PC Connection Q2 2024 Earnings Call Transcript

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Provided by Quartr
July 31, 2024

There are 6 speakers on the call.

Operator

Good afternoon, and welcome to the Second Quarter 2024 Connection Earnings Conference Call. My name is Justin, and I will 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 rebroadcast without any 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

Thank you, 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 both 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 measure discussed and its most directly comparable GAAP measure is available in today's earnings release and on the company's website atwww.connection.com.

Speaker 1

Please note that unless otherwise stated, all 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 Q2 2024 conference call. I'll begin this afternoon with an overview of our 2nd quarter results and highlights of our performance. Tom will then walk us through a more detailed look at our Q2 financials. Connexion achieved a record net income and earnings per share of $0.99 for the Q2 of 2024.

Speaker 2

These results reflect the successful execution of our strategic priorities and our ability to adapt to the needs of our customers in this dynamic environment. We remain committed to stay at the forefront of the technology curve, ensuring that our integrated solutions meet the evolving needs of our customers. In Q2, we experienced growth in endpoint device revenue of 7% as some customers began refresh initiatives, which were primarily driven by Windows 11 and some early AI PC Adopters. Gross profit for endpoint device increased 27% due to a change in customer mix. Our server storage category had strong growth of 19% and software, including cloud and cybersecurity, increased 7%.

Speaker 2

These increases were offset by a 33% decrease in networking solutions. If you recall, a year ago, our networking business benefited from the supply chain recovery resulting in a tough compare. Overall, Advanced Technology revenue was down 8.7% in Q2 compared to the prior year quarter, while gross profit for Advanced Technology increased by 4%. While each of our businesses experienced gross profit growth in the quarter, our customers continue to be very deliberate and cautious with their IT purchases in this uncertain economic environment. Now let's discuss our Q2 performance.

Speaker 2

Consolidated net sales were $736,500,000 an increase of 0.4% compared to last year. Gross profit increased 6.9% to 136,500,000 dollars Gross margins were up 112 basis points to 18.5% in Q2 compared to the prior year quarter. Operating income in Q2 was $30,900,000 an increase of 23.3% compared to Q2 2023. Operating income as a percentage of sales was 4.2% compared to 3.4% of net sales in the prior year quarter. Net income in Q2 was a record $26,200,000 an increase of 32.8 percent compared to $19,700,000 in the prior year quarter.

Speaker 2

In Q2 2024, our diluted earnings per share were $0.99 an increase of 32% from $0.75 in Q2 2023. Now we'll look a little deeper into our segment performance. In our Business Solutions segment, our Q2 net sales were $278,200,000 6.6 percent higher than a year ago. Gross profit for the Business Solutions segment was $66,300,000 an increase of 8.1%. Gross margin increased 34 basis points compared to the prior year quarter to a record 23.8%.

Speaker 2

Our net sales and gross margins were favorably affected by growth in endpoint device and server sales as well as a shift in customer mix. In our Public Sector Solutions business, Q2 net sales were $159,500,000 14% lower than a year ago. Sales to state and local government and education institutions decreased by $17,600,000 while sales to the federal government decreased by 8,300,000 dollars Gross profit for the Public Sector segment was $24,100,000 an increase of 3% compared to Q2 2023. Gross margin increased by 250 basis points to 15.2% for the quarter compared to the prior year. The revenue decline and margin improvement resulted from a few large opportunities in Q2 2023 that were at low margins and did not repeat in the current year quarter.

Speaker 2

In our Enterprise Solutions segment, Q2 net sales were $298,800,000 4.1 percent higher than a year ago as we experienced a 15% increase in sales of endpoint devices. Gross profit for the Enterprise segment was $46,100,000 7.2 percent higher than the prior year quarter. Gross margin increased by 45 basis points to 15.4 percent for the quarter. The margin improvement was a result of changes in customer mix and an increase in software sales, including cloud and cybersecurity recognized on a net basis. I will now turn the call over to Tom to discuss additional financial highlights from our income statement, balance sheet and cash flow statements.

Speaker 2

Tom?

