PC Connection, Inc. (CNXN) CEO Tim McGrath on Q2 2022 Results - Earnings Call Transcript

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PC Connection, Inc. (NASDAQ:CNXN) Q2 2022 Earnings Conference Call August 4, 2022 4:30 PM ET

Company Participants

Samantha Tracy - Investor Relations

Tim McGrath - President and Chief Executive Officer

Tom Baker - Senior Vice President and Chief Financial Officer

Conference Call Participants

Anthony Lebiedzinski - Sidoti

Catherine Huntley - Raymond James

Operator

Good afternoon and welcome to the Second Quarter 2022 Connection Earnings Conference Call. My name is Kyle Mode 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 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. [Operator Instructions] And now I will turn the call over to the company.

Samantha Tracy

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, maybe 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, 2021, 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, GAAP and non-GAAP financial measures will be discussed. A reconciliation between the two 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 2022 comparisons are being made against the second quarter of 2021.

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?

Tim McGrath

Thank you, Samantha. Good afternoon, everyone and thank you for joining us today for Connection’s Q2 2022 conference call. I will begin this afternoon with an overview of our second quarter results, highlights of our performance and then share our updated thoughts on our business and the remainder of the year. Tom will walk us through a more detailed look at our financials.

We had an outstanding second quarter. Our team continued to execute well against our strategic objectives across each of our business segments with all-time record quarterly results for revenue, gross profit and net income. We experienced double-digit growth across all 3 of our business segments. These exceptional results demonstrate the continued execution of our business strategy to connect our customers with technology that enhances growth, elevates productivity and empowers innovation. The technology and solutions that we provide are highly valued by our customers. As we look forward, we believe that our products and services will become even more essential in helping our customers to achieve their business objectives with technology.

On a consolidated basis, Q2 revenue grew by 17.7% compared to last year’s second quarter. The Business Solutions segment grew 22.9%, while the Enterprise segment grew 13.6% and the Public sector grew 16.5%. In addition, we continue to see our customers’ business environments evolve as they adapt to supporting both remote and in-office work. Customers are focusing on the need to improve security, increased productivity, manage costs and modernize their businesses.

Our vertical market teams delivered strong double-digit revenue growth in our finance, manufacturing and retail markets with growth rates of 40%, 16% and 10%, respectively. Our health care vertical, which is our largest vertical, grew revenue 5% year-over-year, following a growth rate of 30% in Q2 of 2021.

During the quarter, we saw pockets of improvement in the supply chain, which resulted in a slight decrease in our backlog sequentially, although still significantly higher than a year ago. The overall supply chain remained challenged, and we expect it to continue through at least the balance of the year. Our team has continued to leverage our partner relationships, scale technology integration and distribution center and logistical capabilities as well as our strong balance sheet to navigate the ongoing supply constraints on behalf of our customers.

Now, let’s discuss our Q2 performance in a little greater detail. As I stated earlier, second quarter revenue was up 17.7% to $828.5 million from 2021, while gross profit was up 17.7% to $136.9 million, both all-time records. Gross margins were 16.5%, up 4 basis points from Q2 2021. Operating income in Q2 was $34.8 million, an increase of 46.3% or 4.2% of net sales compared to $23.8 million or 3.4% of net sales in the prior year quarter. In Q2 2022, our diluted earnings per share, was $0.96, an increase of 46.5% from $0.66 in Q2 2021. We ended Q2 with $94.9 million of cash and cash equivalents.

We will now look a little deeper into segment performance. In our Business Solutions segment, our Q2 net sales hit an all-time record of $328.4 million, an increase of 22.9% compared to $267.3 million a year ago. Gross profit in the Business Solutions segment was $65.5 million, an increase of 27.7% from a year ago. Gross margin increased 75 basis points to 19.9% in the quarter compared to the prior year, primarily due to changes in product mix. We saw an increase in demand for data center products with strong growth in the storage and server categories, cloud, security and software also experienced good growth. In addition, demand for workplace transformation products, remain strong. Our customers continue to invest in technology to gain a competitive advantage, and they turn to us to calm the confusion and guide them through their transformations.

In our Public Sector Solutions business, Q2 net sales were $151.2 million, an increase of 16.5% compared to $129.7 million a year ago. Sales to state, local government and educational institutions were $131.2 million, an increase of 24.8% compared to the prior year, partially offset by a decrease in sales to the federal government year-over-year. The emergency connectivity fund continues to be a driver of demand in the K-12 market and that will extend through December of 2023. Furthermore, the infrastructure stimulus bill allocates funds for technology purchases that should continue to create opportunities for our SLED business.

Gross profit for the Public Sector was $20.8 million, an increase of 15.5% compared to Q2 of ‘21. Gross margin decreased by 12 basis points to 13.8%, primarily due to changes in both product and customer mix. In our Enterprise Solutions segment, Q2 net sales were $348.9 million, an increase of 13.6% compared to $307.2 million a year ago. Gross profit for the Enterprise segment was $50.6 million, an increase of 7.6% compared to the prior year quarter. Gross margin for the quarter decreased to 14.5%. While the gross margin this quarter is in line with historical rates, they are 80 basis points lower than the prior year. As you may recall, in Q2 ‘21, the Enterprise segment benefited from multiple data center rollouts that did not repeat in the current quarter.

