PC Connection Q1 2024 Earnings Call Transcript

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Provided by Quartr
May 1, 2024

There are 6 speakers on the call.

Operator

Good afternoon, and welcome to the First Quarter 2024 Connection Earnings Conference Call. My name is Marmed, and I'll be the coordinator for today. At this time, all participants are in a listen only mode. Following the prepared remarks, there will be a question and answer session. As a reminder, this conference call is the property of Connection and may not be recorded or repodcast without specific permission from the company.

Operator

On the call today are Tim McGrath, President and Chief Executive Officer and Tom Baker, Senior Vice President and Chief Financial Officer. I'll now turn the call over to the company.

Speaker 1

Thanks, operator, and good afternoon, everyone. I will now read our cautionary note regarding forward looking statements. 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 management 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 section of the company's annual report on Form 10 ks for the year ended December 31, 2023, which is on file with the Securities and Exchange Commission as well as in other documents that the company files with the commission from time to time.

Speaker 1

In addition, any forward looking statements represent management's view as of today and should not be relied upon as representing views as of any subsequent date. While the company may elect to update forward looking statements at some point in the future, the company specifically disclaims any obligation to do so other than as required by law even if estimates change. And therefore, you should not rely on these forward looking statements as representing management's views as of any date subsequent to today. During this call, non GAAP financial measures will be discussed. A reconciliation between any non GAAP financial measures discussed and its most directly comparable GAAP measure is available in today's earnings release and on the company's Web site at www.connection.com.

Speaker 1

Please note that unless otherwise stated, all references to Q1 2024 comparisons are being made against the Q1 2023. Today's call is being webcast and will be available on Connection's website. The earnings release will be available on the SEC website atwww.sec.gov and in the Investor Relations section of our website at www.ir.connection.com. I would now like to turn the call over to our host, Tim McGrath, President and CEO. Tim?

Speaker 2

Thank you, Samantha. Good afternoon, everyone, and thank you for joining us today for Connection's Q1 2024 conference call. I'll begin this afternoon with an overview of our Q1 results and highlights of our performance. Tom will then walk us through a more detailed look at our Q1 financials. Clearly, it was a challenging quarter on the top line as the softness we saw last year in endpoint devices continued into the Q1.

Speaker 2

There were some encouraging signs in the quarter, and we were successful in adding net new commercial accounts, while we continue to help our customers evaluate and prepare for their AI implementation strategy. However, those actions did not produce enough revenue to offset lower device sales. The silver lining is that we believe we are well positioned to help our loyal customers meet the demands of the coming technological revolution and to help them drive deeper adoption of cloud and other advanced technologies. Toward that end, our backlog grew by high single digits sequentially. In addition, many of our partners believe that we are experiencing the calm before the AI storm.

Speaker 2

They continue to predict year over year growth driven by the AI ecosystem. Consequently, we expect the second half of the year to be stronger than the first half of the year. Our business is evolving and our product mix continues to be dynamic. As we've said before, we believe that gross profit is a more appropriate measurement of our performance. To illustrate this point, I'd like to highlight that while our reported software and cloud revenue declined, our actual gross profit for software and cloud increased 18% from the prior year, which significantly contributed to the gross margin expansion in the quarter.

Speaker 2

Customers are reprioritizing their capital budgets to prepare for AI initiatives, and we are ready to lead them through that transformation. Now let's discuss our Q1 performance. Consolidated net sales were $632,000,000 13.1 percent below last year. Gross profit decreased 3.5 percent to $118,100,000 However, gross margins were up 187 basis points to 18.7% in Q1 compared to the prior year quarter. As previously mentioned, customer demand for software, which includes cloud and software as a service solutions, helped to fuel the improvement in our gross margins.

Speaker 2

Operating income in Q1 was $13,500,000 a decrease of 25.7% compared to Q1 2023. Operating income as a percentage of net sales was 2.1% compared to 2.5% of net sales in the prior year quarter. Net income in Q1 was $13,200,000 a decrease of 7.4% compared to $14,200,000 in the prior year quarter. In Q1 2023, our diluted earnings per share was 0 point 5 $0 a decrease of 7.7 percent from $0.54 in Q1 2023. We will now look a little deeper into our segment performance.

