PC Connection Inc

NASDAQ:CNXN

Earnings Call Analysis

Record Net Income and Strategic Growth

In Q2 2024, Connection reported a record net income of $26.2 million and a diluted EPS of $0.99, up 32.8% and 32% respectively from the previous year. Revenue grew slightly by 0.4% to $736.5 million, though networking solutions saw a decline. The company experienced notable growth in endpoint devices, server storage, and software. Gross profit improved by 6.9% to $136.5 million with gross margins at 18.5%. Looking forward, Connection sees cautious improvement in device demand, driven partly by Windows 11, and anticipates 2024 performance to outpace the general IT market by 200 basis points.

Strong Earnings and Revenue Growth

In the second quarter of 2024, Connection achieved a record net income of $26.2 million, which represents a significant 32.8% increase compared to $19.7 million in the same quarter of the previous year. Their diluted earnings per share also surged 32% to $0.99, compared to $0.75 in Q2 2023. The company's consolidated net sales were $736.5 million, showing a modest 0.4% growth year-over-year, while gross profit increased 6.9% to $136.5 million, resulting in gross margins rising 112 basis points to 18.5%.

Segment Performance Highlights

Connection's Business Solutions segment reported Q2 net sales of $278.2 million, up 6.6% year-over-year, and a gross profit increase of 8.1%. The Public Sector Solutions segment experienced a decline in sales of 14%, impacted by lower government spending, yet managed to improve gross margins by 250 basis points. In contrast, the Enterprise Solutions segment posted a 4.1% sales increase to $298.8 million driven by a 15% growth in endpoint device sales.

Impact of Technology Trends

Connection noted a significant growth of 7% in endpoint device revenue, attributed to customers beginning refresh initiatives influenced by Windows 11 and early AI PC adoptions. However, networking solutions saw a substantial decline of 33%, primarily due to tough comparisons from the previous year's supply chain recovery period.

Operational Efficiency and Expenses

The company's operating income showed strong performance, rising 23.3% to $30.9 million, with operating income as a percentage of sales climbing to 4.2%. However, selling, general, and administrative (SG&A) expenses rose by 4.2% due to increased variable compensation linked to higher gross profits. As a result, SG&A as a percentage of net sales increased to 14.3%.

Cash Flow and Capital Allocation

Connection generated $95.7 million in cash from operations in the first half of 2024. They ended Q2 with $385.8 million in cash and short-term investments. The company also returned value to shareholders through a quarterly dividend of $0.10 per share and share repurchases totaling $3.6 million during the quarter. As of now, there is $68.5 million remaining for stock repurchases under the existing program.

Future Outlook and Guidance

Looking ahead, Connection anticipates a modest improvement in IT demand. They expect to outperform the IT market rate of growth by 200 basis points for the remainder of 2024, although profitability may see downward pressure on gross margins due to changes in product mix related to the device refresh cycle. In Q2, they indicated expectations for sequential improvements in Q3 over Q2, traditionally a stronger quarter for the company.

Recognition and Strategic Growth Initiatives

Connection was named among Newsweek's most trustworthy companies for the third consecutive year and recognized as a ServiceNow Reseller Partner of the Year. The company remains committed to enhancing its capabilities in AI and cybersecurity, addressing changing customer needs. They are actively facilitating AI workshops to support customers' journeys in this increasingly critical area.

Earnings Call Transcript 2024-Q2

[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. [Operator Instructions] 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. 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.

[Samantha Smith, executive]

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-K 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. 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 at www.connection.com. Please note that unless otherwise stated, all references to second quarter 2024 comparisons are being made against the second quarter 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 at www.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?

[Timothy McGrath, executive]

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 second quarter results and highlights of our performance. Tom will then walk us through a more detailed look at our Q2 financials. Connection achieved record net income and earnings per share of $0.99 for the second quarter of 2024.

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%. 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 lets discuss our Q2 performance. Consolidated net sales were $736.5 million, an increase of 0.4% compared to last year. Gross profit increased 6.9% to $136.5 million. Gross margins were up 112 basis points to 18.5% in Q2 compared to the prior year quarter. Operating income in Q2 was $30.9 million, 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 $26.2 million, an increase of 32.8% compared to $19.7 million in the prior year quarter. 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 $278.2 million, 6.6% higher than a year ago. Gross profit for the Business Solutions segment was $66.3 million, an increase of 8.1%. Gross margin increased 34 basis points compared to the prior year quarter to a record 23.8%. 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 $159.5 million, 14% lower than a year ago. Sales to state and local government and education institutions decreased by $17.6 million, while sales to the federal government decreased by $8.3 million. Gross profit for the Public Sector segment was $24.1 million, an increase of 3% compared to Q2 '23. 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.