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?

Tom Baker

Thanks, Tim. SG&A decreased 82 basis points to 12.3% of net sales in this quarter due to improved efficiencies on higher revenue. On a dollar basis, SG&A increased $9.6 million compared to the prior year quarter. The increase in SG&A was primarily due to an increase in personnel cost associated with an investment in incremental headcount, focused on building stronger marketing and technical organizations and an increase in variable compensation due to higher levels of gross profit.

Q2 operating income was $34.8 million, up 46.3% this quarter from $23.8 million a year ago. Our effective tax rate was 27%, down from 27.3% in the same period a year ago. Net income for the quarter was $25.4 million, an increase of 46.9% from $17.3 million a year ago. Diluted earnings per share, was $0.96, an increase of 46.5% from the prior year period. Our trailing 12-month adjusted earnings before income taxes, depreciation and amortization, or adjusted EBITDA, was $140.5 million compared to $96.7 million a year ago, an increase of 45%.

Cash flow used in operations for the first 6 months of 2022 was $8.4 million versus cash flow generated from operations of $31.8 million for the same period a year ago. The decrease in cash flow from operations reflects higher levels of business activity and consequently, both accounts receivable and inventory increased in the first 6 months of the year.

In the quarter, we generated $29.9 million in operating cash flow as our DSO improved by 3 days and our inventory balance decreased by $11.4 million. Our net cash used in investing activities of $4.6 million in the first 6 months of 2022 was primarily the result of equipment purchases and IT initiatives. We also have $12.7 million for stock repurchases under our existing stock purchase program.

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

Tim McGrath

Thanks, Tom. I want to take a few minutes to review some of the highlights in our business. Our growth in Q2, again, is largely attributable to the customized IT solutions that we deliver on behalf of our customers as they continue to work through their digital transformation and efforts to gain competitive advantage with technology.

Our customers look the Connection to deliver these innovative solutions. Towards that end, we continued to leverage our managed services capability, and we’re excited about the performance and the volume of activity that we experienced during the second quarter at our technology integration and distribution center. Our customers trust us with their mission-critical solution deployments and in fact, we achieved a record volume of custom configurations in the quarter.

Our years of experience with supply chain optimization and our ability to deliver custom solutions continue to be important components of our growth and a competitive differentiator for us. Our growth was also attributed to our expertise in delivering custom solutions to our vertical markets. For example, in the retail vertical, we grew revenue 10% year-over-year as a result of retailers investing in employee productivity, the customer experience and inventory management systems.

Revenue for the manufacturing vertical grew 16% year-over-year as manufacturers focused on productivity, cost reduction and improved quality through the use of innovative technologies as a means to meet business objectives and gain long-term competitive advantages. These changes are driving investments in networking, security, hybrid data center, and end-user devices.

Looking forward to the remainder of 2022, customers want to manage costs while leveraging technology for greater efficiency and as an enabler for competitive advantage. We expect our customers to continue to focus on data center, security and cloud transformation. As discussed, we believe the supply chain constraints will continue to plague the industry. Although the worst is behind us, headwinds will continue into 2023.

We expect our quarter-on-quarter growth rates to be lower in the second half than the first half. These expectations are a result of a tougher comparison from the prior year and our customers serving global markets becoming more deliberate in their technology investments. We believe we can still deliver organic growth rates that are 200 to 300 basis points above the IT industry and continue to take market share. We remain focused on helping our customers achieve their productivity and efficiency goals while keeping them secure and connected in this evolving hybrid work environment.

I’d like to take a moment to thank our valued employees for their continued effort and extraordinary dedication during this rapidly changing environment. We will now entertain your questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Anthony Lebiedzinski.

Anthony Lebiedzinski

Good afternoon. Thank you for taking the question. Yes – so I guess first, Tim, you talked about the customers now being more deliberate and certainly recognizing that you do face tougher comparisons now in the back half of the year. So are you seeing that kind of across the board in each of your three main segments or is one of the – are there any other segments that are – you’re seeing a bit more modest growth? Just how should we think about that?

Tim McGrath

Well, thanks, Anthony. So clearly, in the second half, when you look at the macroeconomic backdrop, the customers that we think are going to be most effective are those customers that are large and perhaps have a global presence. Some of our large customers are slowing down for the second half. But again, we’re pretty confident overall, we’ve got an extraordinary backlog heading into the back half of the year. And overall, we’re bullish on the business. I would say SMB has been resilient and remains very strong. We’re going into the busy season for public sector. As you know, September is a busy month for federal. And so I’d say Enterprise is probably the most under pressure. But that, I think, is consistent with what you’re seeing out there in the competitive landscape, I think we’re in a great company. You saw our competition announced over the last couple of days, and they too had extraordinary results.

