PC Connection, Inc. (NASDAQ:CNXN) Q4 2023 Earnings Call Transcript

PC Connection, Inc. (NASDAQ:CNXN) Q4 2023 Earnings Call Transcript February 14, 2024

PC Connection, Inc. beats earnings expectations. Reported EPS is $0.9, expectations were $0.88. 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 Fourth Quarter 2023 Connection's 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 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: 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 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, 2022, 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 views 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 full-year and fourth quarter 2023 comparisons are being made against the year ended December 31, 2022 and the fourth quarter thereof. 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 Q4 2023 conference call. I'll begin this afternoon with an overview of our fourth quarter results and highlights of our performance. Tom will then walk us through a more detailed look at our Q4 financials. In 2023, we achieved several milestones in spite of the macroeconomic backdrop. We prioritized and then executed on a number of strategic initiatives to grow our solution categories within Advanced Technologies and to shore up our AI readiness. In fact, our advanced technology sales, which includes sales of software, servers, storage, netcom and services grew by 15% in 2023. Furthermore, the sales of Advanced Technologies drove an increase in gross margins of 111 basis points to a record 18%.

The improvement in sales of advanced technologies is a result of continued investment in technical resources. A journey that started over two years ago and will continue for the foreseeable future. In addition to our sales performance, we continue to improve operationally. And as a result, we generated over $197 million of cash flow from operating activities. Now looking specifically at Q4, sales of advanced technology products were up 21%, but that growth was more than offset by the decline of 15% in the sale of end-point devices which includes notebooks, desktops, displays and accessories. From a linearity perspective, Q4 was different from historical trends. Generally, December tends to be the strongest month of the quarter for us from a sales perspective.

This Q4 was just the opposite. October and November were stronger than last year, but December was significantly softer than last year as we experienced very little budget flush and customers pushed out their buying decisions. We continue to believe that gross profit is a better measurement of our performance, and we grew gross profit in the quarter. Now let's discuss our Q4 performance in a little more detail. Consolidated net sales were $696.5 million, 4.9% below last year. Solid execution and strong growth in operating margins helped to minimize the impact of a softer top line. Gross profit increased 4.4% to $129.8 million, and gross margins were up 166 basis points to 18.6% in Q4 compared to Q4 2022. Customer demand for software, which includes cloud and SaaS solutions helped to fuel the improvement in our gross margins.

Operating income in Q4 was $27.9 million, an increase of 16.9% compared to Q4 2022. Operating income as a percentage of sales was 4% compared to 3.3% of net sales in the prior year quarter. Net income in Q4 was $23.8 million, an increase of 26.3% compared to $18.8 million in the prior year quarter. In Q4 2023, our diluted earnings per share was $0.90, an increase of 26.3% from $0.71 in Q4 2022. Now we'll look a little deeper into our segment performance. In our Business Solutions segment, our Q4 net sales were $272.4 million, 2.9% lower than a year ago. The decline in revenue was largely a result of the reduction in demand for end-point devices. Gross profit for the Business Solutions segment was $63.2 million, an increase of 5.2% from a year ago.

Gross margin increased 180 basis points to 23.2% in the quarter compared to the prior year. This increase was in large part the result of our successful execution in growing the sales of integrated solutions and Advanced Technologies, contributed primarily by services and software that are recorded on a net basis. In our Public Sector Solutions business, Q4 net sales were $100.6 million, 14.2% lower than a year ago. We experienced a decrease in sales of end-point devices consistent with our industry, partially offset by an increase in sales of advanced technology solution categories primarily driven by software and servers. Sales to state and local government and educational institutions were lower by 5.2% compared to last year. Sales to the federal government were lower by 33.3% compared to the prior year quarter.

Gross profit for the Public Sector segment was $17 million which was consistent with the prior year. Gross margin increased by 246 basis points to 16.9% in the quarter compared to the prior year. The increase in gross margin percentage was due to a higher mix of software and services. In our Enterprise Solutions segment, Q4 net sales were $323.5 million, 3.3% lower than a year ago. The decline in revenue was primarily due to a decrease in end-point device sales compared to the prior year. Gross profit for the Enterprise segment was $49.6 million, 4.8% lower than the prior year quarter. Gross margin increased by 118 basis points to 15.3% due to growth of advanced technology solutions. I'll now turn the call over to Tom to discuss additional financial highlights.

Tom?

A tech entrepreneur in front of a busy data center, inspecting a server bank.

Thomas Baker: Thanks, Tim. SG&A increased $1.4 million compared to the prior year quarter. The increase in SG&A was due to an increase in investments in our solutions business and marketing expenses. On a percentage of sales basis, SG&A increased 91 basis points to 14.6% of net sales in the quarter compared to 13.7% in the prior year quarter, driven by lower revenues as a result of more revenue netting. Q4 operating income was $27.9 million, an increase of 16.9% this quarter from $23.9 million a year ago. Our Q4 effective tax rate was 25.8%, up from 23.7% due to changes in state income tax rates. We anticipate a tax rate in the low 27% range moving forward. Net income for the quarter was $23.8 million, an increase of 26.3% from $18.8 million last year.

