PC Connection, Inc. (CNXN) Q2 2021 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Second Quarter 2021 Connection Earnings Conference Call. My name is Abigail, 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, Chief Financial Officer. I will now turn the call over to the company.

Good afternoon, everyone. I will now read our safe harbor statement. 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, 2020, 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 even if estimates change. And therefore, you should not rely on these forward-looking statements as representing views as of any date subsequent to today. During this call, GAAP and non-GAAP financial measures will be discussed. A reconciliation between the 2 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 2021 comparisons are being made against the second quarter of 2020. 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?

Thank you, Samantha. Good afternoon, everyone, and thank you for joining us today for Connection's Q2 2021 Conference Call. We are pleased to report double-digit growth across all 3 of our business segments, and we expect to benefit from positive momentum throughout the rest of this year. Overall, revenue in Q2 grew 28% compared to last year's second quarter. The Business Solutions segment grew 39.9%, the Enterprise segment grew 24.5%, and Public Sector grew 15.7%. It's rewarding to see that our strategic investments in helping our customers transform their businesses are delivering value for them and us. Our strong results are also a tribute to our team and the extraordinary execution they deliver on behalf of our loyal customers during this challenging supply environment. Our focus on aligning our sales strategy, combined with expertise in vertical markets, continues to drive positive results for the company. In fact, our manufacturing vertical grew 59% year-over-year as a result of delivering solutions including industrial infrastructure, security, cloud and workplace productivity. In addition, our health care vertical grew 30% year-over-year and 19% sequentially. Demand was driven by our customers' need to improve operational efficiencies, the patient experience and long-term care. We are also seeing continued growth in telehealth and non-contact patient monitoring. Our retail vertical also saw 25% growth year-over-year and 10% sequentially as customers are focusing on solutions that enable smart stores, digital media and point-of-sale technologies, which are all helping to transform and improve the retail experience. As you know, our industry is experiencing supply chain issues. As a result, our backlog once again increased to a record level. We anticipate some of these challenges will persist for the balance of the year and into 2022. We're working with our partners and customers on a daily basis to manage these issues. Fortunately, we're able to leverage our scale and our expertise to help our customers navigate through these supply chain challenges. We are collaborating with a number of our customers to secure and store product in an effort to support rollouts planned for later this year, which is driving higher inventory levels than usual. Our customers know they can rely on us, and we are seeing strong demand for digital transformation, hybrid cloud, cloud and security. Now let's discuss our Q2 performance in a little greater detail. Second quarter revenue was up 28% to $704.2 million from 2020, while gross profit was up 30.7% to $116.3 million. Gross margins were 16.5%, up 34 basis points from Q2 2020. Operating income in Q2 was $23.8 million, an increase of 124.5% or 3.4% of net sales compared to $10.6 million or 1.9% of net sales in the prior year quarter. In Q2 2021, diluted earnings per share was $0.66, an increase of 125.6% from $0.29 in Q2 2020. We ended Q2 with $115.7 million of cash and cash equivalents. Now we'll look a little deeper at the segment performance. In our Business Solutions segment, our Q2 net sales were $267.3 million, an increase of 39.9% compared to $191.1 million a year ago. Gross profit in the Business Solutions segment was $51.3 million, an increase of 37.9% from a year ago. Gross margin decreased by 28 basis points to 19.2% in the quarter compared to 19.5% in the prior year as a result of changes in product mix. Throughout the past year, the Business Solutions segment has been the most affected by the pandemic. And since Q2 last year, we've seen strong recovery despite supply issues. Sequentially, the business experienced 8.5% growth in the period. In our Public Sector Solutions business, Q2 net sales were $129.7 million, an increase of 15.7% compared to $112.2 million a year ago. Sales to state and local government and educational institutions were $105.1 million, an increase of 22.4% compared to the prior year. K-12 and higher ed customers were largely responsible for the increase in the SLED business. Sales to federal government were $24.6 million, a decrease of 6.3% compared to the prior year. Gross profit for the Public Sector segment was $18 million, an increase of 24.6% compared to Q2 2020. Gross margin increased by 99 basis points to 13.9%, primarily due to a change in customer mix and an increase in cloud-based and security software. In our Enterprise Solutions segment, Q2 net sales were $307.2 million, a 24.5% increase compared to $246.8 million a year ago. Gross profit for the Enterprise segment was $47 million, an increase of 25.9% in the quarter. Gross margin for the quarter increased by 17 basis points to 15.3%. We've continued to see strong demand in the Enterprise segment, especially in a manufacturing and health care vertical, both of which exceeded 30% growth. It's also nice to see data center refresh projects coming back into the enterprise space. I will now turn the call over to Tom to discuss additional financial highlights from our income statement, balance sheet and cash flow statement. Tom?