In our Enterprise Solutions segment, Q2 net sales were $298.8 million, 4.1% higher than a year ago as we experienced a 15% increase in sales of endpoint devices. Gross profit for the Enterprise segment was $46.1 million, 7.2% higher than the prior year quarter. Gross margins increase by 45 basis points to 15.4% 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. Tom?

[Thomas Baker, executive]

Thanks, Tim. SG&A increased by 4.2% compared to the prior year quarter. The increase in SG&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&A increased 52 basis points to 14.3% of net sales in the quarter compared to 13.8% in the prior year. Interest income for Q2 amounted to $4.7 million compared to $1.9 million last year, an increase of $2.8 million. Our effective tax rate was 26.4%, down from 26.9% last year.

Net income for the quarter was $26.2 million, an increase of 32.8% from $19.7 million 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%. Our trailing 12-month adjusted earnings before interest, income taxes, depreciation and amortization or adjusted EBITDA was $125.4 million compared to $120.2 million 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 $3.6 million in the quarter at an average price of $64.14 per share.

As of June 30, 2024, we had $68.5 million remaining for stock repurchases under our existing repurchase program. 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 2024 was $95.7 million. Our accounts receivable balance decrease $7.6 million for the first half of 2024, and our DSO remained at 68 days, while our inventory balance increased $12.4 million for the first half of 2024.

Our accounts payable balance increased $53.2 million for the first half of 2024, largely due to timing of payments at the end of the quarter. Cash used in investing activities of $103.4 million was a result of $203.3 million of investment purchases offset by $103.3 million of investment maturities. We used $9 million of cash for financing activities during the first half of 2024, consisting primarily payments of $5.3 million of dividends to shareholders and $3.6 million of stock repurchases.

We ended Q2 with $385.8 million 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 trends.

[Timothy McGrath, executive]

Thanks, Tom. During the quarter, we saw a 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. Health care revenue increased 4% year-over-year driven by major software and system upgrades in our customer base.

Financial Services increased revenue 15% year-over-year, in part to addressability 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 the majority of our customers are evaluating their AI strategy. We continue to strengthen our AI capabilities through the Connection Helix initiatives.

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. 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 third consecutive year, Connection was recognized on Newsweek's 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 dry vails of platform products in packaged ServiceNow professional services in the enterprise market. We believe that we made the entering to 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. 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.

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. Operator?

[Operator]

[Operator Instructions]

And our first question comes from Adam Tindle from Raymond James.

[Adam Tindle, analyst]

Tim, I wanted to start with that comment on seeing the beginning stages of the device refresh. Just wondering if you could 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? 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?

[Timothy McGrath, executive]

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 of you wanted 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 a very little of it is AI PC-based. 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, it will then see a much bigger adoption in 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. 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 pick up 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?

[Thomas Baker, executive]

So Adam, 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 represent [ 27 ]% in revenue and 20% -- 27% GP. So that was a pretty good headwind for the quarter, but 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.

[Adam Tindle, analyst]

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

[Thomas Baker, executive]

So we have, I think, reasonably disciplined and try very hard as we go through -- the past couple of quarters 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&A although the rate 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, continue to -- about the trajectory we're at.

[Operator]

And our next question comes from Anthony Lebiedzinski from Sidoti & Company.

[Anthony Lebiedzinski, analyst]

So I guess, first, just curious, can you comment on the trends that you saw throughout the quarter and kind of an early indication as far as Q3, how that started here for you?

[Thomas Baker, executive]

Yes. 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 first 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.

[Anthony Lebiedzinski, analyst]

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

[Timothy McGrath, executive]

Anthony, so Q3 is historically a strong quarter for us, and we think we're firing on all cylinders there. We're obviously, in a tough macro environment, we want to be cautious for with our what we are seeing on the enterprise large projects come into the funnel.

We're good projects with our public sector business in 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 '24 to be better than the first half. 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.

[Anthony Lebiedzinski, analyst]

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

[Timothy McGrath, executive]

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. In most cases, the fix was provided by CrowdStrike working with Microsoft, so we could provide bodies hands and feet on the ground to help them, and in some cases, setting up a 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.

[Anthony Lebiedzinski, analyst]

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% and storage up 19% in the quarter. For those 2, I mean, how do you think about the sustainability of that going forward here?

[Thomas Baker, executive]

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

[Operator]

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

[Timothy McGrath, executive]

Thank you, Justin. 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 those of you listening to our call this afternoon. Your time and interest in Connection are appreciated. Have a great evening.

[Operator]

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