Speaker 3

Thanks, Tim. SG and A increased by 4.2% compared to the prior year quarter. The increase in SG and A was primarily due to an increase in variable compensation due to higher levels of gross profit in the quarter. On a percentage of sales basis, SG and A increased 52 basis points to 14.3 percent of net sales in the quarter compared to 13.8% in the prior year. Interest income for Q2 amounted to $4,700,000 compared to $1,900,000 last year, an increase of 2,800,000 dollars Our effective tax rate was 26.4 percent, down from 26.9% last year.

Speaker 3

Net income for the quarter was $26,200,000 an increase of 32.8 percent from $19,700,000 last year and diluted earnings per share was $0.99 an increase of 32%. Adjusted earnings per share was $1 an increase of 25.5 percent. Our trailing 12 month adjusted earnings before interest, income tax, depreciation and amortization or adjusted EBITDA was $125,400,000 compared to $120,200,000 a year ago, an increase of 4%. In terms of returning cash to shareholders, we paid a $0.10 per share quarterly dividend in May and we repurchased shares having an aggregate purchase price of $3,600,000 in the quarter at an average price of $64.14 per share. As of June 30, 2024, we had $68,500,000 remaining for stock repurchases under our existing repurchase program.

Speaker 3

Today, we announced that our Board of Directors has declared a quarterly dividend of $0.10 per share. The dividend is payable to shareholders of record on August 13, 2024 and payable on August 30, 2024. Tax flow generated from operations for the first half of twenty twenty four was 95,700,000 dollars Our accounts receivable balance decreased $7,600,000 for the first half of twenty twenty four and our DSO remained at 68 days, while our inventory balance increased $12,400,000 for the first half of twenty twenty four. Our accounts payable balance increased $53,200,000 for the first half of twenty twenty four, largely due to timing of payments at the end of the quarter. Cash used in investing activities of $103,400,000 was a result of $203,300,000 of investment purchases offset by $103,300,000 of investment maturities.

Speaker 3

We used $9,000,000 of cash for financing activities during the first half of twenty twenty four consisting primarily of payments of $5,300,000 of dividends to shareholders and $3,600,000 of stock repurchases. We ended Q2 with $385,800,000 of cash, cash equivalents and short term investments. In terms of capital allocation, we remain committed to growing our business and have an ongoing program focused on investing in both organic and inorganic growth opportunities. Furthermore, as announced above, we have continued to return cash to shareholders in the form of a quarterly dividend and plan to continue to repurchase stock in a disciplined manner. I will now turn the call back over to Tim to discuss current market crunch.

Speaker 2

Thanks, Tom. During the quarter, we saw strong growth in several of our vertical markets. Manufacturing revenue increased 13% year over year. Software, endpoint devices, networking and cybersecurity continue to be a heavy focus for manufacturers as they look for productivity gains while keeping their businesses secure. Healthcare revenue increased 4% year over year, driven by major software and system upgrades in our customer base.

Speaker 2

Financial services increased revenue 15% year over year in part to address flexibility and interoperability between IT systems. In our solutions business, we continue to make progress as a result of our ongoing investments in technology, talent and tools, which resulted in strong growth in cloud, cybersecurity and our managed services. AI is an important area of investment as a majority of our customers are evaluating their AI strategy. We continue to strengthen our AI capabilities through the Connection Helix initiative. As a central element of our go to market strategy, we're actively delivering AI workshops to our customers to help them with their AI journey.

Speaker 2

Furthermore, the Connection Helix team is crafting a targeted approach for the SMB sector, which presents exciting long term growth opportunities, underscoring our commitment to the success and ongoing development of the Connection Helix program. We are also pleased that in Q2, for the 3rd consecutive year, Connection was recognized on Newsweek list of the most trustworthy companies in America for outstanding customer, investor and employee trust. We were recognized as a ServiceNow 2024 America's reseller partner of the year as a result of driving sales of platform products and packaged ServiceNow professional services in the enterprise market. We believe that we may be entering the beginning stages of the device refresh cycle based on our Q2 growth as well as discussions with several of our OEM partners. As a result, we believe that device demand will improve modestly for the balance of the year.

