UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2017

 

OR

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to                   

 

Commission File Number: 0-25790

 

PCM, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   95-4518700
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification Number)

 

1940 E. Mariposa Avenue

El Segundo, California 90245

(Address of principal executive offices)

 

(310) 354-5600

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ]   Accelerated filer [X]
     
Non-accelerated filer [  ]   Smaller reporting company [  ]
     
Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

 

As of August 4, 2017, the registrant had 12,594,342 shares of common stock outstanding.

 

 

 

   
 

 

PCM, INC.

 

TABLE OF CONTENTS

 

  Page
PART I - FINANCIAL INFORMATION  
   
Item 1. Financial Statements (unaudited)  
   
  Condensed Consolidated Balance Sheets as of June 30, 2017 and December 31, 2016 2
     
  Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2017 and 2016 3
     
  Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2017 and 2016 4
     
  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016 5
     
  Notes to the Condensed Consolidated Financial Statements 6
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 16
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
   
Item 4. Controls and Procedures 33
   
PART II - OTHER INFORMATION  
   
Item 1. Legal Proceedings 34
   
Item 1A. Risk Factors 34
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 49
   
Item 6. Exhibits 49
   
Signature 50

 

   
 

 

PCM, INC.

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands, except per share amounts and share data)

 

   June 30,
2017
   December 31,
2016
 
ASSETS          
Current assets:          
Cash and cash equivalents   $7,305   $7,172 
Accounts receivable, net of allowances of $881 and $832    442,460    358,949 
Inventories    77,439    80,872 
Prepaid expenses and other current assets    14,531    16,250 
Asset held for sale        5,812 
Total current assets    541,735    469,055 
Property and equipment, net    66,370    56,352 
Goodwill    83,581    83,388 
Intangible assets, net    13,103    15,074 
Deferred income taxes    722    947 
Investment and other assets    4,530    4,994 
Total assets   $710,041   $629,810 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current liabilities:          
Accounts payable   $355,834   $276,524 
Accrued expenses and other current liabilities    55,648    63,403 
Deferred revenue    7,507    10,960 
Line of credit    107,310    107,396 
Notes payable — current    10,611    11,168 
Note payable related to asset held for sale        4,601 
Total current liabilities    536,910    474,052 
Notes payable    25,055    18,750 
Other long-term liabilities    3,663    7,039 
Deferred income taxes    3,758    1,498 
Total liabilities    569,386    501,339 
Commitments and contingencies          
Stockholders’ equity:          
Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued and outstanding         
Common stock, $0.001 par value; 30,000,000 shares authorized; 17,092,707 and 16,465,567 shares issued; 12,594,342 and 11,967,202 shares outstanding    17    16 
Additional paid-in capital    133,117    127,777 
Treasury stock, at cost: 4,498,365 shares    (26,934)   (26,934)
Accumulated other comprehensive loss    (323)   (639)
Retained earnings    34,778    28,251 
Total stockholders’ equity    140,655    128,471 
Total liabilities and stockholders’ equity   $710,041   $629,810 

 

See Notes to the Condensed Consolidated Financial Statements.

 

2

 

 

PCM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share amounts)

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Net sales   $560,110   $580,994   $1,084,509   $1,079,023 
Cost of goods sold    474,739    497,995    920,933    925,717 
Gross profit    85,371    82,999    163,576    153,306 
Selling, general and administrative expenses    79,747    69,634    153,479    138,422 
Operating profit    5,624    13,365    10,097    14,884 
Interest expense, net    1,986    1,461    3,639    2,935 
Equity income from unconsolidated affiliate    135        273     
Income before income taxes    3,773    11,904    6,731    11,949 
Income tax expense    1,273    4,498    204    4,387 
Net income   $2,500   $7,406   $6,527   $7,562 
                     
Basic and Diluted Earnings Per Common Share                    
Basic   $0.20   $0.63   $0.52   $0.64 
Diluted    0.19    0.61    0.48    0.62 
                     
Weighted average number of common shares outstanding:                    
Basic    12,574    11,715    12,477    11,796 
Diluted    13,486    12,211    13,483    12,262 

 

See Notes to the Condensed Consolidated Financial Statements.

 

3

 

 

PCM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS

OF COMPREHENSIVE INCOME

(unaudited, in thousands)

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Net income   $2,500   $7,406   $6,527   $7,562 
                     
Comprehensive income:                    
Foreign currency translation adjustments    208    42    316    664 
Total other comprehensive income    208    42    316    664 
Comprehensive income   $2,708   $7,448   $6,843   $8,226 

 

See Notes to the Condensed Consolidated Financial Statements.

 

4

 

 

PCM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 

   Six Months Ended
June 30,
 
   2017   2016 
Cash Flows From Operating Activities          
Net income  $6,527   $7,562 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   6,913    8,047 
Equity income from an unconsolidated affiliate   (273)    
Provision for deferred income taxes   164    813 
Non-cash stock-based compensation   1,223    1,004 
Change in operating assets and liabilities:          
Accounts receivable   (81,203)   (55,514)
Inventories   3,433    (30,147)
Prepaid expenses and other current assets   1,784    (10,228)
Other assets   1,294    1,127 
Accounts payable   74,261    153,977 
Accrued expenses and other current liabilities   (4,362)   10,697 
Deferred revenue   (3,453)   11,915 
Total adjustments   (219)   91,691 
Net cash provided by operating activities   6,308    99,253 
Cash Flows From Investing Activities          
Purchases of property and equipment   (9,056)   (2,461)
Acquisition of assets of Systemax       (400)
Acquisition of Acrodex, net of cash acquired       (93)
Net cash used in investing activities   (9,056)   (2,954)
Cash Flows From Financing Activities          
Net payments under line of credit   (86)   (69,138)
Borrowings under notes payable   3,139     
Payments under notes payable   (1,992)   (2,488)
Change in book overdraft   5,038    (16,266)
Payments of obligations under capital leases   (860)   (1,280)
Proceeds from capital lease obligations   587     
Payments of earn-out liability   (6,523)   (5,886)
Proceeds from stock issued under stock option plans   4,722    726 
Payments for deferred financing costs   (635)   (404)
Common shares repurchased and held in treasury       (3,608)
Payment of taxes related to net-settled stock awards   (783)   (197)
Net cash provided by (used in) financing activities   2,607    (98,541)
Effect of foreign currency on cash flow   274    269 
Net change in cash and cash equivalents   133    (1,973)
Cash and cash equivalents at beginning of the period   7,172    11,176 
Cash and cash equivalents at end of the period  $7,305   $9,203 
Supplemental Cash Flow Information          
Interest paid  $3,263   $2,558 
Income taxes paid (refund), net   3,314    (153)
Supplemental Non-Cash Investing and Financing Activities          
Financed and accrued purchases of property and equipment  $14   $711 

 

See Notes to the Condensed Consolidated Financial Statements.

 

5

 

 

PCM, INC.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Basis of Presentation and Description of Company

 

PCM, Inc. is a leading multi-vendor provider of technology solutions, including hardware products, software and services, offered through our dedicated sales force and field service teams and direct marketing channels. Since our founding in 1987, we have served our customers by offering products and services from vendors such as Apple, Cisco, Dell, Hewlett Packard Enterprise, HP Inc., Ingram Micro, Lenovo, Microsoft and Tech Data. We add additional value by incorporating products and services into comprehensive solutions. Our sales and marketing efforts allow our vendor partners to reach multiple customer segments including small, medium and enterprise businesses, state, local and federal governments and educational institutions.

