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PCM, Inc. (NASDAQ:PCMI)

Q4 2013 Earnings Conference Call

February 26, 2014 4:30 p.m. ET

Executives

Frank F. Khulusi – Chairman, President & CEO

Brandon H. LaVerne – CFO, Treasurer and Assistant Secretary

Joseph B. Hayek – President of PCM Sales, Inc.

Analysts

Operator

Good day ladies and gentlemen and welcome to the Fourth Quarter 2013 PCM Incorporated Earnings Conference Call. My name is Eric 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 call 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 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. Such 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 Frank Khulusi. Please proceed sir.

Frank F. Khulusi

Thank you, Eric. Good afternoon everyone. Welcome and thank you all for participating on this call with PCM. Today, we will be discussing the company’s financial results for the year and four quarter of 2013.

I’m pleased to share the following full year and four quarter 2013 highlights with you. For the full year net sales increased to $1.424 billion and increased 3% excluding MacMall. Gross profit increased 2% to $197.8 million and gross profit margin increased to 13.9% from 13.7%. Operating profit increased 38% to $17.3 million. EBITDA increased 16% to $29.2 million. Diluted earnings per share increased 62% to 68% per share. And adjusted EPS increased 41% to $0.79 per share excluding severance and restructuring related costs.

For the fourth quarter net sales decreased 3% to $372.1 million but increased 1% in the commercial. Gross profit decreased 1% to $50.1 million and gross profit margin increased to 13.5% from 13.2%. Operating profit decreased 20% to $4 million and EBITDA decreased 14% to $7 million. Diluted EPS decreased 21% to $0.15 per share and adjusted EPS decreased 14% to $0.18 per share excluding severance and restructuring related costs.

2013 was on balance a good year for PCM. On January 1, 2013 we completed our rebranding and in our first half at PCM, Inc. we grew our gross margins to 13.9% from 13.7%. I’m sorry that’s the first year at PCM, Inc. We increased our operating profit by 38% and increased our EPS by 62%.

In the fourth quarter our team performed very well considering we were negatively impacted by a significant and unanticipated shortage of Apple products that traditionally performed very well in the fourth quarter as well as by the continuing weakness in federal government spending. Despite this environment, we were able to improve our gross margins by 30 basis points to 13.5% in the fourth quarter, a result of our continued success driving higher margin solutions sales throughout our customer base.

Our gross margin for the fourth quarter and full year 2013 are the highest they had been in nearly 20 years. We were able to grow our gross margins and earnings in the full year 2013, while investing significantly in our solutions business, and our large portion of that investment impacted our Q4 results on the SG&A line.

Today, our key focus areas from solutions standpoint are software, services as delivered by us or a partner, and networking storage and servers. These categories together in 2013 grew 11% over 2012 and represented a significant and growing portion of our sales. Specifically networking and storage grew 21% or 18% respectively in 2013. We intend to continue to aggressively this part of our business in the future. We have added and will continue to add competencies and subject matter expertise in all these areas with a focus on cloud and the Internet of Everything. We believe that our investments in these strategic areas position us well for accelerated growth in 2014 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 H. 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 also available on our website.

All comparisons I make will be against full year 2012 or Q4 2012 unless otherwise noted. Our consolidated net sales for full year 2013 were $1.4 billion up slightly from 2012. Our commercial segment net sales was 1% and our Public Sector segment sales was 13% that were offset by a 12% reduction in MacMall sales in 2013 compared to 2012.

We saw strength in our new federal contracts awarded in late 2012, where such increases were mitigated by the ongoing federal budget constraints. The year was also impacted by a lack of newly released Apple products during most of the year and then further by the lack of availability of such products when they were released in the fourth quarter.

For Q4, our consolidated net sales declined 3% to $372.1 million primarily due to a 16% decrease in public sector net sales and a 9% decrease in MacMall net sales and partially offset by a 1% increase in our commercial net sales.

We saw strength in some of our most strategic product categories in Q4 and all of 2013. For the quarter notebooks, storage, software and networking grew at 34%, 26%, 8% and 6% respectively. Gains were offset by declines in input devices, accessories and displays at 40%, 12% and 5% respectively.

For the year, the same strategic categories, notebooks, storage, software and networking grew at 15%, 18%, 8% and 21% respectively. Our top partners by revenue in Q4 2013 were Apple, HP, Microsoft, Cisco, Lenovo and Dell.

On a productivity basis, our Q4 sales increased 3% per account executive over the last year’s Q4 as our average account executive headcount declined in Q4 2013 from 738 to 700 account executives or nearly 5%.

