U.S. Markets close in 48 mins

Edited Transcript of PCMI earnings conference call or presentation 25-Jul-18 8:30pm GMT

Q2 2018 PCM Inc Earnings Call

TORRANCE Aug 1, 2018 (Thomson StreetEvents) -- Edited Transcript of PCM Inc earnings conference call or presentation Wednesday, July 25, 2018 at 8:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Brandon H. LaVerne

PCM, Inc. - CFO, Treasurer, CAO & Assistant Secretary

* Frank F. Khulusi

PCM, Inc. - Co-Founder, Chairman & CEO

* Kimberly Rogers

Hayden IR, LLC - MD

* Robert Jay Miley

PCM, Inc. - President

================================================================================

Conference Call Participants

================================================================================

* Kara Lyn Anderson

B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group

* William Tennent Gibson

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 PCM, Inc. Earnings Conference Call. My name is Victor, and I'll be your coordinator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

For opening remarks and introductions, I would like to turn the call over to Kim Rogers of Hayden IR. Please go ahead.

--------------------------------------------------------------------------------

Kimberly Rogers, Hayden IR, LLC - MD [2]

--------------------------------------------------------------------------------

Thank you, Victor. Good afternoon, everyone. We appreciate you joining us today to discuss PCM's Second Quarter 2018 Financial Results. Joining me on the call today are Frank Khulusi, PCM's Chairman and Chief Executive Officer; Jay Miley, President; and Brandon LaVerne, Chief Financial Officer. Following the prepared comments, we will open the call to your questions.

At this time, I'd 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.

Now I'd like to turn the call over to Frank Khulusi. Please go ahead, Frank.

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [3]

--------------------------------------------------------------------------------

Thank you, Kim. Good afternoon, everyone, and thank you for joining us today. Continuing our momentum from Q1, I'm very pleased with our fantastic results in the second quarter. We achieved record gross profit, gross margin and adjusted EPS through solid execution in our strategic areas of focus and investment.

During the quarter, we increased our focus on higher-margin sales such as managed services, advanced technology, cloud and security solutions and in some cases walked away from some low-margin volume businesses we identified as unprofitable. These moves helped us achieve our highest-ever gross margin of 16.5% of sales, 120 basis points higher than the same quarter last year and resulted in a slight reduction in sales, an outcome we're happy with as our gross profit increased 6% from the same quarter last year.

Reflecting strong expense discipline, consolidated SG&A expenses declined by 3% despite the 6% increase in gross profit. All of this resulted in us reaching on a non-GAAP basis adjusted EBITDA of $19 million, an adjusted EBITDA margin of 3.5% and adjusted EPS of $0.82, all significant bottom line achievements we're proud of.

Additionally, this increased profitability, combined with our focus on working capital management, resulted in approximately $33 million of increased operating cash flow and nearly $36 million in further reductions in our debt, which has now declined by nearly $69 million since the end of 2017. I would like to thank all my fellow coworkers at PCM for their hard work, die-hard dedication and significant contribution to these record results.

At this time, I'd like to turn the call over to our President, Jay Miley, for some more specific details on the quarter. Jay?

--------------------------------------------------------------------------------

Robert Jay Miley, PCM, Inc. - President [4]

--------------------------------------------------------------------------------

Thank you, Frank. As discussed in our last couple of conference calls, we remain very focused on improving our cost structure. In Frank's comments, he indicated that consolidated SG&A expenses decreased 3% on a consolidated gross profit increase of 6%.

I'm going to give you a little more color regarding the improvements we are making here. Excluding the $2.1 million year-on-year increase in SG&A expenses in our U.K. segment, SG&A declined by $4.7 million or 6%. Of that $4.7 million decrease, variable SG&A expenses, including commissions, credit card processing fees and warehouse fulfillment cost, increased as expected by $1.4 million, largely driven by higher commissions on the increased gross profit achieved in Q2 '18. This $1.4 million increase, however, was offset by the planned decrease in all other SG&A expenses of $6.1 million year-on-year or 9.4%, resulting in a 64 basis point improvement in fixed SG&A as a percentage of net sales, which again excludes the U.K. We will continue our cost discipline in quarters to come.

In addition to the surgical focus we have on reducing our cost structure, we also remain committed to the investments we are making in our technology practice groups, in particular the focus we have in our managed services, hybrid data center, security, collaboration and cloud practices. Our end customers are expecting more and more from their trusted advisers, and as such, we are making the appropriate investments to assist them on their digital transformation journey in all areas from the edge to the data center and to the cloud.

