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PCM, Inc. (NASDAQ:PCMI)

Q4 2012 Earnings Call

February 28, 2013 4:30 PM ET

Executives

Frank Khulusi – Chairman, President and CEO

Brandon LaVerne – CFO, Treasurer and Assistant Secretary

Joe Hayek – President, PCM Sarcom

Analysts

Brian Alexander – Raymond James

Chris Krueger – Northland Capital Markets

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2012 PCM Incorporated Earnings Conference Call. My name is Aisha, and I will be your 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.

(Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

On the call with us today are Frank Khulusi, Chairman and CEO; and Brandon LaVerne, CFO. Also joining us today is Joe Hayek, President of PCM South.

At this time, I would like to refer to the Safe Harbor statement and the Private Securities Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information or expectations about the company’s products or markets, or otherwise make statements about the future, which statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from statements made. These risks and uncertainties are detailed in the company’s filings with the Securities and Exchange Commission.

I would now like to turn the call over to Mr. Frank Khulusi. Please proceed sir.

Frank Khulusi

Thank you, Aisha. Good afternoon. Welcome, and thank you all for participating on this call with PCM. This is our first call at PCM and we’re excited to be here with you. Today, we will be discussing the company’s financial results for the fourth quarter of 2012. Before we dive into the details, let me begin by reiterating the exciting news of our corporate name change to PCM Inc. that became effective December 31, 2012. We also changed our ticker symbol to PCMI.

I’m excited to share the following fourth quarter highlights. First, our Q4 net sales increased $2.2 million or 1% to $382 million. Q4 gross profit increased $100,000 to $50.5 million. Q4 EBITDA increased a 118% to $8.6 million. Q4 operating profit increased 399% to $5.5 million. Diluted earnings per share was $0.22 a share, adjusted EPS was $0.24 a share excluding severance and restructuring related costs.

We repurchased 583,658 shares of our common stock in Q4 2012 at an average price of $5.95. For the year, we purchased 653,752 shares of our common stock at an average price of $5.96. Since we first started buying back shares in 2008, we’ve purchased a total of 2.6 million shares and will continue to seek ways of returning capital to shareholders in this way.

I am exceptionally proud of our team regarding both our Q4 performance and our effort related to our ongoing reorganization and rebranding initiative. In Q4, the demand environment was unfortunately far from ideal.

Uncertainty relative to the health of the US and global economy has created continuing delays in deferrals of purchases of new IT solutions. Despite that environment we were able to grow our sales by over 8% sequentially from Q3, while increasing our EBITDA and operating income relative to Q4, 2011 by 118% and 399% respectively. We accomplished this growth through a combination of tight cost controls and solid execution by our team.

During the quarter, we reached several internal milestones related to our reorganization and rebranding initiative including the December 31, 2012 rebranding, consolidating, and streamlining of our brands.

While no endeavor like this is without challenges, our team has worked closely with our customers and partners to ensure that the transition was as seamless as possible. During Q4, we also announced that we’re building a new SSAE 16 certified cloud data center for customer use, which will be located near Columbus, Ohio. This investment is a testament to our commitment to our managed services capabilities, which we believe are best-in-class.

As we discussed in a separate press release earlier today, PCM was recently rated as the number three managed service provider globally in Nine Lives Media’s MSPmentor 501 Global Edition, which evaluates managed service provider on a number of criteria.

We look forward to continuing to grow our services footprint as we continue to seek ways to add value to customers nationwide. I’m very excited about our reorganization and rebranding initiative and what it means to our customers, employees and shareholders. I’m also very excited about 2013 and beyond as we go-to-market under the PCM umbrella.

The combination of our new go-to-market strategy and there – our new consolidated brands, our best-in-class services and consultative selling capabilities that we’ve been spending years building, continued cost discipline and the prospect for a stabilizing demand environment make us confident that we’re very well positioned for 2013 and beyond.

I will now turn the call over to Brandon LaVerne, our CFO, who will take you through our results in a bit more detail. Brandon?