Diluted earnings per share was $0.90, an increase of 26.3%. Our trailing 12 months earnings before income taxes, depreciation and amortization or adjusted EBITDA was $135.5 million compared to $139.3 million a year ago. In terms of returning cash to shareholders, we paid an $0.08 per share quarterly dividend in December. As of December 31, 2023, we had $32.3 million remaining for stock repurchases under our existing stock repurchase program. Today, we announced that our Board of Directors has increased our quarterly dividend by 25% to $0.10 per share. The dividend is payable to shareholders of record on February 27, 2024 and payable on March 15, 2024. Cash flow generated from operations for the year ended 2023 was a record $198 million, an improvement of $163.1 million from the same period a year ago.

Our accounts receivable balance decreased $1.6 million for the year ended 2023. Our DSO increased to 73 days from 70 days for the same period a year ago due to increased netted product sales, which reduced the revenue but not the receivable balance. Our inventory balance decreased $84.5 million for the year ended 2023. Improvements in the supply chain have enabled us to complete and deliver orders for which we were holding a portion of the inventory last year. Our accounts payable balance increased $31.1 million for the year ended 2023, largely due to the time of supplier payments. Our net cash used in investing activities were $160.2 million for the year-end 2023 was the result of $150.6 million of investment purchases and $9.6 million of IT equipment purchases.

The company used $15.7 million of cash refinancing activities through the year ended 2023, consisting primarily of payments of $8.4 million of dividends to shareholders and $5.4 million of stock repurchases. We ended Q4 with $297 million of cash, cash equivalents and short-term investments. I will now turn the call back over to Tim to discuss current market trends.

Timothy McGrath: Thanks, Tom. As we enter 2024, customers continue to be cautious about where they deploy capital. However, we do expect customer spending to increase throughout the year. There are a number of factors that we believe will affect the timing of our revenue growth in 2024. Many customers are taking a wait-and-see attitude with respect to the economic climate and while we see favorable spending trends with some early adopters, we're uncertain as to the timing of device refresh and large project rollouts for our customers. As we said last quarter, we remain very optimistic about the IT landscape. There are several factors that we expect will drive significant IT growth in a number of areas. For example, edge workloads and high-speed connectivity through 5G and 6G, but consistent and persistent challenges in cybersecurity.

Hyperconverged and composable infrastructure solutions that combine server storage and intelligent software into flexible building blocks that replaces legacy infrastructure to enable AI adoption, better flexibility, better security and reduce costs. And of course, AI in its wide encompassing impact on our entire IT ecosystem. Toward that end, our customers are continuing to evaluate artificial intelligence solutions as I look to improve productivity and increase operational efficiencies. We believe that the adoption of artificial intelligence solutions will be a catalyst that drives demand for additional infrastructure, storage, compute and security solutions. The demands of AI-enhanced collaboration tools, improved security and the adoption of new operating systems will require more powerful devices.

These factors are also expected to drive a device refresh cycle as AI adoption increases. Security threats are expected to drive customer demand for hardware, software and services necessary to properly secure IT environment for the foreseeable future. To address these trends, we are taking the following actions. For AI, we're seeing early adoption of AI end-point applications such as CoPilot. We're continuing to tailor our solutions to better assist our customers with their AI journey. As we stated previously, we're also experiencing an increase in demand for advanced technology solutions which are required to power customers' AI initiatives. In addition, we recently announced the Helix Center for Applied AI and Robotics. Helix brings together industry-leading experts, resources and support designed to help organizations of all sizes realize the benefits of artificial intelligence and automation.

The Helix Center for Applied AI and Robotics is designed to provide the guidance, tools and support customers need to unravel the complexity and the confusion around AI and properly identify, understand and access its true potential for their unique environments and business needs. For end-point device, we're working with our customers on readiness assessments to help them evaluate their current environment and identify upgrade opportunities to take advantage of new hardware and software that will facilitate, improve security, enhance collaboration and provide a platform to run AI applications. We have service offerings to assess, design, deploy, and secure systems and operating systems, which we believe will promote adoption for customers.

For security, we're continuing to develop our security catalog of offerings, including four key areas: modern firewall with analytics and security integration, automated network fabric provisioning, network virtualization and managed networks. To accomplish all of these, we've enhanced our presales engagement model with new tools, capabilities and expertise. We've also made significant investments to modernize our service product offerings and capabilities. All these activities are designed to improve our ability to deliver these complex solutions on behalf of our customers. Our customers know they can count on connection to help them standardize, simplify and optimize their end-to-end IT environments and deliver their business outcomes through technology.

We believe our focus and our 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, 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. We continue to believe that IT spend will improve with the refresh of end-point devices in 2024 and beyond. We expect that will happen after the release of the AI-enabled chipsets, which are scheduled to occur during the Q2 and Q3 time frame. The timing of our customer adoption of these new technologies is uncertain, but we are optimistic that by the second half of 2024 will return to more normalized growth rates.

We expect the growth rates for the U.S. IT market will continue to be challenging in the near term. However, we're encouraged by the number of new customers we're acquiring, and we believe we can still outperform the market and take market share, notwithstanding the challenges with the macroeconomic environment. On that note, I'd like to take a moment to thank our extremely dedicated and valued employees for their continued and extraordinary effort during this rapidly changing environment. We'll now entertain your questions. Operator?

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