PC Connection, Inc. (NASDAQ:CNXN) Q1 2024 Earnings Call Transcript May 1, 2024
PC Connection, Inc. misses on earnings expectations. Reported EPS is $0.5 EPS, expectations were $0.64. CNXN isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon, and welcome to the First Quarter 2024 Connection Earnings Conference Call. My name is Marvin, and I’ll be the coordinator for today. [Operator Instructions] As a reminder, this conference call is the property of Connection and may not be recorded or re-pod cast without 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 will now turn the call over to the company.
Samantha Smith: 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-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 measures 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 first quarter 2024 comparisons are being made against the first 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: 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 first quarter 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 and endpoint devices continued into the first quarter. 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. 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.
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 million, 13.1% below last year. Gross profit decreased 3.5% to $118.1 million, 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, operating income in Q1 was $13.5 million, 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 $13.2 million, a decrease of 7.4% compared to $14.2 million in the prior year quarter. In Q1 2023, our diluted earnings per share was $0.50, a decrease of 7.7% from $0.54 in Q1 2023. We will now look a little deeper into our segment performance. In our Business Solutions segment, our Q1 net sales were $255.9 million, 6.3% lower than the 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 $60.6 million, an increase of 0.8% from a year ago. Gross margin increased 165 basis points to a record 23.6% in the quarter compared to the prior year. In our Public Sector Solutions business, Q1 net sales were $93.5 million, 33.4% lower than a year ago.
Sales to state and local government and educational institutions decreased by $7.5 million, while sales for the federal government were lower by $39.5 million compared to the prior year quarter. This quarterly performance can be explained by the fact that in Q1 2023, our results included two large projects with existing customers that accounted for the majority of the decline in revenue in the first quarter of 2024. Gross profit for the Public Sector segment was $15 million, a decrease of 26.3% compared to Q1 ’23. 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 $282.7 million, 10% lower than a year ago. Gross profit for the Enterprise segment was $42.7 million, 1.6% 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?
Thomas Baker: Thanks, Tim. SG&A increased by 1.3% compared to the prior year quarter. We had a decrease in spending on personnel driven by cost containment measures. However, the increase in SG&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&A increased 236 basis points to 16.6% 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. Net income for the quarter was $13.2 million, a decrease of 7.4% from $14.2 million 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 $120.3 million compared to $127.6 million 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. The dividend is payable to shareholders of record on May 14 and payable on May 29, 2024. In addition, the Board authorized an additional $40 million increase to Connection’s existing share repurchase program. $72.1 million is available for share repurchases after giving effect to this increase. Cash flow generated from operations for the first quarter of 2024 was $57.3 million, an improvement of $37.8 million from the same period a year ago.
Our accounts receivable balance decreased $79.3 million for the first quarter of 2024, and our DSO decreased to 70 days from 71 days. Our inventory balance remained flat for the first quarter of 2024 compared to the fourth quarter of 2023. Our accounts payable balance decreased $45.1 million for the first quarter ended 2024. Cash used in investing activities of $51.6 million was a result of $100 million of investment purchases offset by $50 million of investment maturities. The company used $3.1 million of cash for financing activities during the first quarter of 2024, consisting primarily of payments of $2.6 million of dividends to shareholders. We ended Q1 with $352 million of cash, cash equivalents and short-term investments. 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 trend.
Timothy McGrath: 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. 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 up modestly over Q4 2023, and we believe 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 enhance collaboration tools, improved security and the adoption of Windows 11, will require more powerful devices. These factors are also expected to drive a device refresh cycle as a 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 environment 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. Recall that we launched the Helix Center for Applied AI 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.
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 patient’s data. In manufacturing, our forecast is building based on our customers’ need for automation and the need to deal with workforce and skill set shortages as well as inflationary pressures on materials and labor. Many customers are also 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 second consecutive year, Connection was named to the Forbes America’s Best Employers list.
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, Connection was awarded ServiceNow’s Reseller of the Year. Connection was also named of 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. The timing of our customer spending on new technology is uncertain, but we’re optimistic that by the second half of 2024, we will return to more normalized growth rates. We expect the growth rate for the U.S. IT market will continue to be challenging in the near term, however, we believe we can outperform the IT market and take market share, notwithstanding the challenging macroeconomic environment.
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, elevate productivity and empower 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 the continued an extraordinary effort during this rapidly changing environment. We will now entertain your questions. Operator?
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