Speaker 2

In our Business Solutions segment, our Q1 net sales were $255,900,000 6.3% lower than a year ago. The decline in revenue was across most product categories and is a function of our customers exercising caution in their spending as we noted earlier. Gross profit for the Business Solutions segment was $60,600,000 an increase of 0.8 percent from a year ago. Gross margin increased 165 basis points to a record 23.6 percent in the quarter compared to the prior year. In our Public Sector Solutions business, Q1 net sales were $93,500,000 33.4 percent lower than a year ago.

Speaker 2

Sales to state and local government and educational institutions decreased by $7,500,000 while sales to the federal government were lower by $39,500,000 compared to the prior year quarter. This quarterly performance can be explained by the fact that in Q1 2023, our results included 2 large projects with existing customers that accounted for the majority of the decline in revenue in the Q1 of 2024. Gross profit for the Public Sector segment was $15,000,000 a decrease of 26.3% compared to Q1 'twenty three. Gross margin increased by 156 basis points to 16% in the quarter compared to the prior year. In our Enterprise Solutions segment, Q1 net sales were $282,700,000 10% lower than a year ago.

Speaker 2

Gross profit for the Enterprise segment was $42,700,000 1.6 percent higher than the prior year quarter. Gross margin increased by 172 basis points to 15.1% in the quarter compared to the prior year. I'll now turn the call over to Tom to discuss additional financial highlights from our income statement, balance sheet and cash flow statement. Tom? Thanks, Tim.

Speaker 3

SG and A increased by 1.3% compared to the prior year quarter. We had a decrease in spending and personnel driven by cost containment measures. However, the increase in SG and A was due to increases in certain taxes, marketing expenses and investments in our solutions business that align with our strategic initiatives. On a percentage of sales basis, SG and A increased 2 36 basis points to 16.6 percent of net sales in the quarter compared to 14.2% in the prior year quarter, driven by lower revenues. Our Q1 effective tax rate was 27%, up from 26.8% due to changes in state tax rates.

Speaker 3

Net income for the quarter was $13,200,000 a decrease of 7.4% from $14,200,000 last year. Diluted earnings per share was $0.50 a decrease of 7.7%. Our trailing 12 month adjusted earnings before interest, income taxes, depreciation and amortization or adjusted EBITDA was $120,300,000 compared to $127,600,000 a year ago, a decrease of 5.8%. In terms of returning cash to shareholders, we paid a $0.10 per share quarterly dividend in March. Today, we announced that our Board of Directors has declared a quarterly dividend of $0.10 per share.

Speaker 3

The dividend is payable to shareholders of record on May 14th and payable on May 29th, 2024. In addition, the Board authorized an additional $40,000,000 increase to Connection's existing share repurchase program. $72,100,000 is available for share repurchases after giving effect to this increase. Cash flow generated from operations for the Q1 of 2024 was $57,300,000 an improvement of $37,800,000 from the same period a year ago. Our accounts receivable balance decreased $79,300,000 for the Q1 of 2024 and our DSO decreased to 70 days from 71 days.

Speaker 3

Our inventory balance remained flat for the Q1 of 2024 compared to the Q4 of 2023. Our accounts payable balance decreased $45,100,000 for the Q1 ended 2024. Cash used in investing activities of $51,600,000 was a result of $100,000,000 of investment purchases, offset by $50,000,000 of investment maturities. The company used $3,100,000 of cash for financing activities during the Q1 of 2024, consisting primarily of payments of $2,600,000 of dividends to shareholders. We ended Q1 with $352,000,000 of cash, cash equivalents and short term investments.

Speaker 3

In terms of capital allocation, we remain committed to growing the business and we have an ongoing program focused on investing in both organic and inorganic growth opportunities. Furthermore, as announced above, we are continuing to return cash to shareholders in the form of a quarterly dividend and we will continue to repurchase stock in a disciplined manner. I will now turn the call back over to Tim to discuss current market trends.

Speaker 2

Thanks, Tom. In the near term, we believe there are a number of factors that should accelerate growth in IT spending. The requirement for customers to migrate to Windows 11, refresh their aging systems and the demand for the AI PC will drive endpoint device growth. In addition, we expect infrastructure, including server storage and networking, will be positively impacted as customers begin to deploy their AI solutions. The IT industry is undergoing a transformation at an unprecedented pace, driven by rapid advancements in areas like artificial intelligence, cloud computing and edge technologies.

