Abreon acquired net new relationships in Q2 2008 and at this time continue to see solid pipelines for the second half of the year. For MME the strongest growth categories in Q2 2008 were enterprise and contractual licensing, networking, servers and the storage categories. We continue to ramp our abilities in the solutions area for these technology sets as well as in newer areas such as unified communications in digital signage. In our public sector segment, PC Mall Gov, we experienced a modest decline in sales of 1% in Q2 2008 over Q2 2007.

Strong growth of 26% year-over-year in our state, local and education business was offset by a 16% decline in our Federal business. This decline in Federal orders primarily due to shipment delays in certain product categories. The growth we experienced in the split space was driven by the growing productivity that contract vehicles won by PC Mall Gov throughout 2007 and 2008 as well as by the increase in sales account executive headcount.

I’d now like to address the product category results shift in consolidated company. In Q2 2008 we continued to see growth in key categories. Software was our largest category at 17% of revenue reflecting the strong seasonal effect of Microsoft year end. Notebooks are our second largest category at 15% of revenue followed by desktops at 11% of revenue. Servers or 4% of revenues unchanged in our mix from Q2 2007. Networking was 7% of revenue representing the largest change in our product mix and resulting from both the inclusion of Sarcom in Q2 2008 and the achievement of fiscal goals for all of PC Mall, Inc.

Storage was 6% of revenues with displays at 5% of revenues. iPods and MP3 players represented 4% of revenues as did printers. Professional and managed services were 6% of revenues. Services through the acquisition of Sarcom are strategic growth areas for the company representing gross paid profit and revenue opportunity in our key component of our overall solutions strategy. And more specifically related to growth trends for the different product categories, in the software category overall growth was 22% for Q2 2008 over Q2 2007. The highlights in software were strong growth in the areas of security and virtualization and continued success in the expansion of our contractual licensing agreement.

Growth in software was also driven by a strong launch of Office for Mac for our consumer business offset somewhat by a decline in the graphics software area due to an early Q3 launch date by Adobe. Our notebook category grew 27% year-over-year and represents growth on both the Mac platform and the Windows platform. We continue to see strong results and improving ASPs for notebooks over overall growth for notebooks for both platforms key [inaudible] from prior periods.

Desktops grew at 21% again with growth coming on both the Mac and Windows platform. Like notebooks, growth rates for desktops have slowed. Service declined 13% in Q2 2008 versus Q2 2007 primarily due to the timing of certain shipments at the end of the quarter. As I mentioned, networking was our fastest growing category in Q2 2008 with 131% year-over-year revenue growth. All of our segments, all segments of our business show high growth in this category. Other high growth categories include the storage of 22% growth with the bulk of the growth coming the primary storage manufacturers including HP, IBM, LeftHand, EMC, Hitachi, Fujitsu and NetApp [inaudible] at 38% primarily in the MME space, accessories grew at 44% and displays grew by 17%.

Other areas of note in the product mix are workstations continue to grow well albeit on a much smaller basis, 34% year-over-year on represented good revenue profit opportunity. Memory continued to be a challenging category with dropping ASPs. The printer category continued to stall with growth of only 2% with multiple product categories sluggish across segments and the projector category shows solid growth in 9% year-over-year with seasonal demand coming from state and local and education markets.

Now I’d like to turn the call over to Dan.

Daniel J. DeVries

I’d like to spend a couple of minutes talking about Q2 08 consolidated company sales of Apple products and then give the results of our consumer segment sales. Consolidated sales of Apple products increased 10% in Q2 08 from Q2 07. Our Apple topware sales increased 25% in Q2 08 from Q2 07 driven by Mac O/S 10 Leopard. Apple desktop sales increased 12% in Q2 08 from Q2 07 driven by sales of the iMac. Our Apple notebook sales increased by 17% in Q2 08 from Q2 07 driven by the new MacBook Pro and the MacBook Air, both of which were introduced in Q1 08.

Sales of iPods decreased by 2% in Q2 08 from Q2 07. Our consumer segment, which includes our [Macball] and [Intel] brands, grew by 8% or $4.2 million from $55.3 million in Q2 07 to $59.5 million in Q2 2008. Apple sales in the consumer segment of our business grew by 18% in Q2 08 from Q2 07. The Mac CPU lines that experienced the most growth were the Mac consumer lines, including the iMac and the new MacBook Air which have lower margins.

