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

Q1 2018 PCM Inc Earnings Call

TORRANCE Apr 27, 2018 (Thomson StreetEvents) -- Edited Transcript of PCM Inc earnings conference call or presentation Wednesday, April 25, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brandon H. LaVerne

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

* Frank F. Khulusi

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

* Kim Rogers

* Robert Jay Miley

PCM, Inc. - President

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Conference Call Participants

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* 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

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the First Quarter 2018 PCM, Incorporated Earnings Conference Call. My name is Michelle, and I will 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.

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Kim Rogers, [2]

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Thank you, Michelle. Good afternoon, everyone. We appreciate you joining us today to discuss PCM's First 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 their prepared comments, we'll 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 Security and Exchange Commission.

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

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

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Thank you, Kim. Good afternoon, everyone, and thank you for joining us today. The first quarter showed strategic progress as evidenced by the strong financial performance in the quarter.

I'd like to thank my entire team for their hard work and dedication. The improvement in our financial results was achieved through increased performance in the areas of our business, where we have made significant investments and aligned our resources.

I'm pleased with the solid start of the year, with record first quarter results.

We saw revenue grow 4% to our new first quarter record of $542.8 million, on 6% growth in gross billings.

Gross profit increased 6% for our first quarter record $83.6 million. With a record 15.4% gross margin amongst the highest of our industry peers and driven in part by our 22% increase in services, which increased to 8% of net sales.

As a result of our improved gross profit and restrained spending, operating profit grew 32% for our first quarter record $6.2 million, and adjusted EPS grew 26% to $0.34.

We now have a global footprint with a presence in Canada and the U.K. In the first quarter, our Canadian segment grew net sales by 11%. Our new U.K. segment, which we launched in the second quarter of 2017, also delivered strong performance. U.K. net sales nearly doubled from Q4 levels to $18.1 million, while approaching breakeven profitability. Since its inception, the U.K. segment has delivered over $30 million in net sales.

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?

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

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Thank you, Frank. As discussed in our last conference call, we remain very focused on improving our cost structure. To that end, in early Q1 2018, we put in motion several targeted initiatives that are designed to provide productivity improvements throughout 2018.

While the productivity benefits from these initiatives were muted in Q1 by the investments we have made in U.K. business as well as the timing of when certain initiatives were implemented, improvements already -- are already evidenced in both our Commercial segment and Canadian segments.

In our Commercial segment, on a 2% year-over-year net sales growth, SG&A expenses declined 3% year-on-year, resulting in a 57 basis point improvement in this segment's cost structure as a percentage of net sales.

Similarly, in our Canadian segment, on 11% year-on-year net sales growth, we saw a 24 basis point improvement in SG&A expenses as a percentage of net sales.

Despite the focus on improving our cost structure, we also remain committed to our investments in our technology practice groups, which contributed to the 22% increase in service revenues and 14% growth in software.

Together with our investments in security, hybrid data center, cloud and managed services, the net result is a transformed business model that we expect is prime for long-term sustainable growth.

We have a competitive offering supported by an outstanding team, the combination of which is not only helping us to expand into new business areas with existing clients, it is also enabling us to win net new clients.

From a category highlight perspective, software represented 25% of gross billed revenues and grew 14% year-on-year.

Desktops and networking each represented 9% of gross billed revenues and grew 23% and 13%, respectively.

Delivered services represented 8% of the business and grew 22% year-on-year. Displays, servers, accessories and other grew 11%, 15%, 4% and 12%, respectively. These gains were partially offset by a 12% decline in the notebook and tablet category, largely driven by rollouts last year that did not repeat in Q1 of this year.

We also saw a decline in our manufacturer services and warranty category, which declined by 14%, driven by the loss of a federal contract that we chose to walk away from due to the profitability concerns with the contract, as we discussed in the past.

I want to thank our associates around the world for their hard work. We had a lot of successes in the first quarter from both a business development perspective and an operational perspective that position us for future growth.

On the business development front, PCM was named Adobe 2017 America's Partner of the Year. This is the first time that PCM has won this award, which is a testament to our team's hard work.

As an authorized Adobe platinum reseller, PCM has the ability to evaluate and deliver a variety of different Adobe licensing solutions, tailored to any organization size, needs and purchasing strategy.

We were also named the 2017 ESET Most Valuable Partner National Solutions Provider based on our ability to increase total revenue year-over-year as well as the highest number of net new business orders with deal registrations.

As previously highlighted, we are continuing to evolve and invest in our security practice and are at the forefront of solving security challenges our customers face.

Together with ESET, we are bringing the market valuable security solutions to both our Commercial and government clients. We're very pleased to have received this recognition as it demonstrates that the investments we are making are paying off.