To that end, we continue to hire resources in all of the strategic areas. The resources we are hiring are not only focused on securing net new customers for our business. They are also focused on higher value-added activities that, in turn, enable us to earn higher margins, not only on the new business they secure but also on our existing base of business, which is helping to drive our margin rate to record highs.

From a category perspective, software represented 29% of our gross billed revenue but declined 10% year-on-year. The software category is the category that is most affected by our largest software partners' push away from the traditional legacy licensing models towards subscription- and cloud-based annuity software models.

Despite the drop in gross billed revenues, the software category performed very well for us in the quarter as we pivot to this annuity model and is one of the contributing factors to our strong gross profit margin performance as more and more of our legacy software business transforms to a software-as-a-service business model. In fact, we have seen significant sequential and year-over-year growth in this category and are amongst the leaders in the cloud model for our largest software partner.

Notebooks and tablets represent 17% of our billing mix and declined 8%. The decrease in revenue was largely attributable to project business last year that did not recur in our Commercial segment and some Chromebook and tablet volume that we walked away from due to profitability concerns.

Desktop and delivered services, which each represent 8% of our billings mix, grew 18% and 5%, respectively.

Networking and manufacturer services and warranties, respectively, represent 7% and 6% of our mix, and each grew 9%.

The servers, storage and display categories each represent 4% of our mix and grew year-on-year 28%, 18% and 4%, respectively. Accessories also represents 4% of our mix, and it was down 17% year-on-year, while input devices, which represent 2% of our mix, was up 12%.

In summary, we're making solid inroads as we transform our business and execute on our strategic areas of focus. This is exemplified by the fact that we ranked #2 globally by the Channel Futures 11th Annual MSP 501 worldwide rankings, which is the most comprehensive ranking of managed service providers worldwide. On behalf of the entire executive leadership team at PCM, I want to thank our associates around the world for making this ranking possible. The hard work you put in for us day in and day out is making a difference, and this award and many others like it is a testimony that your hard work and dedication is paying off.

I'll now turn the call over to Brandon LaVerne, our Chief Financial Officer, who will discuss our second quarter results in more detail. Brandon?

--------------------------------------------------------------------------------

Brandon H. LaVerne, PCM, Inc. - CFO, Treasurer, CAO & Assistant Secretary [5]

--------------------------------------------------------------------------------

Thanks, Jay. Detailed information about 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. As I review the results for the quarter, all comparisons will be relative to the second quarter of 2017 unless otherwise noted.

Our 2% decline in consolidated net sales was driven primarily by the $24.9 million reduction in Commercial sales and the $1.7 million decline in Public Sector sales but partially offset by increases internationally, with a $13.2 million increase in the U.K. and a $3.8 million or 9% increase in Canada. The decrease in Commercial was impacted by a large low-margin enterprise customer project in the prior year that did not reoccur as well as several specific customer deals we elected not to pursue based upon our focus on profitable growth.

As we've stated in the past, we also had the headwinds of the large low-margin federal contract that we did not rebid back in Q3 last year that continues to affect our year-over-year comparison. Overall, our consolidated sales of services grew 5% in the quarter.

Our top partners by billed revenues in the second quarter of 2018 were Microsoft, HP Inc., Dell, Cisco, Apple, Lenovo and Hewlett Packard Enterprise. Collectively, these top 7 partners represented approximately 60% of gross billed revenues.

Consolidated gross profit grew to an all-time record $90.4 million, with gross margin also improving to a record 16.5%, up 120 basis points, resulting from a higher mix of services and solutions.

Consolidated SG&A expenses decreased by $2.5 million, primarily due to a $2 million decrease in outside service cost largely related to the termination of the Pakistani BPO service contract and a $1 million decrease in telecommunication costs, partially offset by an increase in personnel costs of $1.2 million, which was primarily due to the growth of our new United Kingdom segment.

Interest expense increased by $300,000 to $2.3 million due to higher variable interest rates over the prior year period as well as higher average borrowings outstanding during the second quarter of 2018 versus the second quarter of 2017. Note that we were able to reduce interest expense by 6% sequentially from Q1 2018.

Income tax expense was $3.1 million or 28.4%, reflecting the new lower Federal income tax rate and other factors within tax reform compared to $1.2 million in income tax expense in the second quarter of 2017 or 33.4%. Our annual effective tax rate is 28.5%, and we believe this is a reasonable number for the full year of 2018.