 

We have prepared the unaudited condensed consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in conformity with accounting principles generally accepted in the United States of America, or GAAP, which requires us to make estimates and assumptions that affect amounts reported herein. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances. Due to the inherent uncertainty involved in making estimates, our actual results reported in future periods may be affected by changes in those estimates. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations for interim financial reporting. In the opinion of management, all adjustments, consisting only of normal recurring items which are necessary for a fair presentation, have been included. The results for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC.

 

In connection with our entrance into the United Kingdom (“UK”) market in the first quarter of 2017, we formed a new operating segment called United Kingdom. As a result, we currently operate in four reportable segments: Commercial, Public Sector, Canada and United Kingdom. Our reportable operating segments are primarily aligned based upon our reporting of results as used by our chief operating decision maker in evaluating the operating results and performance of our company. We include corporate related expenses such as legal, accounting, information technology, product management and other administrative costs that are not otherwise included in our reportable operating segments in Corporate & Other.

 

We sell primarily to customers in the United States and Canada, and maintain offices in the United States and Canada, as well as in the Philippines and the United Kingdom. In the three months ended June 30, 2017, we generated approximately 78% of our revenue in our Commercial segment, 14% of our revenue in our Public Sector segment and 8% of our revenue in our Canada segment. PCM UK commenced its sales operations in May 2017 and our United Kingdom segment net sales were $0.4 million in the three months ended June 30, 2017.

 

Our Commercial segment sells complex technology solutions to commercial businesses in the United States, using multiple sales channels, including a field relationship-based selling model, an outbound phone based sales force, a field services organization and online extranets.

 

Our Public Sector segment consists of sales made primarily to federal, state and local governments, as well as educational institutions. The Public Sector segment utilizes an outbound phone and field relationship-based selling model, as well as contract and bid business development teams and an online extranet.

 

Our Canada segment consists of sales made to customers in the Canadian market beginning as of the respective dates of our acquisition of Acrodex and certain assets of Systemax in October and December 2015, respectively.

 

Our United Kingdom segment consists of results of our new subsidiary, PCM Technology Solutions UK, Ltd. (“PCM UK”), which serves as our hub for the UK and the rest of Europe.

 

Beginning in the first quarter of 2017, our financial results do not consolidate the financial results of sales made under some customer contracts we purchased in the En Pointe acquisition, which are now held by a partner which qualifies for certification as a minority and women owned business in accordance with customer supplier diversity policies. We hold a 49% passive equity interest in this partner and we have accounted for our investment in this partner using the equity method of accounting beginning in the first quarter of 2017. We refer to this entity as the non-controlled entity or NCE. We record our results from our 49% equity interest in the NCE’s operations as “Equity income from unconsolidated affiliate” in our consolidated statement of operations.

 

6

 

 

2. New Accounting Standards

 

In March, 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718) - Improvements to Employee Share-Based Accounting,” which simplifies several aspects of accounting for employee share-based payment transactions, including the accounting for income taxes, the calculation of diluted earnings per share, forfeitures, and statutory state tax withholding requirements, as wells as classification in statement of cash flows. We adopted ASU 2016-09 effective January 1, 2017 using the prospective method to recognize excess tax benefits and deficits in our consolidated statements of operations, and using the retrospective method relating to classification of excess tax benefits on our consolidated statements of cash flows. Also, we made an accounting policy election, on a modified prospective basis, to recognize forfeitures as they occur and cease estimating expected forfeitures. As a result of adopting ASU 2016-09, in the three and six months ended June 30, 2017, we recorded a credit to income tax expense of $0.4 million and $2.7 million, respectively, related to the excess tax benefits associated with the exercise of stock options and vesting of restricted stock units on our consolidated statement of operations, and we reclassified $52,000 from cash flows from financing activities to cash flows from operating activities for the six months ended June 30, 2016 to conform to our current period presentation. Also, we recorded a $94,000 cumulative effect adjustment to retained earnings as of January 1, 2017 as a result of our accounting policy election relating to forfeitures. We anticipate ongoing income tax expense volatility as a result of the adoption of this standard.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” which requires lessees to recognize right-of-use assets and lease liability, initially measured at present value of the lease payments, on its balance sheet for leases with terms longer than 12 months and classified as either financing or operating leases. ASU 2016-02 requires a modified retrospective transition approach for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, and provides certain practical expedients that companies may elect. ASU 2016-02 is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently evaluating the effects that the adoption of ASU 2016-02 will have on our consolidated financial statements.

 

In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes,” which requires all deferred tax assets and liabilities, and any related valuation allowance, to be classified as non-current on the balance sheet. The classification change for all deferred taxes as non-current simplifies entities’ processes as it eliminates the need to separately identify the net current and net non-current deferred tax asset or liability in each jurisdiction and allocate valuation allowances. We adopted ASU 2015-17 effective January 1, 2017 on a retrospective basis. As a result of the adoption, we reclassified current deferred tax assets of $3.6 million and current deferred tax liabilities of $0.6 million included in our balance sheet as of December 31, 2016 to noncurrent. There was no impact on our results of operations or our cash flows as a result of the adoption of ASU 2015-17.

 

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330) - Simplifying the Measurement of Inventory,” which requires that inventory within the scope of the guidance be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 applies to inventory that is measured using first-in, first-out (FIFO) or average cost. We adopted ASU 2015-11 effective January 1, 2017 and it did not have a material effect on our consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which, along with amendments issued in 2015 and 2016, will replace most existing revenue recognition guidance under GAAP and eliminate industry specific guidance. The core principle of the new guidance is that an entity should recognize revenue for the transfer of goods and services equal to an amount it expects to be entitled to receive for those goods and services. The ASU, as amended, will be effective beginning in the first quarter of 2018. The new guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively by recognizing the cumulative effect of initially applying the guidance to all contracts existing at the date of initial application (the modified retrospective method). We have engaged resources and created a cross-functional implementation team to analyze the effect of the new guidance, and have communicated progress to date to management and the audit committee. We are currently assessing all potential impacts of the standard on our contract portfolio by reviewing the current accounting policies and practices utilized to identify potential differences that would result from applying the requirements of the new standard to our various contracts. Given the breadth of the types of arrangements we have with customers, a substantial amount of work continues to remain in order to reach conclusions on the effects on our various revenue streams. We will adopt the guidance on January 1, 2018. We currently prefer to adopt the standard using the full retrospective method; however, our ability to do so is dependent on many factors, including the completion of our analysis of information necessary to recast prior period financial statements. Based on these and other factors, we may decide to use the cumulative catch-up transition method.

 

7

 

 

3. Acquisitions

 

Stratiform

 

On December 29, 2016, we completed the acquisition of Stratiform, Inc. for C$2.1 million in cash (or $1.6 million). Stratiform is an industry-leading provider of cloud IT solutions that include consulting, professional and managed services to clients across Canada. As part of the Stratiform acquisition, we agreed to pay certain contingent earn-out consideration related to years ending December 31, 2017, 2018 and 2019 (each year the “measurement period”), and payable 90 days in arrears following each measurement period. We have accrued approximately $0.7 million of contingent earn-out consideration, of which we have included $0.3 million in each of “Accrued expenses and other current liabilities” and “Other long-term liabilities” on our Condensed Consolidated Balance Sheet as of June 30, 2017.