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

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

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Thanks, Jay. Detailed information about our 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, our comparisons will be relative to the first quarter of 2017, unless otherwise noted.

Our 4% growth in consolidated net sales was driven primarily by the $18.1 million in sales from our new U.K. segment, was also impacted by an $18 million increase in sales reported on a net basis.

Our U.K. segment performed very well and improved the sequential results from the fourth quarter by nearly doubling its revenue while controlling costs.

The result was a $1.7 million improvement in its operating income, resulting in a substantial improvement from the $2 million operating loss in Q4 to just under $300,000 for the first quarter of 2018.

Our Public Sector net sales declined $10.5 million or 16%. However, nearly all of that decline resulted from a higher mix of sales reported on a net basis.

Gross billed revenues in our Public Sector business declined by less than 1%, despite the loss of a large federal contract that we were unwilling to rebid at a loss, which will impact our Public Sector results through mid-Q3.

Our Canadian segment continued to perform well, increasing its net sales by 11% in the quarter despite a $1.4 million increase in sales reported on a net basis.

Our top partners by billed revenues in the first quarter of 2018 were Microsoft, HP Inc., Dell, Cisco, Apple, Lenovo and Hewlett-Packard Enterprise. Collectively, these top 7 partners represented approximately 56% of gross billed revenues.

Consolidated gross profit grew to a first quarter record $83.6 million with gross margin also improving to a record 15.4%.

Gross margin was positively impacted by the $18 million increase in sales reported on a net basis and also by improvement in our selling margins driven by a higher mix of services and solutions, partially offset by a reduction in vendor consideration received as a percentage of net sales.

Consolidated SG&A expenses increased by $3.6 million, primarily due to a $4.6 million increase in personnel costs, of which $3.1 million related to our new U.K. segment, which as stated earlier was launched in the second quarter of 2017.

The increase in our SG&A expenses was also related to a $600,000 increase in lease expenses, partially offset by a $1.6 million decrease in outside service costs related to the termination of the Pakistani BPO service contract and a $600,000 decrease in travel and entertainment expenses.

Interest expense increased by $800,000 to $2.5 million due to higher variable interest rates related to the increase in LIBOR over the prior year period as well as higher average borrowings during the first quarter of 2018 compared to the first quarter of 2017.

Income tax expense was $1.1 million or 28.9%, reflecting the new lower federal income tax rate and other factors within tax reform compared to income tax in the first quarter of 2017, which benefited from the credit to income tax expense of $2.3 million related to excess tax benefit associated with the exercise of stock options.

We continue to expect our effective tax rate to be in the 29% range for the 2018 year.

Turning to the balance sheet and cash flow, as we stated last quarter, we had 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 first quarter, we generated $39.5 million of operating cash flow, driven primarily from a $28 million reduction in inventory levels from the peak we saw at the end of the year. We also indicated we will see a reduction in CapEx, which were $1.5 million in the quarter compared to $6 million in the year ago quarter.

As a result, we were able to pay down approximately $30 million of debt during the quarter and expect to see further working capital improvements as we move further into 2018.

Lastly, I'd like to point out that we put a detailed table in our earnings release showing the quarterly impact in our prior year results from the adoption of ASC 606.

Our financials have been restated for 2016 and 2017. And as a result, I'm happy to discuss further with anyone needing a deeper understanding of the impact of ASC 606 on our results.

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

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

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Thank you, Brandon. We are tracking to a record year in sales, gross profit and adjusted EPS for 2018, as we begin reaping the benefits for our 2017 investments in security, cloud, hybrid data center, managed services and other areas.

We are reiterating our 2018 guidance for non-GAAP earnings per share to be in the range of $2 to $2.10 per share, including the results of our U.K. segment, which we anticipate being profitable for the full year of 2018.

Giving effect to the new revenue standard, which is being reflected in our guidance for the first time, and that some of our highest-growing areas of the business such as security are now reported on a net basis, we expect our full year 2018 growth will be approximately 4%.

We are also raising our gross margin guidance from approximately 15% to a new range of 15.0% to 15.5% for the full year.

Further, given the seasonality of our state, local and education component of our Public Sector business, and given the historic strength of netted down revenue in the second quarter, among other factors, we expect revenue growth in the third and fourth quarter to exceed that of the second quarter.

Operator, we can now open the call for Q&A. Michelle?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of William Gibson with Roth Capital Partners.

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William Tennent Gibson, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [2]

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Yes, I think my first question would be for Jay and if you could give us just a little more depth or color on what's going on in the Commercial market and how you are, indeed, grabbing new customers?