Anthony Lebiedzinski

That’s correct. So as far as your backlog, I mean, so you mentioned that it was down sequentially, but still up over a year. Can you give us a little bit more color as far as the components of the backlog? Has that changed much? And if you can just talk about that, that would be great.

Tom Baker

Yes. So I think, Anthony, the part that eased up a little bit was certainly in the device area. When we look at server/storage, networking type things, that continues to be pretty challenged. So – and I’d say the drop wasn’t – the drop in our backlog wasn’t gigantic, but it was, I’d say, moderate.

Anthony Lebiedzinski

Okay. Got it. Okay. Thanks for that color. And then a couple more questions here. So inventory was down sequentially. How should we think about where you think you’ll end up the year with inventory?

Tom Baker

So as you know, Anthony, last quarter, I think it was an all-time high. So we work really hard to bring it down. We do – as things start to ease up a little bit in the supply chain, we can ship more and more of what we have in inventory. So I think as we go through the year, I think it will kind of gently moderate back towards kind of our normal levels, return the, call it, 130 to 150 range. That don’t go all the way there by the end of the year, but certainly, that’s where we’re headed in that direction.

Anthony Lebiedzinski

Got it. Okay. So that would be sort of nice progress from here. And then lastly, so in light of everything that’s going on in the world as far as just macro concerns that are out there. Have you made any changes to your own hiring plans?

Tim McGrath

Actually, we’ve been full steam ahead there. We’ve seen a nice recovery in our ability to hire. There had been a little bit of a lull when things were under pressure a couple of quarters back. So we’re now getting back to a more normal cycle. We’re starting sales classes in a much more usual and ordinary way. And we have no plans to let up on that. And we are also investing in the technical – engineering and technical sales arenas.

Tom Baker

Yes. I would also add to that, Anthony. In the last half of last year, we did make some adjustments to our compensation programs and our benefit programs. And we have been able to reduce the turnover a fair amount.

Anthony Lebiedzinski

Got it. Okay, thank you very much and best of luck.

Tim McGrath

Thank you, Anthony.

Tom Baker

Thanks, Anthony.

Operator

Thank you, Anthony. Our next question comes from the line of Catherine Huntley of Raymond James. Catherine, your line is open.

Catherine Huntley

Hi, guys.

Tim McGrath

Hi, Catherine.

Catherine Huntley

Could you guys just talk a little bit about the managed service capabilities? Was that an incremental uptick quarter-over-quarter? And would you maybe attribute this to the stressed hiring environment that the customers are facing, so maybe they are turning to you guys and using your services instead?

Tim McGrath

Yes, Catherine. So that’s a great observation. We see the demand picking up in a few areas. As I mentioned, it was a record quarter for us for advanced configurations. And certainly, where employees are working remotely or in a hybrid fashion more than ever before, our customers are asking us to completely outfit them to manage that image that asset, and in some cases, that install and deinstall. And the managed service components will be wrapping a helpdesk and emergency services around that. So, all the support that goes around that hybrid worker has been a driver of demand. We are also seeing an uptick for companies who want us to outfit either their office or their location. And we are now able to do that in a very deliberate and precise way in our technology integration and distribution center. So in many cases, we can deliver an office or a location by – with one shipment, everything preloaded, preconfigured and ready to go. So that has really been the uptick in our volume.

Catherine Huntley

Okay. Awesome. Thank you so much for all that color. And could you maybe just give us a sense for how far customers are booking orders out? I know that it may have been elevated during COVID, but has that started to come back down or are you still seeing customers book orders really far out to get ahead of inventory? Thank you.

Tim McGrath

So we are – it does depend, I think, on the category. Some of our security and net com products, they are booking way out in advance because those have the longest lead times including some other very long lead times in some data center products. And that is probably manufacturer-specific but certainly very long lead times. The lead times around our device, our endpoint device business are getting much better, which we’re seeing a little easing of pressure there. So it’s mostly the infrastructure, data center and security products that still have the extended lead times.

Tom Baker

Yes. I would tell you on supplies, like you heard me talk a little bit about the inventory. And hopefully, as the supply chain issues start to work their way through and lessen in severity, we’re going to be able to convince our customers to not hold – let’s get back to holding a month worth of inventory or a few weeks of inventory rather than multiple months. So I think we will try to pull all this stuff together and slowly work down the working capital we have invested in the company.

Catherine Huntley

Awesome. Best of luck and great quarter.

Tom Baker

Thank you.

Tim McGrath

Thanks, Catherine.

Operator

Thank you, Catherine. I would now like to turn it back to the company for closing remarks.

Tim McGrath

Well, thank you, Kyle. I want to thank all our customers, vendors, partners, our shareholders for their continued support and, once again, our dedicated coworkers for their efforts and extraordinary dedication through this time. Thanks. Have a great evening.

Operator

Thank you, gentlemen. Thank you for participation in today’s conference. This does conclude the program, and you may now disconnect. Thank you.

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