Speaker 2

We expect aggregate IT demand to be impacted by cautious investment in infrastructure due to uncertainty with the macroeconomic backdrop as well as concerns about this being an election year. In terms of profitability, the device refresh and the anticipated change in product mix is likely to produce downward pressure on gross margins. As a result, for the balance of 2024, we expect that we'll see modest improvements in our performance and we are confident that we can outperform the IT market rate of growth by 200 basis points. Our focus and business strategy remain 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.

Speaker 2

We help our customers expertly navigate through our complex set of choices within the technology landscape. We help calm the confusion of IT for our customers. We know that in this complex world of technology, change happens and expertise wins. On that note, I'd like to take a moment to thank our extremely dedicated and valued employees for their continued and extraordinary efforts during this rapidly changing environment. We'll now entertain your questions.

Speaker 2

Operator?

Operator

Thank you. And our first question comes from Adam Tindle from Raymond James. Your line is now open.

Speaker 4

Okay, thanks. Good afternoon, Tim. I wanted to start with that comment on seeing the beginning stages of the device refresh. Just wondering if you could maybe share a little bit more color, whether that's from the OEMs and or the customers on why that is materializing now or what's underpinning your belief? Any metrics like your pipeline that might be kind of supporting quantitatively on that?

Speaker 4

And then maybe for Tom in light of this, understand that there's going to be a gross margin headwind on mix related to this. But for gross profit dollar growth, I think for the year, it was kind of a low single digit expectation prior to this. How would you update that now? Thanks.

Speaker 2

Well, Adam, thanks and I appreciate the question. So I'll start, we'll talk a little bit about the device refresh that we mentioned. So we are starting to see the device refresh primarily around Windows 11 take hold. And the question that so many people want to know is how much of that device refresh is purely Windows 11 refresh and how much is AI PC based. And the reality is very little of it is AI PC based.

Speaker 2

Around 10% of our sales are AI PCs in the device market, but that doesn't mean that those customers are using them in an AI application. In some cases, they're just forward looking for applications in the future. And we do work closely with our OEM partners and they continue to believe that as the next generation PCs are available toward the end of 2024 and the early parts of 2025. And it will then see a much bigger adoption and pickup in that device market that would be AI PC driven. So today we are seeing some early adopters, but that next gen technology will really drive much greater adoption in the future.

Speaker 2

In terms of our funnels across the business, I'd say probably enterprise is seeing the most traction right now in terms of funnel and forecast pickup for very large projects. We also are bullish on our public sector business knowing that we had a rough Q2, but we're anticipating a better Q3. And then finally, our business solutions team is really consistently performing well and we expect for the balance of 2024, they'll continue to perform that way. Tom?

Speaker 3

So Adams, in terms of gross profit growth, I think we're still in the low single digits, maybe mid single digits in terms of GP growth for the year. As you heard in the first part of our remarks, our device our endpoint devices were up 7% in revenue and 27% in GP. So that was a pretty good headwind for the quarter that I'm frankly not sure is going to persist through the balance of the year. So that's what's tempering our expectations on GP growth a little bit. I'm not sure we're going to hold that for the balance of the year.

Speaker 4

Okay. That makes sense. And maybe below the GP line, Tom, you've obviously done a nice job driving operating leverage. How about the trajectory from here? Obviously, some indications that the environment is getting better could make the argument that it might be time to make some additional investments.

Speaker 4

Just how you're thinking about balancing operating leverage versus investments at this point and what that means for the operating margin going forward?

Speaker 3

So we have, I think, reasonably disciplined and tried very hard as we go through through the past couple of quarters looking at our investments. We continue to put a significant amount of capital into our Services and Solutions business and we're just trying to fund it by cutting other areas. So I think we've been pretty good about investing as we go along. I think for the next quarter or 2, you'll see a little bit of a tick up in SG and A, although the rates should come down a little bit, especially if the revenues improve some. So I think we're on track with our investment plan and I think we can continue to about the trajectory we're at.

Speaker 4

Very helpful. Thank you very much.

Speaker 2

Thank you.

