PC Connection Inc

NASDAQ:CNXN

Earnings Call Transcript 2021-Q1

[Operator]

Good afternoon, and welcome to the First Quarter 2021 Connection Earnings Conference Call. My name is Jackie, and I will be your operator for today's call. [Operator Instructions] On the call today, are Tim McGrath, President and Chief Executive Officer and Tom Baker, Senior Vice President and Chief Financial Officer. I will now turn the call over to the company.

[Samantha Tracy, executive]

Thanks, and good afternoon, everyone. I will now read our safe harbor statement. 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-K for the year ended December 31, 2020, 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. 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 even if estimates change and therefore you should not rely on these forward-looking statements as representing views as of any date subsequent to today. During this call, GAAP and non-GAAP financial measures will be discussed. A reconciliation between the 2 is available in today's earnings release and on the company's website at www.connection.com. Please note that unless otherwise stated, all references to first quarter 2021 comparison are being made against the first quarter of 2020.

Today's call is being webcast and will be available on Connection's website. The earnings release will be available on the SEC website at www.sec.gov and in the Investor Relations' section of our website at www.connection.com. I would now like to turn the call over to our host, Tim McGrath, President and CEO. Tim?

[Timothy McGrath, executive]

Thank you, Samantha. Good afternoon, everyone, and thank you for joining us today for Connection's Q1 2021 conference call. As you saw from the press release, Q1 revenues were down 10.5% year-over-year. However, the overall level of business activity and customer opportunities accelerated throughout the first quarter and into April. The economic recovery combined with the federal stimulus program is giving our customers both the confidence and the funding to invest in their businesses. In fact, our ending backlog for Q1 in both Enterprise and Business Solutions segments grew over 20% from the end of last year, and our consolidated backlog grew over 15% from March to April reflecting the increased demand. As business momentum continues, we remain optimistic that will show year-over-year improvements in Q2 and for the calendar year 2021. Our main headwind right now is the supply chain. Order to delivery time has stretched out longer than we've ever experienced, and we expect this condition to persist for at least the balance of the year. As you know, the supply chain dynamic is playing out in many industries, not just ours.

Let me now turn to the Q1 numbers. First quarter revenue was $636.9 million, down 10.5% from 2020. Gross profit of $100.5 million was down 11.1%, and average daily sales decreased by 9.1%. If you recall, we experienced a record first quarter in 2020 mainly due to the work from home buying rush created by the pandemic. Gross margins of 15.8% were down 11 basis points from Q1 in 2020, primarily due to public sector representing a larger percentage of revenue in the quarter. Our public sector business runs at slightly lower margins than our other segment, particularly with the mix of mobility products we sold in the quarter. SG&A was in line with expectations. As an absolute number, it was lower than Q1 2020 because of a decrease in variable compensation and a reduction in bad debt expense. As a percentage of sales, SG&A was 13.6% in the first quarter compared with 13% in Q1 of 2020. We are managing expenses closely and expect improvement as the year progresses.

Operating income in Q1 was $14.1 million, a decrease of 31.6% or 2.2% of net sales compared to $20.7 million or 2.9% of net sales in the prior year quarter. In Q1 2021, diluted earnings per share was $0.39, a decrease from $0.56 in Q1 2020. We ended Q1 with $92.3 million of cash and cash equivalents. We will now look a little deeper at segment performance. In our Business Solutions segment, our Q1 net sales were $246.3 million, a decrease of 11.6% compared to $278.8 million a year ago. While average daily sales decreased by 10.2% in the quarter, gross profit in the Business Solutions segment was $47.4 million, a decrease of 9.8% from a year ago. Gross margin increased by 40 basis points to 19.2% in the quarter compared to 18.8% in the prior year as a result of changes in product mix. We're excited to say we're seeing a steady increase in the number of buying accounts in our Business Solutions segment. As you know, the small business sector was among the hardest hit in 2020.

In our Public Sector Solutions business, Q1 net sales were $125.3 million, an increase of 25.7% compared to $99.6 million a year ago. Sales on an average daily basis grew 27.7% in the quarter. Sales to state and local government and educational institutions was $89 million, an increase of 13.2% compared to the prior year. K-12 customers were largely responsible for the increase in the SLED business. Sales to the federal government were $36.3 million, an increase of 72.6% compared to the prior year. The increase in Federal business was due to large project rollouts in the quarter. Gross profit for the Public Sector segment was $50.6 million, an increase of 8.6% compared to Q1 '20. Gross margin decreased by 197 basis points to 12.5%, as mobility solutions represented a larger portion of the product mix. We expect our margins to normalize in the months ahead. We anticipate our customers spend will continue to be strong in this sector.

In our Enterprise Solutions segment, Q1 net sales were $265.3 million, a 20.4% decrease compared to $333.4 million a year ago or a 19.2% decrease on an average daily sales basis. Gross profit for the Enterprise segment was $37.5 million, a decrease of 18.8% in the quarter. Gross margin for the quarter increased by 28 basis points to 14.1%. In Q1, the Enterprise space experienced challenges with product availability with a number of our suppliers. As you know, enterprise customers predominantly order custom configurations that are currently experiencing longer lead times due to supply chain constraints. Consequently, our Enterprise segment and exited the quarter with a record is backlog.