 

Systemax

 

On December 1, 2015, we completed the acquisition of certain Business to Business (B2B) assets of Systemax’s North American Technology Group (NATG) for $14 million in cash. In January 2016, we exercised an option in our purchase agreement and paid $0.4 million related to our purchase of additional customer list information, which was recorded as an increase to goodwill associated with the Systemax assets acquisition.

 

Acrodex

 

On October 26, 2015, PCM Sales Canada, Inc., a wholly-owned subsidiary of PCM, Inc., completed the acquisition of all the outstanding common stock of Acrodex, Inc. (“Acrodex”) for a total purchase price of approximately C$16.7 million (or $13.6 million, net of cash acquired). In March 2016 and June 2016, we paid an additional $0.2 million and $0.1 million, respectively, related to adjustments to the net asset value as defined in the agreement, which was recorded as an increase to goodwill resulting from the Acrodex acquisition.

 

En Pointe

 

On April 1, 2015, we completed the acquisition of certain assets of En Pointe, one of the nation’s largest independent IT solutions providers, headquartered in Southern California. En Pointe is our largest acquisition to date based on revenues, and is expected to significantly enhance our relationships with several key vendor partners, provide incremental advanced technical certifications and operational expertise in key practice areas, and bring the consolidated business significantly increased scale. We acquired the assets of En Pointe’s IT solutions provider business, excluding cash and other current tangible assets such as accounts receivable. The assets were acquired by an indirect wholly-owned subsidiary of PCM, which subsidiary now operates under the En Pointe brand. Under the terms of the agreement, we paid an initial purchase price of $15 million in cash and an additional $2.3 million for inventory. We agreed to pay certain contingent earn-out consideration on a monthly basis, including 22.5% of the future adjusted gross profit of the business and 10% of certain service revenues over the three years following the closing of the acquisition. As of June 30, 2017, we have estimated that the fair value of contingent consideration to be paid throughout the earn-out period ending March 31, 2018 to be approximately $38.6 million. Our original estimate of the fair value of contingent consideration to be paid during the earn-out period, based on expected future results of the acquired business, was $32.5 million at the time of the acquisition. In the fourth quarter of 2015, as a result of an increase in expected future results of the acquired business, we increased the fair value of contingent consideration to $38.6 million. There has been no change to the fair value of expected contingent consideration since December 31, 2015. During the six months ended June 30, 2017 and 2016, we made $6.5 million and $5.9 million, respectively, of earn-out payments to the sellers of En Pointe. As of June 30, 2017, we have made 26 monthly earn-out payments, in aggregate totaling $28.5 million, to the sellers of En Pointe. As of June 30, 2017, we had $10.1 million of accrued earn-out liability included in “Accrued expenses and other current liabilities” on our Condensed Consolidated Balance Sheet for the final monthly payments to be made throughout the earn-out period ending March 31, 2018. The fair value of this contingent consideration is determined and accrued based on a probability weighted average of possible outcomes that would occur should certain financial metrics be reached. Because there is no market data available to use in valuing the contingent consideration, we developed our own assumptions related to the future financial performance of the businesses to determine the fair value of this liability. As such, the valuation of the contingent consideration is determined using Level 3 inputs. The significant inputs into the calculation of the contingent consideration include projected gross profit values of the Commercial and Public Sector components of En Pointe and the weighted average cost of capital of each component.

 

8

 

 

4. Property and Equipment

 

In January 2017, we completed the purchase of real property in Woodridge, Illinois for approximately $3.1 million in cash. The real property includes approximately 29,344 square feet of office space.

 

In September 2015, we listed our real property located in Irvine, California (the “Irvine Property”) for sale. Under a broker agreement, the Irvine Property is available for immediate sale in its present condition. We classified $5.8 million related to the Irvine Property, stated at lower of cost or fair value, as “Property held for sale” and $4.6 million related to the mortgage on the Irvine Property as “Note payable related to asset held for sale” on our Condensed Consolidated Balance Sheet as of December 31, 2016. As of June 30, 2017, the Irvine Property, which continues to be available for sale, has been classified as part of “Property and equipment, net” and the related mortgage as part of “Notes payable-current” and “Notes payable” on our Condensed Consolidated Balance Sheet as it no longer meets the criteria for held for sale classification primarily due to passage of time.

 

5. Goodwill and Intangible Assets

 

Goodwill

 

The change in the carrying amounts of indefinite-lived goodwill was as follows (in thousands) by segment:

 

   Commercial   Public Sector   Canada   Total 
Balance at December 31, 2016  $69,735   $8,322   $5,331   $83,388 
Foreign currency translation           193    193 
Balance at June 30, 2017  $69,735   $8,322   $5,524   $83,581 

 

Intangible Assets

 

The following table sets forth the amounts recorded for intangible assets (in thousands):

 

    Weighted
Average
Estimated
    At June 30, 2017     At December 31, 2016  
    Useful Lives
(years)
    Gross
Amount
    Accumulated
Amortization
    Net
Amount
    Gross
Amount
    Accumulated
Amortization
    Net
Amount
 
Patent, trademarks, trade names & URLs     4     $ 7,722 (1)   $ 2,541     $ 5,181     $ 7,691 (1)   $ 1,901     $ 5,790  
Customer relationships     15       13,456       6,634       6,822       13,369       5,480       7,889  
Non-compete agreements     4       2,369       1,269       1,100       2,361       966       1,395  
Total intangible assets           $ 23,547     $ 10,444     $ 13,103     $ 23,421     $ 8,347     $ 15,074  

  

 

(1)Includes $2.9 million of trademarks with indefinite useful lives that are not amortized.

 

Amortization expense for intangible assets was approximately $1.0 million and $1.4 million for the three months ended June 30, 2017 and 2016, and $2.1 million and $3.0 million for the six months ended June 30, 2017 and 2016. Estimated amortization expense for intangible assets as of June 30, 2017 in each of the next five years and thereafter is as follows: $2.1 million in the remainder of 2017, $3.0 million in 2018, $1.8 million in 2019, $1.3 million in 2020, $0.5 million in 2021 and $1.5 million thereafter.

 

9

 

  

6. Debt

 

The following table sets forth our outstanding debt as of the periods presented (in thousands):

 

    June 30,
2017
    December 31,
2016
 
Revolving credit facility, LIBOR plus 1.50%, maturing in March 2021   $ 107,310     $ 107,396  
Note payable, LIBOR plus 1.50%, maturing in March 2021           8,293  
Note payable, LIBOR plus 1.50%, maturing in March 2021     11,927       1,392  
Note payable, greater of 2% or LIBOR plus 2.15%, maturing in April 2022     4,503       4,601 (1)
Note payable, LIBOR plus 2.25%, maturing in January 2022     4,022       4,137  
Notes payable, 4.12%, 4.33% and 4.60%, matured in March 2017           525  
Note payable, LIBOR plus 2.25%, maturing in January 2020     6,952       7,107  
Note payable, Prime plus 0.375% or LIBOR plus 2.375%, maturing in November 2017     7,912       8,113  
Other note payable, maturing in August 2018     350       351  
Total     142,976       141,915  
Less: Total current debt     117,921       123,165  
Total non-current debt   $ 25,055     $ 18,750  

 

 
 
(1)This note payable, related to the Irvine Property, has been presented on our Condensed Consolidated Balance Sheet at December 31, 2016 as “Note payable related to asset held for sale” and was included as current debt. See Note 4 above for more information regarding the Irvine Property.