Brandon LaVerne

Thanks, Frank. Detailed information about our use of non-GAAP financial measures and a reconciliation of those non-GAAP financial measures are provided in our current report on Form 8-K filed with the SEC earlier today and available on our website.

All comparisons I make will be against Q4, 2011 unless otherwise noted. As we stated in the earnings release, we have revised our accounting for revenue recognition of certain software maintenance and subscription transactions that were previously recorded on a gross basis to record such transactions on a net basis – net sale basis with no corresponding cost of goods sold.

Accordingly, we have revised revenues and cost of sales on all reported prior periods to reflect this immaterial change, which had no impact on our consolidated gross profit, operating profit or earnings per share. All comparisons we make will therefore be using these revised revenue numbers for the current and prior periods.

Our consolidated net sales for Q4 2012 were $382 million, an increase of $2.2 million or 1% over Q4 2011, primarily due to an increase in our SMB segment net sales of $8.5 million, increases of $600,000 and $200,000 in our MacMall/OnSale and Public Sector segments, which were partially offset by a $7.8 million decrease in MME segment net sales.

Overall, we saw strength in four of our five largest categories, including software, tablets, desktops, and delivered services, growing at 9%, 10%, 9%, and 8% respectively. These gains were offset by a 14% decline in our notebook category in Q4 2012.

Our consolidated gross profit for Q4 2012 increased $100,000 to $50.5 million. Consolidated gross profit margin decreased by 5 basis points to 13.2%. Consolidated gross profit and gross profit margin was impacted by a $500,000 or 16% basis point reduction in vendor consideration.

SG&A expenses decreased by $4.3 million or 9% to $45 million, due primarily to ongoing cost containment efforts and represented 11.8% of sales compared to 13% of sales in Q4 2011. A significant portion of the decline was in our overall personnel cost, which reduced nearly $2.8 million over last year. As a result, our consolidated operating profit for Q4 2012 increased nearly 400% to $5.5 million and our consolidated EBITDA more than doubled to $8.6 million. Excluding the restructuring and related cost, EBITDA grew 123% to $8.8 million.

Our effective tax rate for 2012 was 42% compared to 49% last year, and we expect our effective tax rate to be between 41% and 43% in 2013. We generated nearly $14 million of operating cash flow during 2012, compared to cash used in operating activities of $22 million in 2011.

Accounts receivable and inventory reductions increased cash flow by $4 million and $11 million respectively, were offset by an $18 million reduction due to an increase in accounts payable.

Cash used in investing activities totaled $9.4 million during 2002, and was made up entirely of capital expenditures. This includes a $1.3 million purchase of land that’s the foundation for our new datacenter facility that we hope to open in late 2013, early 2014, and we expect to incur an incremental $8 million to $9 million of construction and related cost over this time period.

This compares to cash used in investing activities totaling $30.3 million during 2011, which included CapEx of $28 million, of which $9.6 million was for the purchase of our headquarters building last year, and a large portion of the remainder related to improvements in equipment for our new headquarters office.

Outstanding borrowings under our line of credit declined by $4.2 million from prior year-end to $87.6 million at December 31, 2012 and was a primary driver of our cash used in financing activities along with the $3.9 million used to repurchase our common stock.

Now, I would like to turn the call back over to Frank Khulusi. Frank?

Frank Khulusi

Thanks, Brandon. At this point, I’ll provide you with some additional detail on the demand environment, and our rebranding and our strategic initiatives.

As we discussed earlier, the demand in Q4 was stable relative to Q3 but did not improve materially. We are hopeful that things will improve from that level, but we continue to monitor the environment and will adjust our plans and investment level accordingly.

At the same time, we believe that our unique service offerings and a renewed emphasis on consultative sales in our corporate segment along with a unified brand strategy will allow us to outgrow the market. As we have discussed, on December 31, we changed our name to PCM Inc. Some might ask, well, so what?

Well, these changes go far beyond a simple name change, and the changes we’ve made and continue to make will be felt throughout our company, our customer and partner bases in a materially positive way. We’re making it easier for our OEM partners to do business with us successfully.