I will now turn the call over to Tom to discuss additional financial highlights from our income statement, balance sheet and cash flow statement. Tom?

[Thomas Baker, executive]

Thanks, Tim. SG&A was $86.4 million in this quarter, a decrease of 6.6% from $92.5 million a year ago. As a percentage in net sales, this represented an increase of 58 basis points year-over-year and significantly down from Q4. If we strip out the impact of software netting, our SG&A in the quarter was 11 basis points up from the prior year. Looking forward to Q2, our SG&A as a percentage of sales is expected to decline around 50 basis points from Q1. The year-over-year Q1 decrease in SG&A was driven by a decrease in variable compensation and a reduction in bad debt expense. Q1 operating income was $14.1 million, down 31.6% this quarter from $20.7 million a year ago. Our Q1 effective tax rate was 27.8% down from 28.2% in the same period a year ago. Net income for the quarter was $10.2 million, a decrease of 31.6% from $14.9 million a year ago. Diluted earnings per share was $0.39, a decrease of 31% from the prior year period.

Our trailing 12 month adjusted earnings before income taxes, depreciation and amortization or adjusted EBITDA was $84.4 million compared to $130.9 million a year ago. We have $12.7 million remaining for stock repurchases under our existing stock repurchase program. Cash flow from operations for the first quarter was $6 million versus $44.6 million for the same period a year ago. The change was driven primarily by a decrease in accounts receivable, offset by a decrease in accounts payable. Our net cash used in investing activities of $903,000 in the first quarter was primarily the result of equipment purchases and IT initiatives offset by proceeds from life insurance. The company used $8.5 million cash for financing activities during the first quarter, consisting primarily of the payment of our 2020 special dividend.

I will now turn the call back over to Tim to discuss current market trends.

[Timothy McGrath, executive]

Thanks, Tom. I want to take a few moments to review some of the highlights in our business. Vertical markets continue to be an important part of our strategic focus. In fact, our manufacturing vertical market had solid growth of 30.5% year-over-year. We're seeing an increased demand for advanced technologies, security, IoT, cloud, data and AI as well as the tailwind from the continued demand for notebooks and other mobility solutions as customers continue to advance their workplace transformation strategies. Overall services revenue grew double-digits year-over-year and we achieved Microsoft Advanced Specialization in Windows and SQL Server Migration to Azure.

We accelerated our investment in Connection Cares, our company's social responsibility program, building on Connection's inclusive culture and long-standing history of employee volunteerism. This initiative formalized as the company's community engagement, sustainability and diversity and inclusion efforts into one cohesive program. Looking at the balance of 2021,and assuming that supply chain constraints don't further deteriorate, we believe that we can deliver growth rates that are 300 basis points above the IT industry. We are focused on helping our customers enable their post COVID hybrid workforce, accelerate their digital transformation and empower their innovation. We will now entertain your questions. Operator?

[Operator]

[Operator Instructions] And our first question comes from Anthony Lebiedzinski with Sidoti Company.

[Anthony Lebiedzinski, analyst]

You gave some numbers about the backlogs as far as the percentage increases. I was just wondering if it would be possible for you guys to share details as far as the dollar amounts of those backlogs.

[Timothy McGrath, executive]

We're not publishing the dollar amounts of our inventory backlogs. As you know, they move daily. So at this time, we don't share that information.

[Thomas Baker, executive]

What we're trying to do, Anthony is, just give some sense of the magnitude of what's going on and it's -- they're pretty big numbers.

[Anthony Lebiedzinski, analyst]

Okay. As far as the supply chain constraints that are out there, as you look at those constraints now versus at the end of the quarter, have they gotten worse or are they the same or better? I'm just trying to get a sense of that.

[Timothy McGrath, executive]

I think the way that we should look at that is really with each of our individual segments. Let's start with our Large Account segment, the Enterprise team. That team, as you know, Anthony, is really dependent on large project rollouts, and those rollouts ebb and flow. But more than that, the team is largely dependent on configure-to-order type solutions. So those CTO solutions are the ones that have been the most challenge for our suppliers to deliver. And we do expect the supply chain to get gradually better, and we are looking at a number of options in dealing with all of our suppliers. That said, we still think supply chain disruption will continue throughout Q2, get gradually a little better in the summer, but still working its way all the way through year end. So for the Enterprise team in particular, and those large projects, they're the ones that really felt the challenge from the constraint the most.

