PC Connection, Inc. (NASDAQ:CNXN) Q1 2022 Earnings Conference Call May 5, 2022 4:30 PM ET
Company Participants
Samantha Tracy – Investor Relations
Tim McGrath – President & Chief Executive Officer
Tom Baker – Senior Vice President & Chief Financial Officer
Conference Call Participants
Anthony Lebiedzinski – Sidoti
Catherine Huntley – Raymond James
Operator
Good afternoon, and welcome to the First Quarter 2022 Connection Earnings Conference Call. My name is Rachel and I’ll be the coordinator for today. At this time, all participants are in 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 a 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.
You may begin the conference.
Samantha Tracy
Thanks, Operator, and good afternoon, everyone. I’ll 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 the 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 then it’s required by law even if estimates change, and therefore, you should not rely on these forward-looking statements as representing management 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 first quarter 2022 comparisons are being made against the first 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 Q1 2022 conference call. I’ll begin this afternoon with an overview of our first quarter results, highlights of our performance and then share our updated thoughts on 2022. Tom, will walk us through a more detailed look at our financials.
We are pleased to announce a record first quarter for revenue, gross profit and net income. These results demonstrate the continued execution of our business strategy to connect our customers with technology that enhances growth, elevate productivity and empower innovation.
A number of factors contributed to our record performance, including our focus on helping our customers navigate and optimize their supply chain needs. Our commitment to helping our customers transition back to office in a hybrid capacity and our continued focus on cloud and data center transformation helped to drive this record Q1 performance.
On a consolidated basis, Q1 revenue grew by 23.8% compared to last year’s first quarter. The Business Solutions segment grew 30.1%, the enterprise segment grew 26.4% and the public sector grew 5.8%. We also delivered strong double-digit growth across all of our vertical markets. Our health care vertical, which is our largest vertical grew 25% year-over-year, while our manufacturing, retail and finance verticals grew 20%, 26% and 48%, respectively.
The supply chain issues that we referenced in the past quarters have persisted throughout Q1. Consequently our backlog has increased for the fifth consecutive quarter. Our team has continued to leverage our capabilities to navigate the ongoing supply constraints on behalf of our customers. Our long-standing loyal customers know that we have the expertise, scale and capacity to secure and store product and build out customized solutions on their behalf.
The supply chain issues combined with some large project rollouts currently in progress have resulted in an increased inventory level in the first quarter compared to the fourth quarter of 2021. We expect these supply chain issues to persist for at least the remainder of the year.
Now let’s discuss our Q1 performance in a little greater detail. As I stated earlier, first quarter revenue was up 23.8% to $788.3 million from 2021, while gross profit was up 27.6% to $128.3 million. Gross margins were 16.3% up 49 basis points from Q1 2021 as margins increased in all three segments, despite a stronger mix of endpoint devices. Operating income in Q1 was $30.1 million, an increase of 113.4% or 3.8% of net sales compared to $14.1 million or 2.2% of net sales in the prior year quarter. In Q1 2022, our diluted earnings per share was $0.83, an increase of 113.6% from $0.39 in Q1 2021. We ended Q1, with $67.4 million of cash and cash equivalents.
We will now take a little deeper look into segment performance. In our Business Solutions segment, our Q1 net sales hit an all-time record of $320.4 million, an increase of 30.1% compared to $246.3 million, a year ago. Gross profit in the Business Solutions segment was $62.1 million, an increase of 31.2% from a year ago. Gross margin increased 16 basis points to 19.4% in the quarter compared to the prior year, primarily due to changes in product mix. We saw continued demand from work-for-anywhere solutions, driving endpoint growth, along with strong performance in servers, cloud solutions, networking and services.
In our Public Sector Solutions, business Q1 net sales were $132.5 million, an increase of 5.8% compared to $125.3 million, a year ago. Sales to state and local government and educational institutions were $101.8 million, an increase of 14.4% compared to the prior year. Sales to the federal government decreased $5.6 million year-over-year to $30.7 million. Gross profit for the public sector segment was $17.3 million, an increase of 10.5% compared to Q1 2021. Gross margin increased by 56 basis points to 13.1% primarily due to changes in both product and customer mix.