Turning to the balance sheet and cash flow. We stated at the beginning of the year that we expected an improvement in our cash flow in 2018, resulting not only from our net profits but also from the normalization of our working capital metrics. I'm happy to report that in the second quarter we continued the momentum from the first quarter, and we generated an incremental $33 million of operating cash flow, totaling $72 million for the first 6-month period of 2018.

In addition to the cash flow from our profits, working capital improvements were driven primarily by a $103 million increase in accounts payable and a $25 million reduction in inventory but offset by only an $82 million increase in accounts receivable. The increase in accounts payable and accounts receivable was primarily due to seasonally strong sales and related purchase volume toward the end of the second quarter.

The inventory reduction related to the sell-through of certain purchases remained in the fourth quarter of 2017. We also indicated previously that we would see a reduction in capital expenditures, which were only $2.4 million in the quarter and the first 6 months compared to $9.1 million in the year-ago 6-month period. As a result, our net debt declined by nearly $69 million since the beginning of the year.

At this point, I'll turn it back -- the call back over to Frank to discuss our outlook. Frank?

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [6]

--------------------------------------------------------------------------------

Thank you, Brandon. Due to our strong performance year-to-date as well as having a solid outlook for the rest of the year, we're increasing our 2018 guidance for non-GAAP earnings per share by $0.20 to a range of $2.20 per share to $2.30 per share. We're also increasing our gross margin guidance for the year to a new range of 15.6% to 15.85% on revised sales growth guidance of low-single digits, reflecting our focus on more profitable sales.

Victor, we can now open the call for Q&A, please. Thank you.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And our first question will come from the line of Kara Anderson from B. Riley FBR.

--------------------------------------------------------------------------------

Kara Lyn Anderson, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [2]

--------------------------------------------------------------------------------

I guess as the first one for Brandon. Just wondering if you can provide some insight into sort of working capital expectations for the balance of the year. Where do you think we shake out in terms of cash flow for the full year?

--------------------------------------------------------------------------------

Brandon H. LaVerne, PCM, Inc. - CFO, Treasurer, CAO & Assistant Secretary [3]

--------------------------------------------------------------------------------

So as we see it, we obviously expect some incremental profits in the second half. And combined with that, we do expect some incremental benefits on working capital. So both of those combined should accrete more cash flow in our expectations as we sit today.

--------------------------------------------------------------------------------

Kara Lyn Anderson, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [4]

--------------------------------------------------------------------------------

Great. And then on the gross margin, the range you provided really implies you kind of revert back to, I guess, maybe a low 15% range for the second half of the year versus the 16.5%. What are you seeing or expecting to change in the mix for that change?

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [5]

--------------------------------------------------------------------------------

Well, we expect a strong contribution on the Federal side in the third quarter, which is typically at lower margin, and that's a factor in the equation. Do you want to add anything to that, Brandon?

--------------------------------------------------------------------------------

Brandon H. LaVerne, PCM, Inc. - CFO, Treasurer, CAO & Assistant Secretary [6]

--------------------------------------------------------------------------------

No. I think seasonally you always see Q2 being a very strong gross margin quarter for us as well, and so that clearly impacts the first half of the year compared to the full year so I think...

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [7]

--------------------------------------------------------------------------------

Yes. There's also a higher net down percentage, Kara, in the second quarter than there will be in the third and fourth quarter. So whereas the -- a forecasted decrease in gross margin in Q3 and Q4 from -- as compared to Q2 of this year, these 2 quarters will still be quite a bit up from the same period last year.

--------------------------------------------------------------------------------

Kara Lyn Anderson, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [8]

--------------------------------------------------------------------------------

Great. And then on the U.K. segment, I guess, it was a little lighter than I would have expected for that business that presumably should be ramping when you compare it to the first quarter. Just wondering if you can provide any additional detail on that or insight. Or maybe I'm thinking about it wrong.

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [9]

--------------------------------------------------------------------------------

For the second quarter for the U.K., it's typically seasonally strong from a public sector perspective. And since we are new to the market and none of the acquisition that we made is really that strong on the public sector side from a sales perspective -- from an overall sales perspective. So for us, it really becomes a 2019 type of thing. We did recently win in a couple of different public sector contracts. These just give us a license to hunt, and then you backfill with salespeople whose job is to go count and try to get as much as they can in sales -- in profitable sales to these contracts -- or underlying these contracts. And we expect that activity to actually help us during the second quarter of next year, but we were not able to participate in that at all in the second quarter of this year that just passed. In addition to that, there is a little bit of softness in the U.K. market right now surrounding the whole thing around Brexit, et cetera. We don't think that affected us because we're still kind of small and growing in that market, but we do hear a lot of good things to come in the future. And there was, of course, also a lot of focus on GDPR that took away some of the attention from these companies and some of their capital expenses in the quarter and concentrated it towards achieving the GDPR certification -- not certification but compliance. So overall, we continue to be very optimistic and bullish about -- and really on plan with respect to our long-term plan, I should say, with respect to the U.K. and even for that matter our EMEA aspirations.