In our public sector group, we are seeing very significant growth as the industry is. Our public sector customers seem to have a lots of opportunity, lots of funding, and it's really a good time to be in that business. And towards that end we've had some good success getting products, but many of the products that we're looking at in the future will be constrained, more of those velocity and notebook type products are the products I'm referencing there. So we've had good success, we're going to watch that carefully. And then finally, with our SMB business, there are a lot of positive drivers happening there as our SMB customers are coming back. But that said, they were hit the hardest in 2020 and now that return is happening will be scrambling to make sure we can get their products. So overall, I'd say, Enterprise hit hardest followed by SMB and then we're watch and go carefully. We do expect it will get gradually better. Tom anything to add?

[Thomas Baker, executive]

No, that's it.

[Anthony Lebiedzinski, analyst]

And one last question for me is just overall, how should we think about vendor rebates and incentives? I just wanted to tie that it as to how you expect the gross margins to for the balance of the year.

[Thomas Baker, executive]

So far we haven't seen really a lot of pressure there yet Anthony. I think as time goes out, we are hearing about price increases from some of our vendors, and we'll do our best to make sure we don't get trapped in the middle there. But we have -- we actually performed pretty well on the vendor consideration this quarter, and we fully expect to keep that moving. So I don't see a lot of gross margin compression in the near future.

[Operator]

Our next question comes from Adam Tindle with Raymond James.

[Adam Tindle, analyst]

I just wanted to start with a 2-part question high level on products. Notebooks were up almost 20% year-over-year. Just wondering if you have any visibility into how long you expect that category to remain strong. I think a lot of investors are trying to think about the back half of 2021. And then conversely other areas like net com server storage are down. Just wondering your expectations for the rest of the year on those areas. Are there any indications of projects resuming?

[Timothy McGrath, executive]

I'll start with the first part of your question. Clearly, there's been a lot published and a lot of discussion about the length of the tailwind and how long the notebook refresh will continue, and well, I think it will continue at a decreased rate as the year goes on. However, we are seeing some pretty big areas of opportunity. Just to begin with, we think about the distributed workforce and you think about the trends driving notebooks, Wi-Fi 6, 5G, other connectivity and of course, all of the virtualization and one device per person trend. All of that bodes pretty well for the velocity products. So I do expect that will continue. When we think about our public sector business we've got clearly sled going into their busy season, and a lot of chrome opportunity and chrome units becoming more available.

So again, I think there is pretty good opportunity there. Good opportunity with E-Rate and then finally with our SMB business. When you think about what's happening with the American rescue plan funding, think about retail revitalization and some of the Small Business Administration funding as well as just those businesses coming back. I think demand is going to remain, supply is more of a question mark. When it comes to the server storage networking strategic outlook, obviously, when our customers were not in their buildings, the data center type projects, Refresh and other projects were put on hold and we are now starting to see the funnel still up, lots of project coming back and we're much more optimistic in the networking server arena for the back half of 2021. So we do think growth is going to return there.

[Adam Tindle, analyst]

I know you had mentioned, planning to go -- grow 300 basis points above IT spending for the remainder of the year. Can you just maybe help us shape that out a little bit more. Q2 coming up is-was really difficult quarter a year ago and should be an easy comparison and should see significant growth in that quarter, I would imagine. So are we talking 20 plus percent growth in Q2 and then the back half of the year is going to be half that level or just a way to shape out expectations on top line.

[Thomas Baker, executive]

I think, Adam, if we look at this year, typically we'll do 48.5% or 49% of our revenue in the first half and then the balance in the second half. I think that's going to be a little bit skewed this year, I think we're probably closer to the 47.5% to 48% in the first half, with the balance in the second half. So I can triangulate on where we think next quarter is going to fall. Yes. Next quarter is going to be obviously a pretty easy compare. But the thing that I do worry about there is, as we've been talking about, demand isn't really the issue, it's the supply. And I'm not sure I can get real precise on how that's going to result itself.

[Adam Tindle, analyst]

Yes, I don't think anybody can and that's understandable but helpful. Maybe just one last one for me, Tim, I'm wondering from a customer metrics standpoint, are you seeing any aspect of customer churn as they potentially go to VARs who do have supply right now. I know it's few and far between but are you seeing any indications of customer churn near term?

[Timothy McGrath, executive]

Actually, we're not seeing that customer churn, we are seeing some switching, some of our large customers who can find availability through loss from a different supplier. So we have seen some large projects moves from one of our suppliers to another based strictly on availability. The other, the only other churn that we're seeing is, as I mentioned, great growth in manufacturing, lots of promise in retail, in healthcare, there's a lot of M&A happening and in fact, there's been hundreds of merger and acquisition opportunities in healthcare, which overall is good for us. But that movement does provide some churn. But overall, we are not seeing customer defections, although there are some switching to different manufacturers.

[Operator]

[Operator Instructions] And at this time we have no further questions. Turning the call back for some final remarks.

[Timothy McGrath, executive]

Well thanks, Jackie. I'd like to thank all of our customers, our vendor partners and our shareholders for their continued support. And once again, our dedicated coworkers for their efforts and extraordinary dedication through this time. I'd also like to thank those of you listening to our call this afternoon. Your time and interest in Connection are appreciated. Have a great evening.

[Operator]

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.