Sales of Mac notebooks accounted for 36% of our consumer sales in Q2 08. Sales of Mac desktops accounted for 22% of our consumer sales. Software accounted for 9% of our consumer sales. iPods, iPod accessories and TVs accounted for 8% of consumer sales and storage accounted for 7% of consumer sales.

At this point, I will turn the call back to Frank Khulusi.

Frank F. Khulusi

We are pleased that we have continued to deliver strong results, even in a tough economic environment as evidenced by our results in both the first and the second quarter of this year. Our management team is maintaining its focus on delivering enhanced value to our customers and vendor partners and ultimately our shareholders while keeping our eye on cost. We continue to make what we believe are proactive but prudent investments in our sales force and infrastructure to better position us in this current environment and in better economic times to come.

Now I’d like to open up this call for any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Brian Alexander – Raymond James.

Brian Alexander – Raymond James

If you guys could just spend a couple minutes going through the linearity particularly in the SMB and MMB segments. How’d the quarter start? How did it end? And what have you seen so far in July from a demand standpoint? And then I have a couple followups.

Frank F. Khulusi

We had stated, Brian, in the conference call for the last quarter that we had seen some margin pressures starting to develop from a pricing perspective and a competitive perspective on the SMB side and we are pleased to say that there’s a little bit of a return to rational behavior so we’ve seen some of these margin pressures subside. From a demand perspective going into the second quarter, with the margin pressures in SMB subsiding we see an overall demand scenario from a consolidated company-wide basis that is consistent with the first quarter.

Brian Alexander – Raymond James

If I could just ask a question on the balance sheet. It looks like your DSOs were up quite a bit year-on-year. I guess I was trying to tie that to the linearity question to see if the quarter ended on strength but perhaps there’s another explanation for why the receivables were up as much as they were.

Frank F. Khulusi

The quarter did end on strength and we also had an increase in sales. Brandon, do you want to talk about that, on the public sector side?

Brandon H. LaVerne

Yes, we did have a lift. It’s public sector in Q2 you’ll tend to see a little bit of a lift in your DSOs and we did see a lift in the MME business which lifted their receivables toward the end of the quarter as well.

Frank F. Khulusi

But there is a definitely an end-of-quarter hockey stick.

Brian Alexander – Raymond James

More than normal? Or I’m trying to get a sense for what was so different about this quarter relative to prior Q2s.

Frank F. Khulusi

We do believe it was more than normal. The end of quarter lift, which also included a Sarcom accounts receivable, that also tend to be more end-of-quarter hockey stick-ish.

Brian Alexander – Raymond James

On MME, in terms of the service mix, I think you mentioned, maybe Kris mentioned that the service mix was 20% this year versus 7% a year ago and I think a lot of that is through Sarcom. Just with that driving the gross margins up as much as they did in the MME segment, I’m just trying to get a sense for whether you view that kind of service mix as sustainable. Do you view the gross margins in MME that you achieved this quarter as sustainable? And if you could remind us of what the service gross margins are for that segment.

Frank F. Khulusi

We are definitely focused on the services side. We’ve had a couple of recent service wins that we’re very happy about so we’re very encouraged, very focused on that business as Kris mentioned on her call too. That excitement and energy isn’t just contained on the MME side even though our SMB side is not experiencing material sales yet on the services side but we’re definitely focused on turning those numbers to be more material in the long term. So I think there aren’t too many days that pass at PC Mall where we don’t talk about services as a management team, as being a big part of the future for PC Mall.

As far as the GP, it’s both driven by the services side and by EAs which are reported on a net basis on the software side. So I would not peg that purely to be a services only situation. And then Kris, what do you want to add to that?

Kristin M. Rogers

Just I think part of it, Brian, is that there’s a very healthy mix on both the services side and the EA side and keep in mind that June 30 was the closing of Microsoft year end. That tends to resolve in a pretty strong lift in the end of the quarter with respect to contractual licensing. And then the other thing that we had I think working for us in our MME business from a gross margin standpoint is I mentioned the strong results we had in networking growth. And we have I think had a great opportunity with those businesses to try and capitalize on the gross profit opportunity in the networking space, specifically with folks who like to fill in others. And so I think that the fact that we’re seeing strong growth here is also helping margins.