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Robert Jay Miley, PCM, Inc. - President [3]

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Yes, Bill. So I mean, I think it all stems from the expanded service offerings and our go-to-market approach around solutions, to be quite candid with you. We've made investments that Frank has indicated and that I've indicated or highlighted around managed services, security, hybrid data center, et cetera. You couple that with our already strong presence in the endpoint solutions business, I think we offer a very compelling one-stop shop for many of our customers. And as what we're seeing, quite frankly, is that more and more than not, end customers are looking to narrow the number of folks they're dealing with. And our breadth of offer is a competitive advantage, especially when you compare us to some of the regional and more local VARs and is helping us secure net new customers.

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William Tennent Gibson, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [4]

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Any difference between like large enterprises and small- to medium-size businesses? Or, they performing about the same?

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Robert Jay Miley, PCM, Inc. - President [5]

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Yes. Look, I mean, I think that it ebbs and flows quarter-to-quarter from our perspective in terms of when we look at the segment approach. But clearly, our service offerings, a [hunt] in all segments: Enterprise, mid-market and small business. As you know, we go-to-market in the mid-market enterprise predominantly with the services led, solutions led, approach that's field-centric. In SMB, we go after that business via predominantly an inside sales motion. But both those motions in all those segments have the capability to leverage our solutions capabilities in our services mechanisms. So really, I think -- I guess, the short answer is, I think that we're seeing success across-the-board.

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William Tennent Gibson, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [6]

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And then in the public sectors, we get into the back half of the year, do you think that improves or does that stay tough all year?

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Robert Jay Miley, PCM, Inc. - President [7]

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Well, I don't know if you heard when Brandon said that the -- on a gross billings basis, Public Sector declined by 1%, which is essentially flat. And when you factor the fact that we -- there's a large contract that we've previously disclosed, we chose not, to walk away from, because otherwise it would have been transacted at a loss. And we believe that the people who want it actually ended up with it at a loss. When you factor that out, we actually grew. So I would say, yes, especially when that last and especially with the other changes that we made to the business. However, nothing in our business is guaranteed as we have to win business day in and day out.

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Operator [8]

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(Operator Instructions) And our next question comes from the line of Kara Anderson with B. Riley FBR.

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Kara Lyn Anderson, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [9]

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Just on the SG&A expense, I think previously you said you expected that as a percentage of net sales to improve by 100 basis points. Is that still the expectation with the new revenue, I guess, target for the year?

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Robert Jay Miley, PCM, Inc. - President [10]

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Yes. Yes, Kara, I'll take that. The new ASC 606 changes the math a little bit. But directionally, we're still committed to the 100 basis points.

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

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Actually, the actions that we were going to undertake have a both -- have both a gross dollar amount as well as a percentage of sales amount. The gross dollar amount does not change, but the actual percentage of sales because of new accounting pronouncement makes it where we're coming off of that number a little bit because of how the percentages shake out. However, directionally, it's still in the same range.

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Robert Jay Miley, PCM, Inc. - President [12]

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It's more mathematical effect of the change in the way we're doing the sales number now. So directionally, we're committed to the same things we talked about last time.

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Brandon H. LaVerne, PCM, Inc. - CFO, Treasurer, CAO & Assistant Secretary [13]

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Kara, it's Brandon. I'd also say it's one of the reasons why gross margins are a little bit higher as well. And so with the growth in the business that we've talked about in the growing areas in the net down world, which is basically a software maintenance, hardware maintenance and security, all those numbers get lifted a little bit, and so the bottom line results end up the same. The margin component or the margin mathematical calculation is a little bit different. So nothing has really shifted, it's just that number is not going to be 100 basis points in our current expectation.

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Kara Lyn Anderson, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [14]

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Understood. Glad to hear you're still committed to it, at least from a dollar perspective. And then if the mix does continue to favor services, is there room for the gross margin to continue to improve beyond the new 15% to 15.4%, I think, you -- or 15.5% range that you laid out?

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Frank F. Khulusi, PCM, Inc. - Co-Founder, Chairman & CEO [15]

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Yes, there is. But we don't want to commit to that for 2 reasons. Number one, as I keep repeating, in our business, although we are increasingly having more and more of a recurring revenue stream in our business, we still have to build the business and win the business day in and day out. So that -- we want to be conservative when it comes to that. The second reason is, we don't control what our -- what the competitive environment looks like. And so that is a factor. And then third, we may want to reinvest some of that upside into the -- winning more deals and being more competitive. So with that in mind, we're only comfortable right now stating the existing margin range. But I would say that from an activity perspective and where we're doing as a company, we're definitely going into areas where that allow us over time to increase the gross margin, all other things being equal.

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Operator [16]

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And I'm showing no further questions at this time. And I would like to turn the conference back over to Frank Khulusi for any further remarks.

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

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Well, 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.

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Operator [18]

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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.