Our consolidated gross profit for the quarter was $50.1 million, a decrease of $400,000 or 1% over last year. Consolidated gross profit margin grew 30 basis points to 13.5% in Q4 2013 from 13.2% in Q4 2012. By segment commercial gross profit margin increased 10 basis points to 14.7% from 14.6%. Public sector gross profit margin increased 80 basis points to 8.8% from 8.0% and MacMall gross profit margin decreased 20 basis points to 10.7% from 10.9%.

Consolidated SG&A expenses were $46.1 million in Q4 2013 compared to $45.5 million in Q4 2012, an increase of $600,000 or 1%. Consolidated SG&A expenses as a percentage of net sales increased to 12.4% in Q4 2013 from a 11.9% in Q4 2012. The increase in consolidated SG&A expenses in Q4 2013 was primarily due an increase in personnel cost of $1.1 million partially offset by a non-recurring half a million dollar charge in Q4 2012 related to unreimbursed software maintenance costs.

Our effective tax rate was 42% for Q4 and the full year 2013 compared to 43% for Q4 2012 and 42% for full year 2013. We generated $0.15 of diluted earnings per share during Q4 2013, a 21% decrease from $0.19 diluted EPS we generated in Q4 last year.

For the year EPS was $0.68 per share, a 62% increase over $0.42 per share in the prior year. adjusted EPS which excludes severance and restructuring related costs was $0.79 for 2013, a 41% increase over prior year and was $0.18 per share for the fourth quarter, a 14% decline over the prior year.

Turning to the balance sheet and cash flow, net cash provided by operating activities for the year ended December 31, 2013 was $900,000 compared to $13.6 million for the year ended December 31, 2012. The primary sources of cash during the current period were increases in accounts payable of $31 million and an income before non-cash adjustments partially offset by a $48 million increase in inventory reflecting strategic purchases made near the end of the year and majority of which have already sold through so far in the first quarter of 2014 and it should provide a boost to operating cash flow for 2014.

Capital expenditures during the year ended December 31, 2013 was $15.5 million compared to $9.4 million during the year ended December 31, 2012. CapEx for the year ended December 31, 2013 included approximately $1.3 million related to the unfinanced portion of a building we acquired adjacent to the building we own in Santa Monica, California and approximately $2.8 million of construction related cost to build-out the new datacenter in New Albany, Ohio.

Outstanding borrowings under our line of credit increased by $22.9 million to $110.5 million at December 31, 2013 compared to December 31, 2012, while overall working capital increased by $2.2 million despite the $4.1 million of unfinanced building cost incurred and a $1.6 million investment in stock repurchases made during the year ended December 31, 2013.

Now, I would like to turn the call back over to Frank for some closing comments. Frank?

Frank F. Khulusi

Thanks Brandon. I’ll take a few minutes to update you on the demand environment and highlight a few of our key priorities for 2014. On our Q3 conference call I described the demand environment as essential a tail of multiple market segments. The federal government continues to be challenged from a demand perspective and we believe that will be the case at least in the near term going forward. We’ve continued to do well on the contract in spite fed space which is great and to the good luck of our team there, but awards based on those contracts are not as robust as we would like them to be.

From the MacMall perspective, while in Q3 we saw customer deferred purchases anticipating the refresh of multiple CPUs and tablets from Apple. We were unable to get enough products in Q4 to satisfy the demand that we generated. We’ve seen some recovery in availability thus far in Q1 and we’re working to try and create a more predictable business with Apple going forward.

In our commercial segment which represented 73% of our consolidated sales in Q4, we made some important and meaningful management changes during Q4 that we believe will have a positive impact on our growth and results in 2014. We do expect to add significant headcount in our sales organization in 2014 along with additional headcount of pre and post sales engineers for our datacenter centric as we believe that demand for IT solutions that leverage emerging technologies and services will grow significantly in 2014.

From an overall demand perspective, well thus far in Q1 the macro demand environment is stable and we believe it’s at least tracking GDP growth. We’re optimistic that the environment will at a minimum, remains stable and are looking forward to more healthy growth in IT spending as unemployment declined and companies feel better about investing in IT solutions that can provide them with competitive advantages rather than simply saving them the money in the short-term.

I’ll take a few minutes to update you on our strategic priorities for 2014. While we’re not satisfied with our Q4 results, 2013 was a good year for PCM overall. We believe that IT spending grew sluggishly and we faced multiple headwinds including continued softness in government spending that I talked about before and by a lack of newly released Apple products during most of the year and then further by the lack of availability of such products when they were released in the fourth quarter.

Though delays hampered our growth and challenged us beyond the daily rigors our industry present. However, I’m pleased that despite this environment we’re able to grow our gross margins during the year for nearly 14% as high as it has been on a manual basis and almost 20 years and we’re proud that our GAAP operating profit was up 38% for the year and our GAAP ETS grew by 68% during the year. We were able to achieve these results through a combination of improved mix and disciplined expense management.