Operator

And thank you. And one moment for our next question. And our next question comes from Anthony Lebiedzinski from Sidoti and Company. Your line is now open.

Speaker 5

Good afternoon and thank you for taking the questions. So I guess, first, just curious, can you comment on the trends that you saw throughout the quarter and kind of any early indication as far as Q3, how that started here for you? Yes.

Speaker 3

So Anthony, when I look at the linearity in the quarter, we're kind of about 35% in June, which is down a couple of points from what we've been in the past 2 years, we've got like 37%. And the thing that happened within the month of June, believe it or not, the 1st couple of 3 weeks were pretty were a little bit tough. And then our last week of the quarter, we actually shipped about 30% more than we did in the same last 7 days last year. So we did see a spike at the end of the quarter, which was we're glad to have it, to be honest with you, but it was a little bit unexpected.

Speaker 5

Okay. And then as far as Q3 so far, July, I mean, any comments there as far as what you're seeing?

Speaker 2

Tadee, so Q3 is historically a strong quarter for us, and we think we're firing on all cylinders there. Obviously, in a tough macro environment, we want to be cautious and tempered with our forecast. But we are seeing on the enterprise large projects come into the funnel. We're seeing also good projects with our public sector business and kind of steady as she goes with our business solutions team. So for Q3, as I think you've been hearing in our competitive landscape, we do expect second half of twenty twenty four to be better than the first half.

Speaker 2

We do expect some improvement in Q3 over Q2 sequentially, which is very common for our business. And we're optimistic that we're not calling this quite an inflection point yet, but we are starting to see device refresh come into the picture and that certainly is a welcome change.

Speaker 5

Got you. Yes, that's good to hear. And then as far as just recent events, just curious with the issues with CrowdStrike, was that a positive or negative for you in terms of your work with your clients?

Speaker 2

So thanks. So we do sell CrowdStrike and we were not affected as a company. However, several of our clients were. And it turned out to be a great opportunity for us to support them with their needs. And in most cases, the fix was provided by CrowdStrike, working with Microsoft.

Speaker 2

So we could provide bodies, hands and feet on the ground to help them. And in some cases setting up 24 hour call centers to help walk customers through the changes needed. So it was an opportunity for us to help our customers. In that regard, a very tragic event was good for us in that we were able to help our customers.

Speaker 5

That's good to hear. So yes, you commented also on the device refresh cycle picking up here. As far as other areas of your business, software was up 7%, servers and storage up 19% in the quarter. For those 2, I mean, how do you think about the sustainability of that going forward here?

Speaker 3

Yes. I think especially in the Enterprise business, we're seeing a lot of activity, but we're very it's very unclear as to when they actually start cutting POs. So I think it's going to be a function of what the overall spending environment does. I think we're well positioned when it happens. We're just waiting for the budgets to cut loose.

Speaker 3

And that's why we're a little bit tempered on what we think is going to happen with the infrastructure business.

Speaker 5

Got you. Okay. All right. Well, that's all I had. Thanks very much and best of luck.

Speaker 3

Thank you, Anthony.

Operator

And thank you. And I'm showing no further questions. I would now like to turn the call back over to Tim McGrath for closing remarks.

Speaker 2

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

Speaker 2

Have a great evening.

Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.

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Key Takeaways

  • Connection reported record Q2 net income of $26.2 million and diluted EPS of $0.99, up 32.8% year-over-year.
  • Consolidated net sales rose 0.4% to $736.5 million, gross profit increased 6.9%, and gross margin expanded 112 basis points to 18.5%.
  • Endpoint device revenue grew 7% (27% gross profit growth), server storage climbed 19%, and software (cloud and cybersecurity) was up 7%, while networking solutions fell 33% on a tough prior-year comparison.
  • Management sees early Windows 11-driven device refresh and around 10% AI PC adoption, expecting modest demand improvement in H2 2024 but noting potential gross margin pressure from product mix.
  • The company returned cash via a $0.10 per share quarterly dividend and $3.6 million in share repurchases, with $68.5 million remaining under its current buyback program.
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Earnings Conference Call
PC Connection Q2 2024
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