We’re intensifying our branding messages, and through the unification of our services companies we’re making it easier for account executives to source, discuss, and ultimately provide complex IT solutions to our customers. The rebranding and name change was not the end game or the goal; that was instead an important event for us, one that we are already building upon.

We have for some time been saying that we believe that IT spending was changing in a permanent and material way. Because we recognize this, and through some challenging economic environment we’ve been continually investing in our capabilities and competencies around technologies that will drive IT spending for years to come.

Some of our key OEM partners have recently publicly validated our conviction relative to the fundamental and real change that’s taking place in IT spending. As enterprises and government agencies continue to seek efficiencies and seek to optimize their IT environment, they will look to partners who can help them find their way, who can be their partner.

As you know, we have a wide range of IT services capabilities, not the least of which is our managed service practice which recently won more accolades from Nine Lives Media. Our managed services practice currently leverages two datacenters in Atlanta, Georgia. In Q4, we announced that we’re building a third datacenter near Columbus, Ohio that will enable us to provide additional services to our existing customers and to serve new customers in ways that they will find valuable and compelling.

Cloud computing, along with software and infrastructure-as-a-service mean different things to different people. And that’s okay. We feel like we have a good handle on what the market dynamics will be in services and solutions going forward and we intend to be there for our customers, leading when appropriate and providing them with sound advice and value-added services backed by IT product from a world-class OEM partner.

In short, we feel that while we cannot control the demand environment, we can position ourselves as value-added partners to our customers regardless of the demand environment. By including rigid cost disciplines in general, with selective but important investments and the re-branding of the organization we continue to embrace, we will be very well positioned for both 2013 and beyond.

Thank you again for joining us on this call. At this time, I’d like to open it up for any questions you may have. Aisha?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Brian Alexander with Raymond James. Please proceed.

Brian Alexander – Raymond James

Okay. Thanks, good evening everybody. Frank, maybe just to pick up on the...

Frank Khulusi

Hi.

Brian Alexander – Raymond James

Hi. Maybe just to pick up on the last part of what you’re talking about as far as cloud goes, help us understand to what extent are your customers moving to the cloud, in particular public cloud whether it be infrastructure-as-a-service, software-as-a-service, and is this impacting your business in any way? Is that causing customers that were formally buying software and/or infrastructure from PCMI that are no longer doing so?

And how do you enable them to move to public cloud? What’s the role for your business for customers that choose the transition? Thanks.

Frank Khulusi

Yes, so there is – customers are moving to cloud. And the various ways that that takes shape is either a private cloud and our participation there as to a system and managing that better and taking cost out. And then there is the component of it where we are running it for them on our premises and then there is the public cloud aspect where it’s more on a software as a service, pay per drink, there are shared services with other participants etcetera. But Joe do you want to take that on and end on it?

Joe Hayek

Sure. Brian, you probably know this better than most, but there are lots of things going on with the cloud and with the migration of people’s infrastructure from them making capital investments themselves and having captive data centers to embracing different types of clouds and – public clouds, the folks that provide those are pretty well known. We believe that those will primarily be the province of very small businesses, folks that don’t mind swiping a credit card every month and getting the SOAs that they think are okay for them and really just viewing it as a cost decision.

And then there are other, kind of call it the very, very large companies out there that are probably never going to embrace outsourcing that way because their data is in their own minds too important to them, or they need a datacenter on every continent or whatever the case may be, but in the middle is what we think about as the big opportunity for us, right, and that’s kind of the hybrid cloud or the private cloud where companies want to embrace the idea of an outsourced datacenter, an outsourced cloud computing, but they want to have a provider that – a service provider, not just a collocation provider, but a service provider who can do full outsource – full managed outsource including monitoring, including provisioning, including reporting etcetera, and candidly, who will have service level agreements that guarantee uptime, and you have one person to talk to if you are upset with the way things are going.

And the other thing I would say relative to your question with respect to cloud is that not everybody is going to do all those different things. And so we segment our services really into two different categories, one being the managed services where we would utilize our datacenter or put people in customer datacenters, but the other really is more on the consulting side and more on the professional services side, we have done a good job in our own minds at least of working with customers to consolidate datacenters.