--------------------------------------------------------------------------------

Kara Lyn Anderson, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [10]

--------------------------------------------------------------------------------

Great, that's very helpful. One more for me. Just...

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [11]

--------------------------------------------------------------------------------

Did I answer your question? Or would you any additional color on that?

--------------------------------------------------------------------------------

Kara Lyn Anderson, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [12]

--------------------------------------------------------------------------------

No, I think that was sufficient. One more point or question for me. Just hoping you might be able to elaborate on the telecommunication savings and whether that is a onetime thing or a sustainable savings going forward.

--------------------------------------------------------------------------------

Robert Jay Miley, PCM, Inc. - President [13]

--------------------------------------------------------------------------------

Yes, I'll take that question. So the savings was largely driven by an effort that we've undertaken over the last several quarters to reduce the number of circuits we have in some of our satellite offices. We moved quite a few of our satellite offices to our voice-over-IP solution that is ultimately helping us bring the cost down. You'll see sustained year-on-year improvement in that line. Sequentially, I will suggest that it'll probably tick up a little bit. But the reality is year-on-year you're going to see continued improvement for the rest of this year.

--------------------------------------------------------------------------------

Brandon H. LaVerne, PCM, Inc. - CFO, Treasurer, CAO & Assistant Secretary [14]

--------------------------------------------------------------------------------

Okay. Kara, this is Brandon. I -- the way I would portray that is I wouldn't necessarily annualize $4 million from the point you're seeing. So this is something that we try and call out the material items each quarter to make sense. This is an area that we've been focused on for a little bit. And so we do expect reductions in telecoms, as you said. I just don't know that you can model a $1 million quarterly savings based upon how the costs flow each quarter.

--------------------------------------------------------------------------------

Operator [15]

--------------------------------------------------------------------------------

And our next question comes from the line of William Gibson from Roth Capital.

--------------------------------------------------------------------------------

William Tennent Gibson, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [16]

--------------------------------------------------------------------------------

I'd like to follow up on Kara's question on the margins. And you mentioned third quarter being stronger on the federal side. Are they -- is the government transitioning less to the subscription model? Is that what is behind that?

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [17]

--------------------------------------------------------------------------------

No. This -- seasonally for us and for everybody, end of the fiscal year for the government comes into Q3. And therefore, we do get an uptick in those sales, and they're typically at lower margins. So when you -- when that happens, your overall consolidated margin goes down.

--------------------------------------------------------------------------------

William Tennent Gibson, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [18]

--------------------------------------------------------------------------------

And would -- just a follow-up. Within the advanced technology space, could -- perhaps we could have a little more color on the major groups?

--------------------------------------------------------------------------------

Robert Jay Miley, PCM, Inc. - President [19]

--------------------------------------------------------------------------------

Yes. The major groups in our Advanced Technologies space, I mean, we have a hybrid data center practice, we have a security practice, we have a collaboration practice, we have a cloud migration practice, all of which in our Q2 quarter performed well. And we aren't surprised by that because we've been very focused on that area. We've been making significant investments in that area. And I would suggest that we're bullish on the second half of the year as it pertains to the performance of these practices.

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [20]

--------------------------------------------------------------------------------

The performance of the company overall.

--------------------------------------------------------------------------------

William Tennent Gibson, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [21]

--------------------------------------------------------------------------------

Yes. And then just lastly, I noticed -- at least in the past, you've given revenue guidance. Do you think we could get growth in the second half? Or is there a range you expect? Or is it more of the same?

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [22]

--------------------------------------------------------------------------------

No. I mean, we did give a -- in our guidance it talks about sales growth as well, which we said is low-single digits for the year. That factors in our results so far year-to-date for the first half and implies a growth of low-single digits for the second half.

--------------------------------------------------------------------------------

Operator [23]

--------------------------------------------------------------------------------

(Operator Instructions) And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Frank Khulusi for closing remarks.

--------------------------------------------------------------------------------

Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [24]

--------------------------------------------------------------------------------

Thank you all for joining us this afternoon, and we look forward to updating you on our progress in the coming quarters. Until then, goodbye.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

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