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PCM Inc. (NASDAQ:PCMI)

Q2 2013 Earnings Call

August 6, 2013 9:00 am ET

Executives

Frank Khulusi – Chairman, President, Chief Executive Officer

Brandon LaVerne – Chief Financial Officer

Joseph Hayek – President, PCM Sales

Analysts

Brian Alexander – Raymond James

Operator

Good day ladies and gentlemen and welcome to the Second Quarter 2013 PCM Incorporated Earnings conference call. My name is Sade and I’ll be your 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 is being recorded for replay purposes.

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

At this time, I would like to refer to the Safe Harbor statement under 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, Sade, and good morning everyone. Welcome and thank you all for participating on this call with PCM. Today we’ll be discussing the Company’s financial results for our record second quarter of 2013.

I’m excited to share the following second quarter highlights with you. We achieved record second quarter results in every meaningful P&L category. Let me share with them you. We achieved record Q2 net sales, increasing 4% to $366.4 million. We achieved record gross profit, increasing 5% to $51.1 million, and our gross margin increased to 14% from 13.8%. This was our highest quarterly gross profit in the history of our Company.

We achieved record Q2 EBITDA, increasing 40% to $9.2 million or $9.3 million when you exclude severance and restructuring-related costs. We achieved record Q2 operating profit, increasing 84% to $6.3 million; and finally, we achieved record Q2 diluted EPS, increasing 125% to $0.27 per share with adjusted EPS of $0.29 per share when you exclude severance and restructuring-related costs.

In a stable but still challenging demand environment, we believe we were able to grow our market share by increasing sales by 4% year-over-year and 9% sequentially. More importantly, we grew our gross margin to 14% from 13.8% despite lower margin sales to certain government accounts, and nearly doubled our operating profit to a Q2 record. While achieving this faster than market growth, our teams improved our commercial sales mix and kept SG&A expenses flat, resulting in the operating leverage that drove our Q2 record $0.29 of EPS for this quarter when you exclude restructuring-related costs.

We saw strength in many of our strategic offerings, including software, networking, storage and notebooks, which increased 20%, 24%, 37% and 25% respectively. The productivity of our teams continues to improve and we remain focused on the growth of our solutions portfolio and on providing our customers with customized IT solutions. Our rebranding and other growth initiatives and investments continue, and we look forward to those initiatives making more substantive contributions to our future results.

I will 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 this morning and also available on our website. All comparisons I make will be against Q2 2012 unless otherwise noted, and as noted in our prior quarter calls, we’ve revised our revenues and cost of sales numbers for the prior periods in order to conform to the current period presentation related to our revised accounting for revenue recognition of certain software maintenance and subscription transactions on a net basis that had previously been recorded on a gross basis.

Our consolidated net sales were $366.4 million in Q2 2013 compared to $351.7 million in Q2 2012, an increase of $14.7 million or 4%. Consolidated sales of services were $32.6 million in Q2 2013 compared to $31.1 million in Q2 2012, an increase of $1.5 million or 5% and represented 9% of net sales in each period. The increase in our consolidated net sales was primarily due to a $25.3 million or 71% increase in our public sector segment sales, driven by sales in new or expanded federal contracts entered into late last year partially offset by an $8.5 million or 50% decline in our MacMall segment sales resulting primarily from lower tablet sales and a $2.2 million or 1% decline in our commercial segment sales.

As Frank indicated, we saw strength in many of our most strategic product categories, including software, networking, storage and notebooks, growing at 20%, 24%, 37% and 25% respectively. These gains were partially offset by declines in desktops, tablets, and servers of 2%, 44% and 18% respectively. Our top partners in Q2 2013 were HP, Apple, Cisco, Microsoft, Lenovo, and Dell.

On a productivity basis, our Q2 sales increased 8% per account executive as our average account executive headcount declined in Q2 2013 from 740 last year to 714, or nearly 4%. Our consolidated gross profit was $51.1 million in Q2 2013, an increase of 2.6 million or 5% from $48.5 million last year. Consolidated gross profit margin grew to 14% in Q2 2013 from 13.8% last year, reflecting our improved product mix and a focus on solution sales. We were able to improve our gross margin despite lower margin sales to certain federal customers.