Brian Alexander – Raymond James

Maybe just one followup if I can on the software side because I think there’s another competitor or two out there that also had very strong licensing quarters. Was that mostly influenced by Microsoft because I heard you mention a couple other areas that were strong and do you expect the software licensing growth you saw this quarter because it seems to always be very strong in the second quarter? Do you expect on a year-over-year basis for that growth rate to be consistent with what you saw this quarter as we move throughout the year or is there something that Microsoft or some of these other software publishers might have done to inflate demand in the second quarter if you will?

Kristin M. Rogers

Yes, my personal experience, Brian, is that there was nothing unnatural about Q2 from a manufacturer or a publisher perspective to inflate the results. I think it was just a strong year end with Microsoft but I also think that your earlier statement in your question is purely just that we’re seeing very solid growth with the enterprise player’s possible wording so I don’t know that I mentioned all of them. For example, virtualization we’re having strong results with VMware and so my expectation is that we will continue to see solid growth with all [inaudible] across the board specifically in the enterprise space.

Frank F. Khulusi

I dampen that with the economic environment that we’re in. So we don’t want to set expectations too high.

Operator

Your next question comes from Chris Krueger – Northland Securities, Inc.

Chris Krueger – Northland Securities, Inc.

I don’t know if you said in the call but did you give the percentage of your total sales that Apple and HP represented for the quarter?

Brandon H. LaVerne

I didn’t give that but I do have them. Apple for Q2 2008 was 19% and HP was 20%.

Chris Krueger – Northland Securities, Inc.

In your press release, you indicate that you had some Federal public sector contracts, that the timing of certain shipments impacted the business there. So should we look for some improvements in the third quarter for the public sector, maybe back to a growth track?

Frank F. Khulusi

Our current expectation is for an improvement in the public sector but again that’s dampened by the fact that we don’t have visibility considering the current economy. But based on what we know today, we do believe a return to some growth although we do not think that the growth will be as high as it was in the first quarter.

Chris Krueger – Northland Securities, Inc.

Can you talk a little bit about your advertising strategy? I know that you’ve cut some spending there. I’m sure you’ve shifted things around to how you go about that.

Frank F. Khulusi

Sorry, can you repeat the question, Chris?

Chris Krueger – Northland Securities, Inc.

Your advertising strategy. I know that you’ve shifted some dollars around and maybe you’re spending less on advertising. Can you just talk about the overall strategy and what you’re doing there?

Frank F. Khulusi

Yes. I wouldn’t call it shifting dollars around. I would call it a conscious effort to optimize advertising and at the same time, a conscious effort to delivery good value to our customers in an environment where you need to provide good value in order to get their share of the wallet. So we do think that long term as the economy rebounds, being aggressive today possibly gives us further opportunities downstream so I’m happy to say that we were able to shift advertising dollars into promotional dollars but we did not do that for the sole purpose of actually doing that.

Chris Krueger – Northland Securities, Inc.

I don’t know if you can provide this. Can you guys give the sales mix from last years third quarter for the four groups?

Frank F. Khulusi

The sales mix for the four groups for last year?

Chris Krueger – Northland Securities, Inc.

For last year’s third quarter, just for modeling purposes for this year.

Frank F. Khulusi

We don’t have that.

Brandon H. LaVerne I don’t have that with me. So I would suggest that we should not at this point.

Chris Krueger – Northland Securities, Inc.

One last question. The lawsuit, the $800,000, can you remind us again what that had to do with?

Frank F. Khulusi

We had a previous settlement that we disclosed some time ago and this is what was leftover out of that. We had settled a lawsuit with a couple of our smaller subsidiaries and we just settled at this point. That’s out of our hair.

Chris Krueger – Northland Securities, Inc.

All done then?

Frank F. Khulusi

Yes.

Operator

You have no further questions at this time.

Frank F. Khulusi

Once again I would like to thank all the members of the PC Mall team for their hard work and commitment to PC Mall and I would like to thank all of you for participating on this call and to remind you to call us whenever you have a technology need. Call 800-555-MALL or visit our website at PCMall.com.

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