 

The following table sets forth the maturities of our outstanding debt balance as of June 30, 2017 (in thousands):

 

   Remainder of
2017
   2018   2019   2020   2021   Thereafter   Total 
Total long-term debt obligations  $9,524   $2,524   $2,524   $8,395   $6,091   $6,608   $35,666 
Revolving credit facility   107,310                        107,310 
Total  $116,834   $2,524   $2,524   $8,395   $6,091   $6,608   $142,976 

 

Line of Credit and Related Notes

 

We maintain a credit facility, which functions as a working capital line of credit with a borrowing base of inventory and accounts receivable, including certain credit card receivables, and a portion of the value of certain real estate. On January 19, 2016, we entered into a Fourth Amended and Restated Loan and Security Agreement (the “Fourth Amended Loan Agreement”) with certain lenders and Wells Fargo Capital Finance, LLC as administrative and collateral agent (the “Lenders”). On July 7, 2016, we entered into a First Amendment to the Fourth Amended Loan Agreement (the “First Amendment”) with the Lenders and on February 24, 2017, we entered into a Second Amendment to the Fourth Amended Loan Agreement (the “Second Amendment”) with the Lenders.

 

As amended to date, the terms of our credit facility provide for (i) a Maximum Credit, as defined in the credit facility, of $345,000,000; (ii) a sub-line of up to C$40,000,000 as the Canadian Maximum Credit ((i) and (ii) collectively the “Revolving Line”); (iii) a Maturity Date of March 19, 2021; (iv) interest on outstanding balance under the Canadian Maximum Credit based on the Canadian Base Rate (calculated as the greater of CDOR plus one percentage point and the “prime rate” for Canadian Dollar commercial loans, as further defined in the Fourth Amended Loan Agreement) or at the election of the Borrowers, based on the CDOR Rate, plus a margin, depending on average excess availability under the Revolving Line, ranging from 1.50% to 1.75%; and (v) interest on outstanding balance under the Maximum Credit based on the Eurodollar Rate plus a margin, depending on average excess availability under the revolving line, ranging from 1.50% to 1.75%. The credit facility also includes a monthly unused line fee of 0.25% per year on the amount, if any, by which the Maximum Credit, then in effect, exceeds the average daily principal balance of outstanding borrowings during the immediately preceding month.

 

The credit facility is collateralized by substantially all of our assets. In addition to the security interest required by the credit facility, certain of our vendors have security interests in some of our assets related to their products. The credit facility has as its single financial covenant a minimum fixed charge coverage ratio (FCCR) requirement in the event an FCCR triggering event has occurred. An FCCR triggering event is comprised of maintaining certain specified daily and average excess availability thresholds. In the event the FCCR covenant applies, the fixed charge coverage ratio is 1.0 to 1.0 calculated on a trailing four-quarter basis as of the end of the last quarter immediately preceding such FCCR triggering event date. At June 30, 2017, we were in compliance with our financial covenant under the credit facility.

 

Loan availability under the line of credit fluctuates daily and is affected by many factors, including eligible assets on-hand, opportunistic purchases of inventory and availability and our utilization of early-pay discounts. At June 30, 2017, we had $166.5 million available to borrow for working capital advances under the line of credit.

 

In connection with, and as part of, our revolving credit facility, we maintain sub-line with a limit of $12.5 million secured by our properties located in Santa Monica, California and has a monthly principal amortization of $149,083.

 

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Also on July 7, 2016, we entered into a Credit Agreement with Castle Pines Capital LLC (“Castle Pines”), which provides for a credit facility (“Channel Finance Facility”) to finance the purchase of inventory from a list of approved vendors. The aggregate availability under the Channel Finance Facility is variable and discretionary, but has initially been set at $35 million. Each advance under the Channel Finance Facility will be made directly to an approved vendor and must be repaid on the earlier of (i) the payment due date as set by Castle Pines or (ii) the date (if any) when the inventory is lost, stolen or damaged. No interest accrues on advances paid on or prior to payment due date. The Channel Finance Facility is secured by a lien on certain of our assets, subject to an intercreditor arrangement with the Lenders. The Channel Finance Facility has an initial term of one year, but shall be automatically renewed for one year periods from year to year thereafter unless terminated earlier by either party within reasonable notice periods.

 

Other Notes Payable

 

In March 2015, we completed the purchase of real property in Irvine, California for approximately $5.8 million and financed $4.9 million with a long-term note. The loan agreement provides for a seven-year term and a 25 year straight-line, monthly principal repayment amortization period that began on May 1, 2015 with a balloon payment at maturity in April 2022. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility. In September 2015, we listed the Irvine Property for sale.

 

In January 2015, we completed the purchase of certain real property in Lewis Center, Ohio for approximately $6.6 million and financed $4.575 million with a long-term note. The $4.575 million term note provides for a seven-year term and a 25 year straight-line, monthly principal repayment amortization period that began in February 2015 with a balloon payment at maturity in January 2022. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

Throughout 2014, we entered into three financing arrangements with a bank to finance the costs of equipment, software and professional services related to our ERP upgrade. The total amount financed was $5.6 million, with a quarterly repayment schedule which matured in March 2017.

 

In December 2012, we completed the purchase of 7.9 acres of land for approximately $1.1 million and have incurred additional costs of $12.2 million through December 31, 2014 towards the construction of a new cloud data center that we opened in June 2014. In July 2013, we entered into a loan agreement for with a bank for draws up to $7.725 million to finance the build out of the new data center. The loan agreement provides for a five-year term and a 25 year straight-line, monthly principal repayment amortization period with a balloon payment at maturity in January 2020. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

In June 2011, we entered into a credit agreement to finance a total of $10.1 million of the acquisition and improvement costs for the real property we purchased in March 2011 in El Segundo, California. The credit agreement provides for a five-year term and a 25 year straight-line, monthly principal repayment amortization period with a balloon payment at maturity in September 2016. In August 2016, we entered into an amendment with the lender extending the term of the loan to November 30, 2017. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

At June 30, 2017, the effective weighted average annual interest rate on our outstanding amounts under the credit facility, term note and variable interest rate notes payable was 2.85%.

 

The carrying amounts of our line of credit borrowings and notes payable approximate their fair value based upon the current rates offered to us for obligations of similar terms and remaining maturities.

 

7. Income Taxes

 

We determine our interim income tax provision by applying our effective income tax rate expected to be applicable for the full fiscal year to pre-tax income (loss) for the interim periods, adjusting the result for any discrete items which occurred during the interim period.