Turning to our plans for 2014. First, we intend to grow our head count of account executives. We believe that new headcount additions coupled with increased productivity will allow us to grow our top line in excess of underlying market growth. As I mentioned earlier, we have continued to see growth in our solutions business which we define as datacenter centric products, software and services. That group of solutions grew 11% in 2013 and represents a significant and growing portion of our business.

We intend to continue to grow that business and we will. We have made significant investments in our subject matter expertise in all free sales capabilities, much of which began in the second half of 2013 and we will continue to grow our leverage that competency in 2014. As an example, we expect that construction of our new file datacenter will be completed in Q2 and we look forward to the expanded and enhanced capabilities which will allow us to bring to our customers beginning later in 2014.

On the SG&A side, in 2013 we were and in 2014 we will continue to be disciplined in our spending and drive operating leverage in our business. Considered together we believe that the plans that we’ve laid out and are committed to and the expands we have seen thus far in 2014 will allow us to grow more rapidly than the overall IT market during 2014.

Furthermore, we believe that by leveraging our investments and focusing on higher margin solutions we will continue to drive both our growth and our profitability by also remaining disciplined on expenses that are not directly tied to our customers’ need, we will in 2014 as we did in 2013 drive significant operating leverage.

In closing we’re convinced that IT is changing and we’re committed to being drivers of that change and champions of that change. The strategic priorities of our customers which include mobility cloud, software defined everything and anything, big data and internet for everything are and has been our priorities for some time. And our capabilities and our expertise in these areas position us well to partner with our world class OEM and advising guide our customers as they attempt to optimize their own IT environment not for today but for the next several years.

At this point, I’ll turn the call back over to Eric and open it up for any questions. Eric?

Question-and-Answer Session

[Operator Instructions] And our first question comes from [indiscernible] please go ahead.

Unidentified Analyst

Hi, guys.

Frank F. Khulusi

Hi, Bill.

Unidentified Analyst

I got, just one simple question and maybe you can explain this to me but when I look at Q4 and I look at your group and sister group of insights CDW, PC Connection and you guys, they were all up 4% on the top line, you were down 3 and in Q3 CDW and PC Connection showed revenue growth inside showed negative 3 and you showed negative 1. My question is are you all losing market share to I guess primarily to CDW and PC Connection and if so what you’re doing to stream that?

Frank F. Khulusi

Well, as we talked about there earlier, our Q4 challenges were kind of specific where more of a percents of our sales comes from the Apple side of things and therefore our Q4 is more dependent on Apple tends to be very heavy Apple and we could not get the supply that did affect us in the fourth quarter. If you look at our Q1 and Q2, we were comping pretty nicely.

If you look at Q4, you see from a demand perspective the year-over-year in October, improved upon in November and then improved upon again in December, so we’re exiting the year end December, we’re comping up and then in Q1 so far we’re very much within the trend that we talked about which is to exceed the industry growth forecast that analysts have talked about which is low to middle single digits and our trend so far for Q1 have exceeded that in December and they’ve also exceeded that so far in Q1.

The last thing that I want to talk about is that we do quite a bit of business that we account on a net basis in the [passport] category and certain contracts and actually on our growth phases have the sales encountered on a gross basis and not on a net basis. We would have comped up actually in Q4 versus Q4 last year.

We tend to be little bit disproportionately lower in terms of software compared to these competitors that you mention and we’re currently undertaking a huge push and are making it significant investment in that regard. And our Q4 results we were very pleased with on the software side, bill has been counted on a gross basis instead of a net basis we would have reported growth for the fourth quarter.

Unidentified Analyst

Are you implying that these other three they reported on a gross basis on the software?

Frank F. Khulusi

No, I’m not implying that but what I’m implying is our growth in those categories may have exceeded there and therefore when you talk through some of that end or when you talk through that end and you would get the year-over-year comp to be positive.

Brandon H. LaVerne

And Bill, just to clarify to, it’s not even necessarily the growth in the category, it’s a growth in the piper products underneath that category that are reported on a net basis. And so, we can’t just compare, we think we’re growing pretty substantially in the areas within the software specifically in areas where there is a lot more net [indiscernible] a pure license which is reported to gross.

Unidentified Analyst

Well, I’m just trying to get it figured out guys, the last guys report by a couple of weeks, it looks like to me your competitions did a better job and you all did get a handle on it, thank you.

Frank F. Khulusi

Thank you.

Operator

[Operator Instructions] I see no further questions at this time.

Frank F. Khulusi

Thank you, Eric. I would like to thank everyone on the PCM team for your continued efforts, dedication and good work. Thank you all very much again for spending some time this afternoon 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 first quarter conference call. In the meantime please contact us if you have any questions or if you have a need for IT solutions. Thanks again and have a great evening.

Operator

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

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