Speaker 2

However, customers continue to be cautious with their AI investments while they're evaluating their AI strategies. Similar to the competitive landscape, sales of endpoint devices were over Q4 2023, and we believe that this may be the beginning of the recovery we have been expecting. Customers are continuing to evaluate AI solutions as they look to improve productivity and increase operational efficiencies. We believe that the adoption of AI solutions will be a catalyst that drives demand for additional infrastructure, storage, compute and cybersecurity solutions. The demands of AI, enhanced collaboration tools, improved security and the adoption of Windows 11 will require more powerful devices.

Speaker 2

These factors are also expected to drive a device refresh cycle as AI adoption increases. And of course, security threats are expected to continue to drive customer demand for hardware, software and services necessary to properly secure IT environments for the foreseeable future. Now let's double click on some of these important areas for connection. For AI, we are also seeing adoption of AI endpoint applications such as Microsoft Copilot as well as organizations developing localized and cloud based large language model systems. We are continuing to tailor our solutions to better assist our customers with their AI journey.

Speaker 2

Recall that we launched the Helix Center for Applied AI and Robotics, bringing together industry leading experts, resources and support during Q4. We are confident that our Helix center will be a competitive advantage for connection in the area of AI and our customers and partners who work with Helix share that same sentiment. Let me give you an update on our vertical market activity. In retail, while we saw a decline year over year, we are experiencing momentum. For example, we did have sequential quarterly revenue growth and we are seeing an increase in project planning for future AI solutions.

Speaker 2

In Financial Services, our revenue and gross profit increased 8% year over year. In Healthcare, we saw a significant increase in proposal requests for services and cybersecurity, driven in part by the need for health care providers to secure their patients' data. In manufacturing, our forecast is building based on our customers' need for automation and the need to deal with facing the need to modernize their facilities and technology infrastructure in support of Industry 4.0. In addition, cybersecurity remains a top priority in manufacturing. We're also pleased that in Q1, for the 2nd consecutive year, Connection was named to the Forbes America's Best Employers list.

Speaker 2

Connection ranked 13 out of 400 organizations on the 2024 list. Connection was named the 2024 HP Personal Systems National Solution Provider Partner of the Year for exemplary achievements in growth and innovation. In addition, Connexion was awarded ServiceNow's reseller of the year. Connexion was also named a Microsoft solution partner for the Microsoft Cloud. This designation was awarded for achieving proficiency in all 6 solutions areas: business applications, modern work, security, Azure Data and AI, Azure Infrastructure and Azure Digital and App Innovation.

Speaker 2

The timing of our customer spending on new technology is uncertain, but we're optimistic that by the second half of twenty twenty four, we will return to more normalized growth rates. We expect the growth rates for the U. S. IT market will continue to be challenged in the near term. However, we believe we can outperform the IT market and take market share, notwithstanding the challenging macroeconomic environment.

Speaker 2

We believe our focus and our business strategy remains well aligned with the shifting dynamics of how customers deploy, utilize and consume technology. We continue to connect our customers with technology that enhances growth, elevates productivity and empowers innovation. We help our customers expertly navigate through a complex set of choices within the technology landscape. We help calm the confusion of IT for our customers. On that note, I'd like to take a moment to thank our extremely dedicated and valued employees for their continued and extraordinary effort during this rapidly changing environment.

Speaker 2

We will now entertain your questions. Operator?

Operator

Thank you. At this time, we'll conduct a question and answer session. Our first question comes from the line of Anthony Lebiedzinski of Sidoti and Co. Your line is now open.

Speaker 4

Good afternoon and thank you for taking the questions. So first, just wondering if you guys could comment on the cadence of your sales throughout the quarter. And it sounds like there's still caution in the Q2, but maybe you can just also kind of talk about how should we think about the Q2. I know you're more hopeful on the second half, but just as far as maybe you could just talk about the quarter that you just reported and then just your outlook for Q2, if you could share any more details that would be great.

Speaker 3

Okay. Hey, Anthony, it's Tom. How are you doing?

Speaker 4

Good. How are you?