 

Accounting for Uncertainty in Income Taxes

 

At June 30, 2017 and December 31, 2016, we had unrecognized tax benefits of $0.5 million related to research credits. For the three and six months ended June 30, 2017 and 2016, we did not recognize any interest or penalties for uncertain tax positions, nor were there any interest or penalties accrued at June 30, 2017 and December 31, 2016. We do not anticipate any significant increases or decreases in our unrecognized tax benefits within the next twelve months.

 

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We are subject to U.S. and foreign income tax examinations for years subsequent to 2012, and state income tax examinations for years subsequent to 2011. However, to the extent allowable by law, the tax authorities may have a right to examine prior periods when net operating losses or tax credits were generated and carried forward for subsequent utilization, and make adjustments up to the amount of the net operating losses or credit carryforwards.

 

8. Stockholders’ Equity

 

We have a board approved discretionary stock repurchase program under which shares may be repurchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending on market conditions. Our Board of Directors originally adopted the plan in October 2008 with an initial authorized maximum of $10 million. The plan was amended in September 2012 and increased to $20 million, and again amended in April 2015 and increased to a total of $30 million. Under the program, the shares may be repurchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending on market conditions. We expect that the repurchase of our common stock under the program will be financed with existing working capital and amounts available under our existing credit facility. The repurchased shares are held as treasury stock. No limit was placed on the duration of the repurchase program. There is no guarantee as to the exact number of shares that we will repurchase. Subject to applicable securities laws, repurchases may be made at such times and in such amounts as our management deems appropriate. The program can also be discontinued at any time management feels additional purchases are not warranted.

 

We did not repurchase any shares of our common stock under this program during the three months ended June 30, 2017. From the inception of the program in October 2008 through June 30, 2017, we have repurchased an aggregate of 4,081,687 shares of our common stock for a total cost of $25.9 million. At June 30, 2017, we had $4.1 million available in stock repurchases under the program, subject to any limitations that may apply from time to time under our existing credit facility.

 

We have never paid cash dividends on our capital stock and our credit facility prohibits us from paying any cash dividends on our capital stock. Therefore, we do not currently anticipate paying dividends; we intend to retain any earnings to finance the growth and development of our business.

  

9. Earnings Per Share

 

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding during the reported periods. Diluted EPS reflects the potential dilution that could occur under the treasury stock method if stock options and other commitments to issue common stock were exercised, except in loss periods where the effect would be antidilutive. For the three months ended June 30, 2017 and 2016, approximately 114,000 and 626,000 common shares, respectively, have been excluded from the calculation of diluted EPS because the effect of their inclusion would have been antidilutive. For the six months ended June 30, 2017 and 2016, approximately 107,000 and 551,000 common shares, respectively, have been excluded from the calculation of diluted EPS because the effect of their inclusion would have been antidilutive.

 

The reconciliation of the amounts used in the basic and diluted EPS computation was as follows (in thousands, except per share amounts):

 

   Amount ($)   Shares   Per Share
Amounts ($)
 
Three Months Ended June 30, 2017:               
Basic EPS               
Net income  $2,500    12,574   $0.20 
Effect of dilutive securities               
Dilutive effect of stock awards       912      
Diluted EPS               
Adjusted net income  $2,500    13,486   $0.19 
                
Three Months Ended June 30, 2016:               
Basic EPS               
Net income  $7,406    11,715   $0.63 
Effect of dilutive securities               
Dilutive effect of stock awards       496      
Diluted EPS               
Adjusted net income  $7,406    12,211   $0.61 

 

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    Amount ($)     Shares    Per Share Amounts ($) 
Six Months Ended June 30, 2017:               
Basic EPS               
Net income  $6,527    12,477   $0.52 
Effect of dilutive securities               
Dilutive effect of stock awards       1,006      
Diluted EPS               
Adjusted net income  $6,527    13,483   $0.48 
                
Six Months Ended June 30, 2016:               
Basic EPS               
Net income  $7,562    11,796   $0.64 
Effect of dilutive securities               
Dilutive effect of stock awards       466      
Diluted EPS               
Adjusted net income  $7,562    12,262   $0.62 

 

10. Segment Information

 

Summarized segment information for our continuing operations for the periods presented is as follows (in thousands):

 

   Commercial   Public
Sector
   Canada   United Kingdom   Corporate &
Other
   Consolidated 
Three Months Ended June 30, 2017                              
Net sales  $439,538   $76,789   $43,600   $362   $(179)  $560,110 
Gross profit   67,218    11,064    7,185    53    (149)   85,371 
Depreciation and amortization expense(1)   1,430    207    198        1,556    3,391 
Operating profit (loss)   19,750    4,832    291    (1,585)   (17,664)   5,624 
                               
Three Months Ended June 30, 2016                              
Net sales  $445,022   $98,980   $37,004   $   $(12)  $580,994 
Gross profit   67,754    9,661    5,595        (11)   82,999 
Depreciation and amortization expense(1)   1,609    286    330        1,750    3,975 
Operating profit (loss)   22,486    4,276    824        (14,221)   13,365 
                               
Six Months Ended June 30, 2017                              
Net sales  $848,011   $144,057   $92,284   $362   $(205)  $1,084,509 
Gross profit   131,042    17,959    14,727    53    (205)   163,576 
Depreciation and amortization expense(1)   2,824    414    505        3,170    6,913 
Operating profit (loss)   37,960    6,226    1,515    (1,737)   (33,867)   10,097 
                               
Six Months Ended June 30, 2016                              
Net sales  $829,427   $171,443   $78,166   $   $(13)  $1,079,023 
Gross profit   125,847    15,676    11,797        (14)   153,306 
Depreciation and amortization expense(1)   3,243    576    668        3,560    8,047 
Operating profit (loss)   38,714    5,723    2,503        (32,056)   14,884 

 

 

(1) Primary fixed assets relating to network and servers are managed by the Corporate headquarters. As such, depreciation expense relating to such assets is included as part of Corporate & Other.

 

As of June 30, 2017 and December 31, 2016, we had total consolidated assets of $710.0 million and $629.8 million, respectively. Our management does not have available to them and does not use total assets measured at the segment level in allocating resources. Therefore, such information relating to segment assets is not provided herein.

 

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11. Commitments and Contingencies

 

Total rent expense under our operating leases, net of sublease income, was $1.5 million in each of the three month periods ended June 30, 2017 and 2016, respectively, and $2.9 million and $3.0 million in the six month periods ended June 30, 2017 and 2016, respectively. Some of our leases contain renewal options and escalation clauses, and require us to pay taxes, insurance and maintenance costs.

 

Legal Proceedings

 

From time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other litigation related to the conduct of our business. Any such litigation could result in a material amount of legal or related expenses and be time consuming and could divert our management and key personnel from our business operations. In connection with any such litigation, we may be subject to significant damages or equitable remedies relating to the operation of our business. Any such litigation may materially harm our business, results of operations and financial condition.

 

As described above in Note 3, we acquired certain assets of En Pointe Technologies in 2015. The assets were acquired by an indirect wholly-owned subsidiary of PCM, which subsidiary now operates under the En Pointe brand (“En Pointe”). We are currently involved in several disputes related to the En Pointe acquisition as described below. Any litigation, arbitration or other dispute resolution process could be costly and time consuming and could divert our management and key personnel from our business operations. In connection with any such matters, we may be subject to significant damages or equitable remedies relating to the operation of our business and could incur significant costs in asserting, defending, or settling any such matters. While we intend to pursue and/or defend these actions vigorously, we cannot determine with any certainty the costs or outcome of such pending or future matters, and they may materially harm our business, results of operations or financial condition.