We had a customer that had over 100 data centers globally, wanted to consolidate those. We worked with them – consulted with them pretty significantly and ultimately moved them into two datacenters, neither of which was ours. But those are the types of things that we’re thinking of. And with respect to software-as-a-service and infrastructure-as-a-service, there is an impact there to the way the people have consumed things and purchased things historically.

We don’t anticipate. We don’t want to embrace and literally host 100s of software publishers on a software-as-a-services model. We do that for the vendors and the publishers that we think are strategic. It doesn’t make a lot of sense for us to specifically get into offering all of those as a service. We’ll do that when it’s appropriate and we obviously offer infrastructure-as-a-service and a kind of utility model that ultimately will work its way into the desktop as well, although that’s going fairly well, but in early stages. So hopefully that’s a helpful answer to your question.

Brian Alexander – Raymond James

Very much. Thanks, Joe. On the demand environment, Frank, it sounded like it was a bit subdued in Q4. We did see that from some of the other companies in the space, but we did also hear that there was a bit of a bounce back as the quarter progressed, maybe beyond what we would normally see from a linearity perspective in the fourth quarter. So can you just help us understand if you did see demand get better as the quarter went on? Was it unusually backend loaded or was linearity consistent with what you’ve seen in prior fourth quarters?

Frank Khulusi

We saw that some – we saw some of the same thing, and I will take it further to say that the – I wouldn’t call it robustness, but the improvement has continued so far in Q1.

Brian Alexander – Raymond James

Could you be – maybe be a little more specific? When you say improvement, are you talking about year-over-year trends improving? It’s specific customer segments, specific product categories?

Frank Khulusi

The year-over-year comparison is improving – has improved in Q1 so far compared to Q4 as reported, which is the average for the three-month period, which takes into consideration the sequential improvement that happened throughout the quarter.

Brian Alexander – Raymond James

And that’s true within SMB and MME?

Frank Khulusi

That is correct.

Brian Alexander – Raymond James

Okay. And so when you think about – when – not that you are giving guidance for the full year, but when you think about what’s realistic for 2013 and from a growth perspective – and I think you are confident that you should gain market share, how are you thinking about market growth and how are you I guess staffing up for 2013, and how are you I guess looking at your infrastructure relative to the growth opportunities this year?

Frank Khulusi

Well we – I guess we are a little bit more optimistic than end up being the case in 2012. I mean, who would have known that with all the fiscal cliff stuff that that would have had as much of an impact as it did. But – so that makes us a little bit I guess more reluctant to share with you our views. However, the – most are internal plans, and the early innings so far this year give us confidence that we should be able to, and our goals would indicate that we should be able to grow significantly faster than market, whatever that means.

We really are a little bit more reluctant – I mean 45 days or half our quarter does not a year make. So we are a little more reluctant to give you a very optimistic view, but we are internally optimistic that things should be improving from 2012. And with all the plans that we’ve done that are specific to us and the things that we’ve recently implemented, that should help accelerate that as well.

Brian Alexander – Raymond James

Are you seeing the sales cycles which elongated in the back-half of last year is that – are those normalizing? Is there less, kind of scrutiny at the senior management level over certain projects? Are we seeing pipelines come in a little bit as projects move forward and maybe a little bit more flavor for what gives you the optimism going into 2013?

Frank Khulusi

I’d say it’s somewhat of a mixed bag. I mean, I wouldn’t say from a reluctance or an approval level, I don’t say all of a sudden it’s open wallets again. Things are still tight. However, they’ve improved sequentially and improved on a year-over-year basis compare wise, and it’s both in SMB and MME. The larger part of that tend to be – have a lot more scrutiny, they tend to be more prone to slippage. We’ve experienced that ourselves and there is a period where we count on something one month and we receive a phone call and now it’s next month or whatever. But Joe, do you want to expand on that?