In our Enterprise Solutions segment, Q1 net sales were $335.4 million, an increase of 26.4% compared to $265.3 million, a year ago. Gross profit for the Enterprise segment was $48.9 million, an increase of 30.3% in the quarter. Gross margin for the quarter increased by 44 basis points to 14.6%. The increase in gross margin percentage was primarily due to changes in product mix as customers transitioned back into the office. In addition, we also had good growth in storage, networking and security.
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 111 basis points to 12.5% of net sales in this quarter due to improved efficiencies and higher revenue. On a dollar basis, SG&A increased $11.8 million compared to the prior year quarter. This increase was primarily due to an increase in variable compensation, due to higher levels of gross profit and an increase in marketing costs. Q1 operating income was $30.1 million, up 113.4% this quarter from $14.1 million a year ago.
Our effective tax rate was 27.7% down from 27.8% in the same period a year ago. Net income for the quarter was $21.8 million, an increase of 114% from $10.2 million a year ago. Diluted earnings per share was $0.83, an increase of 113.6% from the prior year period. Our trailing 12-month adjusted earnings before income taxes, depreciation and amortization or adjusted EBITDA was $129.1 million compared to $84.4 million a year ago, an increase of 53%.
Cash flow used in operations for the first quarter was $38.3 million versus cash flow from operations of $6 million for the same period last year. The decrease in cash flow from operations reflects higher levels of business activity and consequently both accounts receivable and inventory increased in the quarter. Our DSO improved by five days in the quarter, while inventory turns declined as a result of, the supply chain issues and large project rollouts mentioned earlier. Our net cash used in investing activities of $2.5 million, in the first quarter was primarily the result of equipment purchases and IT initiatives. In addition, we also have $12.7 million for stock repurchases under our existing stock repurchase 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 customers look to Connection to deliver innovative IT solutions. And with the changing landscape, hybrid return to office continues to be of high importance and a significant driver of our growth in Q1.
Our growth in market share in Q1 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 in this rapidly evolving market. We expect this trend will continue at least into the third 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 customized solutions to our vertical markets. For example, in the retail vertical, we grew 26% year-over-year as a result of retailers’ new customer acquisition strategies, which include upgrading in-store infrastructure and improving the overall customer experience.
The health care vertical saw revenue growth of 25% year-over-year as health care IT decision-makers have reengaged in major IT investments, including employee health record migrations to the cloud and the revitalization of on-premise investments, as the balance of IT activity shifts more towards infrastructure and data center solutions in the workplace.
Revenue for the manufacturing vertical grew 20% year-over-year, as manufacturers are revisiting, accelerating or investing for the first time in smart manufacturing solutions and technology modernization.
Looking forward to the remainder of 2022, we expect our customers to continue to focus on data center and cloud transformation, as well as other infrastructure projects that have been put off due to the pandemic. More than ever before, customers are asking us to help them manage their IT solutions. We’re pleased to say, we are delivering a record number of configurations and IT services through our technology integration and distribution center.
We believe that we can continue to deliver growth rates that are 200 to 300 basis points above the IT industry and take market share. Naturally, we are monitoring the recent developments in the supply chain that impact both production and delivery and we expect that supply chain constraints will continue for the remainder of the year.
We remain focused on helping our customers with their supply chain optimization, cloud and data center transformation, as well as hybrid return to work. I’d like to take a moment to thank our valued employees for their continued effort and extraordinary dedication in 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 the line of Anthony Lebiedzinski with Sidoti. Your line is open.
Anthony Lebiedzinski
Good afternoon. And thank you taking the questions. I hope you guys are doing well.
Tim McGrath
Yes. Thank you.
Anthony Lebiedzinski
So, hey — so, first, as far as the backlog, so you mentioned that it’s up for the fifth consecutive quarter. Can you give us a sense as to what are the main components of that backlog? How should we think about that?
Tim McGrath
Yes. So thanks, Anthony. It’s pretty widespread and it does vary based on supplier. Some of the data center networking and security hardware products have a fairly significant backlog and those dates continue to be problematic. Some of the more endpoint device/laptop products have done a little better recently, but our backlog is still comprised of a lot of the endpoint devices.