Our commercial segment gross profit margin increased 80 basis points to 15.7% from 14.9%, driven by a higher mix of solution sales. Our MacMall segment gross profit margin increased 50 basis points to 11.7% from 11.2%. Our public sector segment gross profit margin decreased from 10.3% to 8.7% primarily due to the lower margin federal business we mentioned earlier.

Consolidated SG&A expenses were $44.8 million in Q2 2013 compared to $45.1 million last year, a decrease of $300,000 as our efforts to increase productivity and operate more efficiently paid dividends. Consolidated SG&A expenses as a percentage of net sales decreased to 12.2% in Q2 2013 from 12.8% last year, and this was our fourth consecutive quarter of year-over-year SG&A margin decline.

Consolidated operating profit was $6.3 million in Q2 2013 compared to $3.4 million in Q2 2012, an increase of $2.9 million or 84% driven largely by gains in our commercial and public sector segments. Our consolidated EBITDA increased $2.6 million or 40% to $9.2 million from $6.6 million last year. We incurred approximately $100,000 of severance and restructuring-related costs in our EBITDA in Q2 2013 versus $600,000 in the prior year.

Our effective tax rate for each of Q2 2013 and 2012 was 43% and we currently expect our rate for the remainder of 2013 will be substantially the same. As a result, we generated $0.27 of diluted earnings per share during Q2, 125% increase over the $0.12 diluted EPS we generated in Q2 last year. Excluding severance and restructuring-related charges, our Q2 adjusted EPS was $0.29 compared to $0.15 last year.

Turning to the balance sheet, cash used in operations for the six months ended June 30, 2013 was $10.4 million compared to cash provided by operations for the six months ended June 30, 2012 of $21.3 million. The primary utilization of cash during the period was an increase in accounts receivable of $27.3 million primarily due to the increased sales in our public sector business, the timing of sales made during the quarter, as well as increase in sales billed on a gross basis but reported on a net basis.

Capital expenditures during the six months ended June 30, 2013 were $5.7 million compared to CAPEX during the six months ended June 30, 2012 of $5.1 million. 2013 CAPEX includes approximately $1.3 million representing the unfinanced portion of a building we acquired that’s adjacent to the building we own in Santa Monica, California.

Outstanding borrowings under our line of credit increased by $12.8 million to $104 million at June 30, 2013 compare to year-end, while overall working capital increased by $3.4 million despite a $1.6 million investment in stock repurchases during that time period.

Now I’d like to turn the call back over to Frank for some closing comments.

Frank Khulusi

Thanks, Brandon. At this point, I’d like to give you an update on the demand environment through the second quarter of 2013 and provide you with some updates on our ongoing strategic initiative and rebranding.

When we were together three months ago, we were beginning to see more normal seasonal demand trends. Those have continued. While I would not characterize the demand environment as robust, it seems to be stable and we believe is tracking GDP growth. We also believe that we can continue to take share, though we are doing it with an eye on solution sales.

In Q2, we dramatically improved our product mix in the commercial space while the federal contracts contributed to growth but slightly lower margins in our government business. In addition, sales of services continue to grow. We have spent and continue to spend significant time and resources building our services and solutions capabilities and will continue to invest in our people, processes and technologies in this important initiative.

Specifically regarding our services business in Q3, typically we see seasonally flat to a slight increase in revenue in our services business from Q2 to Q3. This year, that sequential pattern will be challenged due to an ongoing software upgrade that is impacting one of our primary solution partners in the healthcare space. We believe that this upgrade and the resulting delay in our services revenue associated with that partner, while temporary, could impact our Q3 services revenue by approximately $2.5 million and EPS by approximately $0.03 per share.

Turning to our strategic initiatives, we continued to focus on growing our sales of solutions and services. While our commercial gross margin expanded by 40 basis points in Q1 of 2013, in Q2 it expanded 80 basis points versus last year, and we continue to refine our solution selling approach. The changes that we’re making are intended to better enable our account execs and those that support them to more effectively bring value-added solutions and services to our customers, increasing their efficiency and their productivity. As we continue to add to our capabilities, including our new planned Ohio data center, we intend to continue to both nurture our account executives with improved tools, training and support, and challenge them to be more relevant to their customers who are constantly seeking partners who can understand and optimize their IT environments. We believe that this will increase our penetration within our various account bases and will also provide scale to our offerings.