 

Delaware Litigation with Collab9. On December 5, 2016, Collab9, Inc. (formerly, En Pointe Technologies Sales, Inc.) filed an action against PCM, Inc. and its subsidiary, En Pointe Technologies Sales, LLC, in the Superior Court of Delaware in New Castle County, Delaware. The action arises out of a March 12, 2015 Asset Purchase Agreement (“APA”) pursuant to which the Company acquired assets of Collab9’s information technology solutions business. Collab9’s complaint alleges that the Company breached the APA by failing to pay Collab9 the full amount of the periodic “earn-out” payments to which Collab9 is entitled under the APA. The complaint also alleges that the Company breached an obligation to cooperate with Collab9’s evaluation of its claim for breach of the APA’s earn-out provisions. The complaint does not specify the amount of damages Collab9 is seeking, but asserts that the amount of underpayment is “millions of dollars.” On February 8, 2017, the Company filed an answer to Collab9’s complaint in which the Company denied that it breached the APA and asserted that there is no merit in Collab9’s claim. On June 23, 2017, Collab9 informed the Company that Collab9 believes it has additional claims that the Company (i) breached an alleged obligation under the APA to provide a SAP software license to Collab9, (ii) improperly used, manipulated and/or copied data residing on the acquired business’ information technology platform, and (iii) improperly terminated Collab9’s access to certain software and data residing on that platform; however, Collab9 has not amended its complaint to include these claims. The court has not yet established a schedule for pretrial proceedings or for trial on the merits of Collab9’s claims. The Company believes the claims are speculative and wholly without merit, and intends to vigorously defend the claims. However, the outcome of this matter is uncertain and, as a result, the Company cannot reasonably estimate the loss or range of loss that could result in the event of an unfavorable outcome. Accordingly, no amounts have been accrued for any liability that may result from the resolution of this matter.

 

On April 11, 2017, the Company amended its answer to include counterclaims against the sellers in the Collab 9 transaction, including Collab9. These counterclaims assert claims for breach of contract, tortious interference, and intentional misrepresentation. The counterclaims include allegations that the sellers intentionally breached their representations and warranties concerning the financial statements of the business whose assets the Company acquired under the APA, and the need for minority business certifications which were required for certain acquired contracts under the APA. The counterclaims also include allegations that the sellers failed to disclose related party interests or retained control over Ovex Technologies (Private) Limited (“Ovex”), a third party operation in Pakistan that provided support functions for the acquired business. At this time, the outcome of this matter is uncertain.

 

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California Litigation with Collab9. On January 13, 2017, Collab9 filed an action against PCM, Inc. and its subsidiary, En Pointe Technologies Sales, LLC, in the Superior Court of California for the County of Los Angeles. The complaint alleges that, in connection with the Company’s processing of transactions with certain customers whose contracts the Company purchased the rights to under the APA following the closing of the APA, the Company, without authorization, accessed and altered electronically stored data of which Collab9 claims to have retained ownership. It further alleges that, although Collab9 authorized the Company to access the data in question during a post-closing transition period, the Company continued to access and alter the data Collab9 claims to own after an alleged termination of such authorization, and, in so doing, violated California’s Computer Data Access and Fraud Act. The Company believes the claims are wholly without merit, and intends to vigorously defend the claims. On February 21, 2017, the Company moved to dismiss the case on the ground that the APA governs this dispute and contains a provision designating New Castle County, Delaware as the exclusive forum in which claims arising out of or relating to the APA may be brought. Following briefing and oral argument on July 12, 2017, the court granted the Company’s motion to dismiss. We do not know whether Collab9 will refile the claim asserted in this action in a Delaware court. If a new action is filed in Delaware, the outcome of this matter is uncertain and, as a result, the Company cannot reasonably estimate the loss or range of loss that could result in the event of an unfavorable outcome. Accordingly, no amounts have been accrued for any liability that may result from the resolution of this matter.

 

California Litigation Against Yunus, Ovex, Din and Zones. On February 22, 2017, En Pointe filed an action against former employee Imran Yunus in California Superior Court alleging misappropriation of trade secrets, breach of contract, and other claims relating to Mr. Yunus’s departure from his employment at En Pointe to commence employment at a competitor. After discovering new facts about an alleged conspiracy to cause Ovex employees to resign and join a competitor, En Pointe amended the complaint on June 1, 2017 to add Zones, Inc., Ovex and Bob Din as defendants. In its complaint, En Pointe seeks damages against Zones, Yunus, and Din, and injunctive relief against all defendants. The core allegations relate to an alleged scheme orchestrated by defendant Din to conspire with Ovex management to cause Ovex employees to leave Ovex, taking En Pointe’s confidential information and trade secrets, and join competitor Zones. On June 6, 2017, a temporary restraining order was issued by the court in which defendants were ordered, among other things, to immediately provide En Pointe with access to information in their possession and to not use or disclose En Pointe’s trade secrets and confidential information. Ovex partially complied with the order and En Pointe continues to work with Ovex to complete the transfer to En Pointe of certain information in Ovex’s possession which En Pointe uses in connection with its business. On July 13, 2017, the court denied En Pointe’s request for a preliminary injunction, without prejudice, and dissolved the temporary restraining order for periods after July 13, 2017 without relieving defendants of their obligations while the temporary restraining order was in effect. The court based its decision primarily upon its determination that, at this stage of the litigation, there lacked sufficient evidence at this time to support the continued need for injunctive relief. A case management conference was held on July 27, 2017, at which a trial date was set for August 27, 2018.

 

Pakistan Litigation. On June 3, 2017, Ovex filed an action in Pakistan against En Pointe and PCM’s subsidiary in Pakistan claiming that En Pointe breached a contract pursuant to which Ovex provided En Pointe with back-office administrative support and customer service support. The complaint sought damages, declaratory relief that En Pointe’s termination of services contract should be suspended, and other injunctive relief. On the same date, the court in Pakistan issued a temporary order suspending the termination of the services contract pending a further hearing on the action and indicating that such order will not affect any other order or proceeding of any other competent judicial authority. En Pointe has filed applications before the court in Pakistan seeking orders dismissing the injunction and staying the case filed by Ovex seeking damages. En Pointe’s applications are based on its assertion that any matters to be litigated arising out of or in connection with the services contract is subject to a binding and enforceable exclusive arbitration clause in the services contract. The Company believes the claims by Ovex are speculative and wholly without merit, and intends to vigorously defend the claims. However, the outcome of this matter is uncertain and, as a result, the Company cannot reasonably estimate the loss or range of loss that could result in the event of an unfavorable outcome. Accordingly, no amounts have been accrued for any liability that may result from the resolution of this matter.

 

Ovex Arbitration. On June 6, 2017, En Pointe commenced arbitration against Ovex claiming damages arising from various claimed breaches by Ovex of the services contract between the parties. On July 7, 2017, an emergency arbitrator granted En Pointe some interim relief, including (i) a declaration that the arbitration clause in the services contract is valid and not waived, (ii) that any claim relating to termination of the services contract, or for beach of the contract, or for damages arising out of the services contract must be conducted within the arbitration, and (iii) that the services contract terminates no later than August 18, 2017. A permanent arbitrator for the action was appointed on August 3, 2017.