Thanks, Tim. SG&A was $92.6 million this quarter, an increase of 19.6% from $77.4 million a year ago. As a percentage of net sales, this represented a decrease of 93 basis points year-over-year. The year-over-year Q2 increase in SG&A was primarily driven by an increase in variable compensation and increases in health care costs. Q2 operating income was $23.8 million, up 124.5% this quarter from $10.6 million a year ago. Our Q2 effective tax rate was 27.3%, down from 27.9% in the same period a year ago. Net income for the quarter was $17.3 million, an increase of 126.3% from $7.6 million a year ago. Diluted earnings per share was $0.66, an increase of 125.6% from the prior year period. Our trailing 12-month adjusted earnings before income taxes, depreciation and amortization, or adjusted EBITDA, was $96.7 million compared to $110 million a year ago. We have $12.7 million remaining for stock repurchases under our existing stock repurchase program. Cash flow from operations for the first 6 months of 2021 was $31.8 million versus $102.4 million in the same period a year ago. In the year-ago quarter, we generated significant cash as business activity dropped off and partners extended terms. Cash flow for the first 6 months was driven by a decrease in accounts receivable as DSO improved by 5 days since December. An increase in inventory of $26.2 million negatively affected cash flow as customers are ordering in advance of need and requesting that we stage the inventory for future rollouts. In addition, a decrease in payables at $9.1 million also negatively impacted cash flow for the first half of 2021. Our net cash used in investing activities of $3.1 million in the first 6 months of 2021 was primarily the result of equipment purchases and IT initiatives, offset by proceeds from life insurance. The company used $8.7 million of cash for financing activities during the first 6 months, consisting primarily of the Q1 payment of our 2020 special dividend. I will now turn the call back over to Tim to discuss current market trends.

Thanks, Tom. I want to take a few moments to review some of the highlights in our business. In Q2, Connection experienced significant demand in products and solutions that enable our customers to be productive from anywhere, not just from their offices. We expect to see these trends continue to drive growth as the world experiences a new level of demand in work-from-anywhere and learn-from-anywhere solutions. In addition, cloud, and in particular, hyperscale cloud, is a central tenet of our multiyear growth strategy. Towards that end, we're making additional investments in all of our cloud initiatives. Our customers are continuing to make security a top priority. In addition to securing their environment, they also need help to manage more devices remotely. These trends are driving double-digit growth in security and in managed services. As we look forward, environmental, social and governance initiatives are providing another growth opportunity for us. And in fact, we're supporting all of our suppliers' initiatives towards that end and expect that this activity will increase. In addition, we are continuing to invest in Connection Cares, our company's social responsibility program. Building on Connection's inclusive culture, this initiative formalizes the company's community engagement, sustainability and diversity and inclusion efforts into one cohesive program. Looking at the balance of 2021 and assuming that supply chain constraints don't further deteriorate, we believe we can deliver growth rates that are 400 to 500 basis points above the IT industry. We're focused on helping our customers enable their post-COVID hybrid workforce, accelerate their digital transformation and empower their innovation. We'll now entertain your questions. Operator?

[Operator Instructions]. Our first question comes from the line of Anthony Lebiedzinski with Sidoti & Company.

So first, regards to the backlog, how much of that is related to PCs? If you could just kind of give us some more details about the record backlogs that you're seeing?

Well, thanks, Anthony. So certainly, a significant part of that is in the mobility and PC arena. Mobility, well ahead of desktops. In addition, we're seeing some backlog in our net/com and security products on the hardware side of that business. But those are the primary areas, along with accessories, monitors and devices that support the kind of work-from-anywhere, learn-from-anywhere initiatives.

Got it. Okay. That makes sense. So just wondering now with some of the latest news in regards to the Delta variants affecting timing, I think, of some companies. Some major companies have announced delays as far as when they think they'll get their employees back into the offices. How should we think about the impact in your business if more companies go with that strategy?

So it's a great question. We obviously spend a lot of time trying to forecast and predict that. But toward that end, interestingly enough, if companies do send more people back out, there still are a number of reasons to upgrade. Technology itself is a significant driver as the PC is much more essential in this environment. There are collaboration issues and opportunities. And overall, while a lot of that surge has already happened, we're optimistic that, that will continue at least through the balance of this year. In addition to that, we are seeing the infrastructure projects come back into the data center. And so we don't expect that, that will be interrupted either. However, obviously, safety is a primary concern for all of our people. We're working very carefully to ensure that everyone remains safe and to help our customers toward that end. So that's really the best information that we have right now.

All right. That's great to hear. And then last question for me. As far as margins, obviously, very nice improvement from a year ago here in the second quarter. How should we think about the gross and operating margins for the back half of the year? Any sort of high-level thoughts that you may have would be very helpful.

So obviously, Anthony, Q2 is typically a pretty good software quarter, which is -- generally gives us a tailwind on the margin standpoint. And I think as we look forward to the balance of the year, I think we'll probably stay right about where we are. They maybe -- I don't know, a little bit up or down. But I think largely, the table's set for that. In terms of the operating margins, G&A was obviously up a fair amount year-on-year. Last year in the quarter, we didn't really have any bonuses, and the variable comp was close to 0, excluding commissions. Obviously, this year has improved. So a lot of that is coming back. And then we did see some health care costs come through that are a fair amount higher than we're typically experiencing. If we look into next quarter, I think dollar for dollar, we could see a little bit of a decrement next quarter, even if business is up a little bit. So that kind of hopefully gives you enough info to kind of model this out.

And there are no further questions. I will now turn the call over back to the company.

Thanks, Abigail. 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 throughout this time. 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.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.