In closing, I’m very proud of the way that our teams continue to think strategically while executing in the short term. We’re cognizant that we have to earn our customers’ and partners’ trust every day, and we believe that we’re succeeding and continue to improve. We will redouble our efforts to work hard and work smart to ensure that the solutions we provide and execute are world-class. We believe that the work we’ve done and continue to do with this goal of providing world-class service positions us very well to successfully serve our customers as a trusted IT solutions provider as we head into the second half of 2013 and beyond.

At this point, I would like to turn the call back to our operator and open it up for questions.

Question and Answer Session

Operator

Thank you. [Operator instructions]

Our first question comes from the line of Brian Alexander with Raymond James. Your line is open.

Brian Alexander – Raymond James

Thanks, and good morning guys.

Frank Khulusi

Good morning, Brian.

Brian Alexander – Raymond James

Hi Frank. Some of your competitors have talked about more pricing pressure in certain product categories, more the transactional categories, and I know you talked about emphasizing solution sales probably more on this call than you have in the past. I was just wondering if you could comment on whether you guys saw that type of pricing pressure, particularly in the commercial space which, based on your results, would suggest that perhaps you walked away, maybe, from some deals given that your gross margins, I think, were up 80 basis points in that segment and your revenue was relatively flat. But if you could just talk about the competitive dynamic that you’re seeing, that would be great.

Frank Khulusi

First of all, it’s important to note that our revenue actually was not relatively flat—well I mean, still you can call it relatively flat, but when you exclude the impact on the software being treated on a net basis and when you look at it on a gross basis, our revenue growth in that segment outperformed by a little bit what we reported, so there was actually a little bit of growth there.

But specific to the environment from a pricing pressure perspective that you’re talking about, I’d like to turn it over to Joe.

Joseph Hayek

Sure. Brian, you’re exactly right. What people have said is true – it is still fairly competitive out there. You’ve got IT spending growth, we believe kind of tracking GDP growth, which is not 10, 12%, so in certain categories it is fairly competitive, particularly in the late May and June months we saw that. So we did walk away from certain business that would be done at lower margins, not because it was 100 basis points or 200 basis points lower than we might want it to be if it was strategic for us, but if it was effectively a one-off we’re not as interested in doing that unless it provides us a beachhead with a customer. Secondarily, as you mentioned, as you noticed, we are as focused as we’ve ever been with all of our people trying to be more strategic with our customers, so be default with some of those product categories, you have slightly longer sell cycles, and we’re okay with that.

Brian Alexander – Raymond James

So maybe expanding on the commentary around solution selling, could you guys be maybe a little bit more specific on what you’re doing differently today relative to six to nine months ago in terms of recruiting account executives, training account executives, adding new vendors, new product categories? How is the Company operating and executing differently today than it was six to nine months ago, specifically related to the solution selling comments?

Joseph Hayek

So I’d be maybe not as descriptive as you might like for competitive reasons or just from a disclosure perspective, but in short a lot of what we have been doing is really trying to embrace different product categories, really trying to increase our penetration in different product categories with our various customers. We may start out somewhere, but we obviously always want to get into more places. I mean, I think you saw specific improvements in netcom and in storage. You know, servers are still a little soft. I think we continue to see some softness in the data center market, and I think that’s been fairly commonly known or a common theme with others out there in the space.

But in general, Brian, we’re really investing more in our people and we’re investing more in our partners. And without saying a whole lot more than that, we don’t believe it’s rocket science or that we’ve developed some proprietary algorithm on how to do that, but we are spending a lot more time on it and are a lot more thoughtful on it and have engaged some folks to help us with it, and so far that’s going fairly well and we expect and hope that it will continue to go well in the future.

Frank Khulusi

Also our service capability is a very strong enabler in that regard, and from that perspective is a huge barrier to entry for some of our competition. We have spent literally years and years developing that and it’s culminated late last year, beginning of this year with our putting it all together under one brand and under one leadership, so I believe that has been an enabler as well. When you add to that the direction and training that we give our people and the resources that they need to be successful, I think it’s creating a very successful formula at this point. I think the upside is far greater than where we are today.