Speaker 3

Good. In terms of the cadence through the quarter, it was a lot like Q4 to be honest with you. Typically what we'll see is 37% to 39% of our revenues coming through in March. This quarter was about 34%. So I think as the quarter went on, I think people continue to get a little bit more apprehensive about the economy and the interest rate environment.

Speaker 3

So I think that's what was causing the pullback a little bit. In terms of Q2, as you can tell, revenue is getting harder and harder to forecast just because of all the software netting. And so what I'll tell you is that the operating income line when you back out the effect of the special charges we had last year, We're probably going to be flat to maybe up low single digits year over year. And on the gross profit line, maybe see some low single digit growth. That's kind of what it's looking like right now.

Speaker 4

Okay. So gross profit, low single digit growth year over year, right, you said? Yes. Okay. Perfect.

Speaker 4

Okay.

Speaker 3

Got you.

Speaker 4

And then the other line,

Speaker 3

flat to up just to low single digits.

Speaker 4

Okay. That's very helpful. So you talked about this call as well as previous calls about AI enabled PCs. As far as the timing of the rollout, do you have a better sense as to when that could happen? And as far as the on those devices, anything you can share as to what how that could impact your business?

Speaker 2

Sure. So Anthony, this is Tim. Thanks for the question. Hope you're well. The timing there's still some question marks around it, but the technology itself, the timelines are getting much clearer.

Speaker 2

So today, as you know, you can get a PC that will run co pilots and it can certainly participate in an AI environment. The generation of products that's coming out over the next couple of months from our suppliers will have the neuro processor, which will enable many, many advantages for the users and Qualcomm is announcing a chipset. But the next generation AI PC that will be out late in the year and early next year will have more AMD, Intel processing capability and many more of the legacy apps will run on that. So that, for example, will be a next generation PC that you could run securely with an AI application in your own environment, better security, better collaboration, better performance. And so that time line is you could run AI PCs today.

Speaker 2

There is a generation coming in a couple of months, but that next generation is really end of year. And for many of our customers, though, we've been helping them with that transformation and understanding that Windows 11 will expire in October of 2025, but many of our customers are starting now to port their applications and to plan their technology rollouts so they're ready. As you know, many applications will take some time to port over. And finally, a lot of AI testing. So I'd say the future is bright, but the timing of that is still uncertain.

Speaker 2

It looks more toward the second half and later in our year.

Speaker 4

Got you. Okay. And then last question for me before I pass it on to others. Obviously, you guys continue to have a very strong balance sheet, lot of cash. So the buyback increase, which was good to see.

Speaker 4

Now as far as acquisitions, can you comment on that whether you're still looking at anything as far as valuation multiples? Has there been any sort of change since your last call?

Speaker 2

Yes. Anthony, really not much has changed since our last call. We are interested in acquiring additional solutions capabilities with complementary cultures. And certainly, we have the balance sheet to do that, and we continue to look. And we are starting to see I think the M and A activity heat up out there in the competitive landscape at least a little more than it had been.

Speaker 2

So we continue to look. But in the meantime, we're really confident about the plan we have in place, strategy we're deploying and the team we have to go execute that plan. So steady as she goes.

Speaker 4

Understood. Well, thank you and best of luck.

Speaker 3

Thank you. Thanks, Anthony.

Operator

Thank you. One moment for next question. Our next question comes from the line of Adam Tindle of Raymond James. Your line is now open.

Speaker 5

Okay, thanks. Good afternoon. I just wanted to start on overall guidance for the year. And Tim, I think on the last call you had talked about for gross profit dollars for 2024, expectation to grow low to mid single digits. I think here, obviously, we've got a little bit of a hole to start with gross profit dollars down.

Speaker 5

And it sounded like the commentary suggested Q2 was going to be low single digits year over year. Is there maybe a different way that we should be thinking about gross profit dollar growth for the year in total? And if you want to maybe go over some of the key product drivers that might be wildcards on the upside or the downside? I know it's hard to predict, but the things that you're looking at that might drive things greater or lower than that, that'd be helpful. Thanks.

Speaker 2

Yes. So I'll get a little help from Tom here, Adam, but thanks for the questions. Good to hear from you. When you think about it, we continue to believe, as you heard us say repeatedly, that gross profit is the right metric for us to be focused on because of the amount of business that we do that's on a net basis. And when it comes to GP, we are thinking the back half is going to be the back half of the year is going to be certainly stronger than the front half.