 

Federal Anti-Suit Injunction Action. On June 12, 2017, En Pointe filed a petition in the U.S. District Court for the Central District of California to compel arbitration for claims relating to the services contract with Ovex and for an anti-suit injunction against Ovex. In this action, En Pointe has sought an order directing that any claims for damages arising out of the services contract must occur in arbitration, and any attempt to pursue damages in a foreign jurisdiction will be blocked by an anti-suit injunction. The court has set a hearing on En Pointe’s petition for September 18, 2017.

 

Securities Class Action. On May 3, 2017, a purported securities class action was filed in the United States District Court for the Central District of California, entitled Miller v. PCM Inc., Case No. 2:17-cv-03364 (C.D. Cal. filed May 3, 2017). In this action, plaintiff, purportedly on behalf of a putative class of purchasers of PCM securities from June 17, 2015 through May 2, 2017, alleges that the Company and certain of its officers violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by intentionally or recklessly making false and/or misleading statements and/or failing to disclose that the financial statements of En Pointe, a company PCM acquired in 2015, materially overstated the profitability of En Pointe’s business. The complaint seeks unspecified damages against the defendants on behalf of a putative class of purchasers of the Company’s stock between June 17, 2015 and May 2, 2017. On July 27, 2017, the court appointed three individuals as lead plaintiffs and approved their selection of lead plaintiffs’ counsel. The defendants have not been served, and there is no current deadline for defendants to respond to the complaint. The Company denies the allegations in the complaint and will vigorously defend against this lawsuit. However, the outcome of this matter is uncertain and, as a result, the Company cannot reasonably estimate the loss or range of loss that could result in the event of an unfavorable outcome. Accordingly, no amounts have been accrued for any liability that may result from the resolution of this matter.

 

***

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations together with the consolidated financial statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those described under “Risk Factors” in Part II, Item 1A and elsewhere in this report.

 

BUSINESS OVERVIEW

 

PCM, Inc. is a leading multi-vendor provider of technology solutions, including hardware products, software and services, offered through our dedicated sales force and field service teams and direct marketing channels. Since our founding in 1987, we have served our customers by offering products and services from vendors such as Apple, Cisco, Dell, Hewlett Packard Enterprise, HP Inc., Ingram Micro, Lenovo, Microsoft and Tech Data. We add additional value by incorporating products and services into comprehensive solutions. Our sales and marketing efforts allow our vendor partners to reach multiple customer segments including small, medium and enterprise businesses, state, local and federal governments and educational institutions.

 

In connection with our entrance into the United Kingdom (“UK”) market in the first quarter of 2017, we formed a new operating segment called United Kingdom. As a result, we currently operate in four reportable segments: Commercial, Public Sector, Canada and United Kingdom. Our reportable operating segments are primarily aligned based upon our reporting of results as used by our chief operating decision maker in evaluating the operating results and performance of our company. We include corporate related expenses such as legal, accounting, information technology, product management and other administrative costs that are not otherwise included in our reportable operating segments in Corporate & Other.

 

We sell primarily to customers in the United States and Canada, and maintain offices in the United States and Canada, as well as in the Philippines and the United Kingdom. We opened a small office in Pakistan during the second quarter of 2017, which is currently used primarily as an administrative office. We have not hired any employees in Pakistan at this time. In the three months ended June 30, 2017, we generated approximately 78% of our revenue in our Commercial segment, 14% of our revenue in our Public Sector segment and 8% of our revenue in our Canada segment. In the six months ended June 30, 2017, we generated approximately 78% of our revenue in our Commercial segment, 13% of our revenue in our Public Sector segment and 9% of our revenue in our Canada segment. PCM UK commenced its sales operations in May 2017 and our United Kingdom segment net sales were $0.4 million in the three months ended June 30, 2017.

 

Our Commercial segment sells complex technology solutions to commercial businesses in the United States, using multiple sales channels, including a field relationship-based selling model, an outbound phone based sales force, a field services organization and online extranets.

 

Our Public Sector segment consists of sales made primarily to federal, state and local governments, as well as educational institutions. The Public Sector segment utilizes an outbound phone and field relationship-based selling model, as well as contract and bid business development teams and an online extranet.

 

Our Canada segment consists of sales made to customers in the Canadian market beginning as of the respective dates of our acquisition of Acrodex and certain assets of Systemax in October and December 2015, respectively.

 

Our United Kingdom segment includes the results of our new subsidiary, PCM Technology Solutions UK, Ltd. (“PCM UK”), which serves as our hub for the UK and the rest of Europe.

 

We experience variability in our net sales and operating results on a quarterly basis as a result of many factors. We experience some seasonal trends in our sales of technology solutions to businesses, government and educational institutions. For example, the timing of capital budget authorizations for our commercial customers can affect when these companies can procure IT products and services. The fiscal year-ends of U.S. Public Sector customers vary for those in the federal government space and those in the state and local government and educational institution (“SLED”) space. We generally see an increase in our second quarter sales related to customers in the U.S. SLED sector and in our third quarter sales related to customers in the federal government space as these customers close out their budgets for their fiscal year. Further, our Canadian business may see seasonal increases in the first quarter due to Canadian SLED budgets being closed out in the first quarter. We may also experience variability in our gross profit and gross profit margin as a result of changes in the various vendor programs we participate in and its effect on the amount of vendor consideration we receive from a particular vendor, which may be impacted by a number of events outside of our control. As such, the results of interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the full year.

 

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A substantial portion of our business is dependent on sales of Dell, HP Inc. and Microsoft products as well as products purchased from other vendors including Apple, Cisco, Hewlett Packard Enterprise, Ingram Micro, Lenovo, and Tech Data. Our top sales of products by manufacturer as a percent of our gross billed sales were as follows for the periods presented:

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Microsoft   20%   20%   17%   17%
HP Inc   9    9    9    10 
Dell   9    9    9    9 

 

Our planned operating expenditures each quarter are based in large part on sales forecasts for the quarter. If our sales do not meet expectations in any given quarter, our operating results for the quarter may be materially adversely affected. Our narrow margins may magnify the impact of these factors on our operating results. Management regularly reviews our operating performance using a variety of financial and non-financial metrics including sales, shipments, margin, vendor consideration, advertising expense, personnel costs, account executive productivity, accounts receivable aging, inventory turnover, liquidity and cash resources. Our management monitors the various metrics against goals and budgets, and makes necessary adjustments intended to enhance our performance.

 

General economic conditions have an effect on our business and results of operations across all of our segments. If economic growth in the U.S., Canada, the UK and other countries slows or declines, government, consumer and business spending rates could be significantly reduced. These developments could also increase the risk of uncollectible accounts receivable from our customers. The economic climate in the U.S., Canada, the UK and elsewhere could have an impact on the rate of information technology spending of our current and potential customers, which would impact our business and results of operations. These factors affect sales of our products, sales cycles, adoption rates of new technologies and level of price competition. We continue to focus our efforts on cost controls, competitive pricing strategies, and driving higher margin service and solution sales. We also continue to make selective investments in our sales force personnel, service and solutions capabilities and IT infrastructure and tools in an effort to meet vendor program requirements and to position us for enhanced productivity and future growth.