Brian Alexander – Raymond James

Well that answers my next question, because I was going to ask with this upward movement in gross margins comfortably above 15% in the commercial segment, whether you believe that’s sustainable; and it sounds like based on that response, Frank, that you think it’s sustainable and potentially can improve from here.

Frank Khulusi

I believe it’s very sustainable and potentially can improve meaningfully from here; however, keep in mind that doesn’t mean that I’m speaking to that with respect to quarter to quarter. Quarter to quarter, there is always gyrations. You take one big order or one big customer rollout or whatever at slightly lower margins, that can affect those results quite a bit. From an overall—so your question, I think, was very pointed to the commercial perspective, but if you also project that from an overall Company perspective, keep in mind that the third quarter is heavier in terms of our concentration of federal sales, which tend to be lower margin, and also keep in mind the comment I made earlier with respect to the services business, that is somewhat delayed from the third quarter to the fourth quarter at this point.

So from a sequential overall margin perspective, you can’t look at it that way, quarter to quarter; but long-term trend is definitely up.

Brian Alexander – Raymond James

And my questions are usually pointed, so thanks for recognizing that. Just a couple more – on the services impact for Q3 that you called out, I appreciate the disclosure there. I just wanted to make sure I understand. Is that a system implementation at your customer or is that a system implementation at PCMI?

Frank Khulusi

It’s a system implementation at multiple customers as a result of a platform that’s available from an OEM partner being delayed and the resulting projects of services that we render around that platform being delayed accordingly.

Brian Alexander – Raymond James

I see, and that’s just a one quarter phenomenon?

Frank Khulusi

It’s what we think at this point is a one quarter phenomenon, yeah. We’re pretty—I mean, we don’t just think a little, we think that a lot; so we’re very confident at this point that it is a one quarter phenomenon, but you don’t know what you don’t know.

Brian Alexander – Raymond James

Sure.

Frank Khulusi

So this has nothing to do with us, Brian, whatsoever.

Brian Alexander – Raymond James

No, that’s clear. Maybe final big-picture question for you or for Joe, on the cloud, just give us an update on what you’re seeing from a public cloud perspective. Are you seeing customers take more applications and more work loads, adopt more of an infrastructure as a service approach to their business? It seems to be a big concern that investors have around your vendors and around your space, and I was just wondering if you can give us an update on what you’re actually seeing occur in the marketplace.

Joseph Hayek

Sure, and it really is—I think you may have mentioned this in your survey, but the real growth in cloud is fairly scattered, right? Everybody talks about it and everybody is there, but there’s lots of reticence, I think, for people to right this minute completely turn their operations upside down and go 100% to the cloud for lots of applications. There are certain applications that have been there for a while. There are other applications that are more generally available or are specific to a customer’s operations, be it a certain system, be it an accounting system, be it CRM, be it sales – whatever. But we’re really seeing from a cloud perspective that people are thinking really incrementally about it.

There is lots of stuff that’s happening over the next two, three, four years with respect to software-driven data centers and different platforms, different ERPs, all those different things that are happening, so what we’re really seeing is people embracing the concept. I think the penetration for folks that have really embraced that is still fairly low. I think of it almost akin to 20 years ago in the EMS space where you had the industry growth and you also had the penetration of what was happening there versus people doing it all themselves.

But it’s really incremental. There are new applications every day. Software is a very dynamic space, and so it’s always going to be hosted; but infrastructure specifically, we’re seeing lots and lots of people that have in the last two or three years realized that they need to have a strategy. Maybe they have stuck their toe in the water, but we believe that probably in the next four to five years in our target market, which is the 100 to non-Fortune 50, if you will, the pace of adoption will increase not just for co-location or for DR, but for more of the outsource services, and that’s really where we intend to play.

Brian Alexander – Raymond James

Perfect. All right, thanks Joe and good job, guys.

Frank Khulusi

Thank you very much, Brian.

Operator

Again ladies and gentlemen, if you have a question at this time, please press the star then the one key on your touchtone telephone.

At this time, I’m not showing any further questions. Thank you. I would now like to turn over the call to Frank Khulusi for any further remarks.

Frank Khulusi

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

Thanks again, and have a great day.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect and everyone have a great day.

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