Speaker 2

Clearly, we were not happy with Q1 and we are expecting to see single digit growth and recovery in Q2 and we'll know more about Q3 and Q4, but do think the year is weighted toward that back half.

Speaker 3

Yes. So Adam, what I would say is clearly Q1 didn't meet expectations. And I think the results in Q1 are going to show themselves in the full year results. So I think you're probably looking at low single digit in low single digit growth in GP this year. Because Q2 is looking maybe a little bit weaker than we had expected as well when we started out the year.

Speaker 3

So I think those are going to carry through. In terms of what changes that, a lot of it comes back to this cycle of devices. And if we see a spike in device sales, there'll be probably a little lower margin, that volume does help us out a lot. NetComm had a pretty weak quarter this quarter for us. If that comes back and we think it will in the half of the year, that will obviously be a little more accretive.

Speaker 3

So that's kind of how we're thinking about it now. It's pretty murky still.

Speaker 2

Yes. In terms of specific product categories, as I'm sure you know, Adam, the whole AI ecosystem is going to be very good for our server category. Later in the year, our end point AI enabled PC or end point device category and our storage category. And right now, cloud and cybersecurity on the software side have been strong, so good margin players. So what we really need to see through the balance of this year is that endpoint device adoption start to pick up.

Speaker 2

And we're confident that it will, even if they're not AI PCs in the early months, still Windows 11 and the benefits that are offered there, along with an aging PC installed base are pretty good reasons for our customers to start to move and to start to get their applications ported.

Speaker 5

Okay, that's very helpful. Thanks to you both. Tim, I think in the prepared remarks, you obviously AI is a huge topic for everybody. And you mentioned Microsoft CoPilot that seems to be the one that most investors are really focused on as sort of a leading product that's kind of leading the charge in AI. Just wonder on that type of a product specifically, if you could cover, what does that mean for a reseller in terms of a co pilot license and how are the economics similar or different to the reseller versus a traditional EA or ELA?

Speaker 5

Thanks.

Speaker 2

Yes, thanks. So for CoPilot, there is a monthly fee and there's a pretty good ecosystem around that, again, as we help our customers. We're running it internally now. Many of our we're running it internally now. Many of our

Speaker 4

customers are running it as well.

Speaker 2

In fact, our CoPilot sales have been strong. They have we had a very good quarter for CoPilot. And that is an ongoing annuity stream. Now as the next gen PCs are available, we do expect that CoPilot will continue to be adopted at an accelerated rate because you'll be able to run CoPilot on your individual system in a secure environment without necessarily having to burst out to a cloud. So that will be more secure and more contained, and we expect that will drive some volume.

Speaker 2

But the differences on the commission side and the revenue side are that today that really will be an ongoing annuity as the customer continues to adopt versions.

Speaker 5

Okay. Was that any sort of a factor in the software revenue decline? I know you talked about revenue and gross profit dollar being a big difference in software. I guess, maybe just a little bit more color on that trend, whether it relates to this or something different and should that continue?

Speaker 3

Yes. I think there's a couple of things in there, Adam. Certainly, that contributed to the margin. But there's a couple of other things in there. Last year at this time, we had some very large deals go through that were recorded on a gross basis, believe it or not.

Speaker 3

So that's why when you look at it, we had a pretty significant drop in revenue, but a really nice increase in gross profit. And it just has to do with the nature of the deals that are going through that particular quarter. You get a couple of $20,000,000 $30,000,000 deals, it does move the needle.

Speaker 5

Got it. That's helpful. Thank you.

Speaker 2

Thank you, Adam. Thanks, Adam.

Operator

Thank you. This concludes the question and answer session. I would now like to turn it back to Tim McGrath for closing remarks.

Speaker 2

Well, thank you, Marvin. I'd like to thank all of our customers, vendor partners and shareholders for their continued support. And once again, our coworkers for their efforts and extraordinary dedication. I'd also like to thank all of you listening to the call this afternoon. Your time and interest in Connection are appreciated.

Speaker 2

Have a great evening.

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PC Connection Q1 2024
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