Anthony Lebiedzinski
Got you. Okay. All right. And then, in terms of just the quarter that you just reported, obviously, a very solid start to the year. But I just wanted to get a better sense as to — as far as the revenue and overall, ASPs versus volumes. I just wanted to get a better sense of that whether — what were the, just kind of overall components of that increase?
Tim McGrath
Yes. I think, Anthony, it was largely volume driven. And in the hardware part of our business, our all-in margins did improve year-over-year a little bit. But it was — there’s a lot of volume going through the system right now.
And I think in terms of the margin rate, we also did get a little bit of tailwind from the software netting. But it was not as significant as just the sheer amount of product we put through the system.
Anthony Lebiedzinski
Okay, great. And then — and so, as we look to update our models for the balance of the year, how should we think about your ability to drive continued revenue growth? Obviously, there’s a lot of noise in the market and a lot of skittishness fears about maybe a potential recession. It doesn’t sound like you guys are seeing any of that. But how should we think about the kind of the balance of the year?
Tim McGrath
Well, that’s a great question. Obviously, we’ve been watching the competitive landscape closely, working closely with our suppliers. And we saw that IGC and others have talked about a potential decline in endpoint or in the device market, so we’re watching that closely. But if you look at the composition of our customers and overall composition of our gross profit models, so much of it is depend on customized solutions — or dependent on, excuse me, customized solutions and so many of those customized solutions do have an endpoint component. And we do share the view like many of our suppliers that PCs are still essential. We think the demand will continue. And certainly everyone’s forecasting that demand will pull back in the second half of the year, but we’re pretty optimistic. Because of the level of customization we do and because we build those devices into an overall solution, we’re still really confident certainly through Q2 and beyond that we’re going to have good demand. Tom?
Tom Baker
Yes. And frankly, when we talk to our partners, I think most of them are pretty bullish as well. I think generally people think that data center will pick up a little bit more in the second half. But sitting here today, things seem to be plugging along and it looks like it’s going to continue.
Anthony Lebiedzinski
Okay. That’s great to hear. All right. Well, thank you and best of luck.
Tom Baker
Thanks, Anthony
Tim McGrath
Thanks, Anthony
Operator
Our next question comes from the line of Catherine Huntley with Raymond James. Your line is open.
Catherine Huntley
Hey, this is Catherine on for Adam. Thank you so much for taking our questions and congratulations on the results.
Tim McGrath
Thank you, Catherine.
Catherine Huntley
So just looking at the IT market versus you guys this year, how are you thinking about your growth of you versus the IT market? In the past, you’ve shared with us that it could be on a blended basis, 6% to 7%. Is this the framework we should stick to moving forward into this year?
Tim McGrath
Actually again, a great question. When we look at the balance of the year, we believe in many instances, we are taking market share and we believe that we can grow 200 to 300 basis points above that overall IT market rate of growth. And certainly for Q2, that number is elevated above the 6% to 7% mark and I think we’re closer to…
Tom Baker
Maybe north of that.
Tim McGrath
Yes, we’ll be well north of that in Q2. And again, we’re fairly optimistic about the balance of the year. And as Tom mentioned, we do know that mix will change. More data center, more cloud, more infrastructure in the back half of the year.
Catherine Huntley
Perfect. That’s great color. And can you give us a sense for how far customers are booking orders ahead specifically in data centers since that’s still constrained? I can imagine for endpoint devices, it’s probably alleviated. But are customers still booking orders out really far ahead in data center and networking?
Tim McGrath
Yes, they are. So the data infrastructure and data center networking projects are often planned well in advance. And we recently, in fact this week, placed some orders for data center equipment and the lead time was in months. So it really — many of those suppliers still are struggling getting us product and we’ve encouraged our customers and our sales force to make sure they’re as proactive as possible to be in front of that. But no doubt about it, many of those lead times are still extended.
Catherine Huntley
Awesome. Thank you so much and keep up the great work.
Tim McGrath
Thank you.
Operator
Thank you. And this concludes our question-and-answer session. I would now like to turn the conference back to Tim.
Tim McGrath
Well, thanks Rachel. I’d like to thank all of our customers, vendor partners and 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 all of you for listening to the call this afternoon. Your time and interest in Connection are appreciated. Have a great evening.
Operator
This concludes today’s conference call. Thank you for participating. You may now disconnect.
