PC CONNECTION INC Q3 FY2024 earnings call

Management Statement and Operational Highlights

• Connection achieved record net income with earnings per share of $1.02 for Q3 2024. Gross profit showed moderate growth in business segments while making strategic investments for the evolving technology landscape.
• In Q3, notebook, mobility, and desktop revenue grew 17% driven by PC refresh initiatives, with approximately 25% of those PCs being AI enabled. However, advanced technology demand was negatively affected by customer IT roadmap challenges due to AI uncertainty.
• Software category (cloud and cybersecurity) had strong growth of 11%, but networking solutions declined 32% due to tough year-over-year comparisons.
• Customized go-to-market approach for verticals led to consistent growth in key market sectors like Healthcare (20% growth), Retail (23% growth), Manufacturing (1% growth), Financial Services (5% growth).
• AI remains a focus with the Connection Helix initiative, including the Center for Applied AI and Robotics, supporting customers' AI strategies.

Segment Performance

• Business Solutions segment: Q3 net sales were $252.6 million, 6.1% lower than the previous year. Gross profit was $63.1 million, an increase of 0.7%. Gross margin reached a record 25%, up 170 basis points compared to the prior year quarter. This was favorably affected by customer mix, increase in cybersecurity, and software sales.
• Public Sector Solutions business: Q3 net sales were $175.1 million, 18.7% higher than the previous year. Sales to the Federal Government increased by $25.6 million, and sales to state and local government and education institutions increased by $2 million. Gross profit was $26.1 million, an increase of 4.4% compared to Q3 2023. Gross margin decreased by 200 basis points to 14.9% due to a few large project rollouts at lower margins.
• Enterprise Solutions segment: Q3 net sales were $297 million, 7.4% higher than the previous year. Gross profit was $46.2 million, 4.4% higher than the prior year quarter. Gross margin decreased by 40 basis points to 15.6% due to lower software license fees and product mix.

Guidance

• Expect device demand to improve in 2025 overall.
• IT demand may continue to be impacted by deal scrutiny and cautious investments in infrastructure due to the macroeconomic backdrop.
• For the remainder of 2024, demand is expected to remain somewhat muted.
• Confident in outperforming the IT market growth by 200 basis points.

Risks

• Customers continue to navigate IT roadmaps in the face of AI uncertainty, Windows 10 expiration, and infrastructure changes.
• Uncertainty around the November 5th election has caused customers to remain guarded.
• Device Refresh and product mix changes put downward pressure on gross margins.

Q: Good afternoon. Tim, I noticed that gross margin was down 30 basis points and understand that PC mix may be driving some of that, but wanted to ask on the competitive environment as well. One of your main competitors this morning cited an increasingly competitive environment. So, just wondering what you’re seeing from that standpoint in the quarter and how you’re expecting that to evolve going forward?

A: Well, thanks, Adam. I would say really our gross margin pressure was the result of large project rollouts for big contract wins that we had in particular with the Federal Government and in Enterprise. Those were the main drivers. However, no doubt about it, in this economic backdrop, customers are cautious. There are really -- they’ve been very concerned about what that IT budget is going to look like next year, how they adopt AI and where that fits into the budget and that has made the market more competitive as customers evaluate their options.

Q: Okay. And Tom, Tim had mentioned that the Device Refresh is going to continue to mix down and put pressure on the gross margin line, which makes sense. Just wondering how you’re thinking about the impact to operating margin and ability to grow earnings. Any initiatives that you’re considering to sort of offset that gross margin pressure and how we should think about operating margin and ability to grow earnings?

A: Yeah. So I think what you’re seeing, Adam, is a few things. One, if we get a pickup in the device, the endpoint device market, which I think pretty much everyone agrees is going to happen in 2025, we’ll see some margin rate compression, but we should see overall gross profit growth. So we’ll grow the dollars. Frankly, kind of the struggle we had this quarter, I wouldn’t say, it’s necessarily a struggle, but our operating, our SG&A was up. And we’ve been investing, we’ve had the opportunity to hire some people and we’ve been taking advantage of it. We’re trying to improve our technical sales capabilities and those things just take a little bit of time to manifest themselves and to improve profit. But we’re really trying to get set up for next year. But I think that’s kind of where we’re at.

Q: Good morning. Actually, good afternoon, sorry. And thanks for taking the questions. So I guess just to follow up on the previous comment about the strategic investments in terms of AI readiness, technical sales and customer engagement. I guess when would it be reasonable for you guys to start to see the benefits of that spending? Would it be Q1 or later? I mean, just any sort of ballpark estimate would be helpful just for us to gauge as far as when we could expect tangible benefits from that?

A: Well, thanks, Anthony. So I think there are a couple of different components that really make up that and so I do think that in 2025, you’ll see continued uptick in the AI device side of the ecosystem. Again, a lot of that just driven by the aging install base and Windows 10 and the need to refresh. But we do think that AI at the edge, at the PC level, is going to be a continued driver. However, the AI applications and the proof-of-concepts and a lot of the on-prem AI implementations, we think are pushed more to the back half of the year. There are longer term engagements. They require a lot of study, a lot of proof-of-concept and customers are still cautious as they really look at what the ROIs will be. So the irony is probably the greatest promise for technology in our industry that we’ve seen since the advent of the internet, yet the timing of that, I think, does remain a little delayed.

Q: So looking at the quarter, obviously, even with the tough macro environment, your sales were up in two out of the three segments. In terms of just the Business Solutions, which was down, how should we think about the recovery for that segment? You think it will be delayed till next year? Like, just -- what are your thoughts just on Business Solutions?

A: Yeah. Again, a good question, Anthony. So we’re seeing our Enterprise customers really start to plan for the future. So we’re seeing an uptick in RFPs, in requests for quotations. So the Enterprise business is really starting to move. We’re also seeing some continued growth in the Federal space. But in our SMB space, our customers have been more cautious. And we talked about endpoint upgrades and the reality is a lot of Windows upgrades are being done on current devices rather than new devices and we didn’t expect that, not to the level that we’re seeing that. And that SMB customer, I think, is more dependent on the macroeconomic backdrop, very concerned about the outcome of the election and just cautious overall. So we don’t see that SMB customer coming back with the speed or the velocity that we think that Enterprise customer will be coming on.