Joe Hayek

No, I think that’s pretty fair. I mean, the environment hasn’t gotten markedly better in Q – as you recall, right, late summer saw really the swoon in spending if you will. That contributed to some muted demand in Q3 and into Q4. People, as you know – on the enterprise space have their wits about them and are heading into 2013 working their strategic plans. And I would say that we have seen more of a return to normal behavior – not 1999 behavior, but normal behavior kind of call it pre-August of last year.

Brian Alexander – Raymond James

Okay. And I would agree 1999 probably wasn’t normal either. But a final from me, whoever wants to take it, just on the notebook decline of 14%, was that pretty widespread across your vendors and across your customer segment. And more importantly, do you have any sense how much of that has been driven by tablet cannibalization, or do you think it’s just delayed acceptance of the new operating system for Microsoft?

Frank Khulusi

It’s a combination of factors; for one, for us it was more a little bit of a timing issue in that the end of Q3 we have some unusually large notebook orders that took place. Also, within Q4 we’ve had – we would have sold more notebooks had we have more supply, specifically with respect to Apple. That’s normally a part of our number.

And the third piece – you’re right on, you hit the nail on the head. There is a bit of a cannibalization with respect to tablet and notebook. So the three factors place together. I tend to probably be a little bit different than most people. I’m not smarter, but I tend to have my own view with that – with respect to tablet cannibalization. That is a bit of a temporary effect.

I think one of the reasons notebooks haven’t sold very well is that there is – was a little bit of stagnation in the increases in technology; it hasn’t kept up with I guess some of the other increases that we’ve seen elsewhere. And as notebook vendors start really investing and making their notebooks a lot better and smarter, as we start it seeing happen, I think some of that is going to rebound.

So I’m not assuming gloomy with respect to the future of notebooks as some people are.

Brian Alexander – Raymond James

Got you. I would agree with that. Okay. Thanks everyone. Appreciate it.

Brandon LaVerne

Thank you.

Frank Khulusi

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Chris Krueger with Northland Capital Markets. Please proceed.

Chris Krueger – Northland Capital Markets

Hello, guys.

Frank Khulusi

Hi, Chris.

Chris Krueger – Northland Capital Markets

Hi. Most of my questions are already answered, but just one more, can you talk a little bit about the Public Sector? I mean, I know with all those government sequester talk, things like that, I’m wondering what your viewpoint is on that? And also, going back to last quarter when you announced – I believe is the FDI win, I’m wondering if you’ve had any progress with that yet either?

Frank Khulusi

Yes. Whether you called it sequester, whether you just call it ongoing budget woes, the issue with the Federal government continues to be very tight, first strings, and we continue to experience and feel that across the whole line of business with the government – with the federal government, including the FDI win.

So with respect to the FDI win, as you know it’s a multi-year contract. Part of it is a license to hunt; part of it is guaranteed. We’ve gotten with respect to the guaranteed portion about $5 million approximately – just out of $5 million of revenues in the fourth quarter that it contributed. And not to reiterate what we previously said, but for those people that didn’t hear it, that business is a very little margin business that’s intended to be an enabler with respect to certain other things that we’re trying to do and accomplish that we wish to not disclose for competitive reasons.

So it’s not going to be hugely accretive in terms of bottom line, but it certainly will enable us to do those other things that are part of our plans for 2013 and beyond.

Chris Krueger – Northland Capital Markets

All right. Thanks. That’s all I got.

Frank Khulusi

Well, around a bit of contribution, overall that business is definitely challenged by the ongoing problems, but we are – we continue to be optimistic about it in the long term as we continue to be optimistic about this country in the long term.

Chris Krueger – Northland Capital Markets

All right. Thanks. That’s all I got.

Frank Khulusi

Thank you.

Operator

There are no further questions in the queue at this time. I would now like to turn the call over to Frank Khulusi for closing remarks. Please proceed.

Frank Khulusi

Thank you, Aisha once again. And I would like to thank everyone on the PCM team for their continued efforts, dedication and great work. In addition, thank you all very much for spending some time with us on this call, and for your interest in PCM and for your questions. We appreciate your support and look forward to speaking with you again on our first quarter conference call. In the meantime, please contact us with any questions or if you have a need for IT solutions. Thank you again and have a great evening.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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