 

STRATEGIC DEVELOPMENTS

 

Acquisitions

 

In recent years, we have completed several strategic acquisitions to increase the capabilities, scale and value we provide our customers and partners, as follows:

 

  En Pointe: In April 2015, we acquired certain assets of En Pointe Technologies, one of the nation’s largest independent IT solutions providers, headquartered in Southern California. This acquisition has significantly enhanced our relationships with several key vendor partners, provided incremental advanced technical certifications and operational expertise in key practice areas, and has provided our consolidated business significantly increased scale, especially in the enterprise and public sector spaces.
     
  Acrodex: In October 2015, we acquired Acrodex, Inc., an Edmonton, Alberta (Canada) based solution provider. Acrodex provides full end-to-end infrastructure solutions primarily to Canadian based commercial and governmental customers from initial plan and design, through procurement and installation, to full support and on-going management. Acrodex’s core business areas include software value-added reseller services, software asset management and hardware sales and services, including client device products, servers, storage, networks, printers and a full complement of accessories and devices. Services are a significant component to Acrodex’s product mix and include managed services, cloud-based services, consulting, IT management and other IT service areas. This acquisition enhances our ability to provide full solutions to customers across the United States and Canada.
     
  TigerDirect: In December 2015, we acquired certain Business to Business (B2B) assets of Systemax’s North American Technology Group (NATG), including the TigerDirect brand, the right to hire approximately 400 B2B sales representatives located across the United States and Canada, all rights to the NATG B2B customer list, certain B2B customer and vendor contracts, trademarks and other intellectual property rights and certain fixed assets and equipment. We believe that this acquisition provided additional scale and opportunity to PCM in the SMB space.

 

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  Stratiform: In December 2016, we acquired Stratiform, Inc., a Calgary, Alberta (Canada) based provider of cloud IT solutions that includes consulting, professional, and managed services to clients across Canada. Stratiform, an innovative Gold Certified Microsoft Partner, expands our existing capabilities in Microsoft cloud technology, including Azure Cloud solutions, Office 365 and Enterprise Mobility Suite.

 

Since our acquisition of En Pointe, we have received third party back office support in Pakistan to supplement our captive support operations in other geographies. We expect the agreement for these outsourced services in Pakistan to expire in the third quarter of 2017. We have taken steps to transition these IT, accounting, customer service and order management and other support services to our wholly-owned service operations in the Philippines and other geographies. While we expect that the transition of these services may require management attention in the near term, we expect to achieve longer term efficiencies, improved capabilities and cost savings from this transition.

 

We are currently involved in several disputes related to the En Pointe acquisition. These proceedings are described under the heading “Legal Proceedings” in Part I, Item 1, Note 11 to the Notes to the Condensed Consolidated Financial Statements of this report and are incorporated herein by reference. Any litigation, arbitration or other dispute resolution process could be costly and time consuming and could divert our management and key personnel from our business operations. In connection with any such matters, we may be subject to significant damages or equitable remedies relating to the operation of our business and could incur significant costs in asserting, defending, or settling any such matters. While we intend to pursue and/or defend these actions vigorously, we cannot determine with any certainty the costs or outcome of such pending or future matters, and they may materially harm our business, results of operations or financial condition.

 

Investment in Non-Consolidated Affiliate

 

Beginning in the first quarter of 2017, our financial results do not consolidate the financial results of sales made under some customer contracts we purchased in the En Pointe acquisition, which are now held by a partner which qualifies for certification as a minority and women owned business in accordance with customer supplier diversity policies. We hold a 49% passive equity interest in this partner and we have accounted for our investment in this partner using the equity method of accounting beginning in the first quarter of 2017. We refer to this entity as the non-controlled entity or NCE. We record our results from our 49% equity interest in the NCE’s operations as “Equity income from unconsolidated affiliate” in our consolidated statement of operations.

 

Real Estate Transactions

 

In January 2017, we completed the purchase of real property in Woodridge, Illinois for approximately $3.1 million in cash. The real property includes approximately 29,344 square feet of office space.

 

In March 2015, we completed the purchase of real property in Irvine, California (the “Irvine Property”) for approximately $5.8 million and financed $4.9 million with a long-term note. The real property includes approximately 60,072 square feet of office and warehouse space and land. Certain of our subsidiaries were tenants of the building, which are continuing to use the office and warehouse space. In September 2015, we listed the Irvine Property for sale under a broker agreement. Under a broker agreement, the Irvine Property is available for immediate sale in its present condition.

 

ERP Upgrades

 

We have been in the process of upgrading our ERP systems. We have made significant progress in the configuration and implementation of the SAP platform. We anticipate migration of a significant portion of our legacy systems to the SAP platform throughout the remainder of 2017 and completion of the project in 2018 with a total expected capitalized cost of under $5 million.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our consolidated financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, net sales and expenses, as well as the disclosure of contingent assets and liabilities. Management bases its estimates, judgments and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Due to the inherent uncertainty involved in making estimates, actual results reported for future periods may be affected by changes in those estimates, and revisions to estimates are included in our results for the period in which the actual amounts become known.

 

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Management considers an accounting estimate to be critical if:

 

  it requires assumptions to be made that were uncertain at the time the estimate was made; and
  changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations or financial position.

 

Management has discussed the development and selection of these critical accounting policies and estimates with the audit committee of our board of directors. We believe the critical accounting policies described below affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. For a summary of our significant accounting policies, including those discussed below, see Note 2 of the Notes to the Consolidated Financial Statements in Item 8, Part II, of our Annual Report on Form 10-K for the year ended December 31, 2016.

 

Revenue Recognition. We adhere to the guidelines and principles of sales recognition described in ASC 605 — Revenue Recognition. Under ASC 605, product sales are recognized when the title and risk of loss are passed to the customer, there is persuasive evidence of an arrangement for sale, delivery has occurred and/or services have been rendered, the sales price is fixed or determinable and collectability is reasonably assured. Under these guidelines, the majority of our sales, including revenue from product sales and gross outbound shipping and handling charges, are recognized upon receipt of the product by the customer. In accordance with our revenue recognition policy, we perform an analysis to estimate the number of days products we have shipped are in transit to our customers using data from our third party carriers and other factors. We record an adjustment to reverse the impact of sale transactions based on the estimated value of products that have shipped, but have not yet been received by our customers, and we recognize such amounts in the subsequent period when delivery has occurred. Changes in delivery patterns or unforeseen shipping delays beyond our control could have a material impact on our revenue recognition for the current period.

 

For all product sales shipped directly from suppliers to customers, we take title to the products sold upon shipment, bear credit risk, and bear inventory risk for returned products that are not successfully returned to suppliers; therefore, these revenues are recognized at gross sales amounts.

 

We also sell certain products for which we act as an agent in accordance with ASC 605-45. Products in this category include the sale of third-party services, warranties, software assurance (“SA”) or subscriptions. SA is an “insurance” or “maintenance” product that allows customers to upgrade, at no additional cost, to the latest technology if new applications are introduced during the period that the SA is in effect. These sales do not meet the criteria for gross sales recognition, and thus are recognized on a net basis at the time of sale. Under net sales recognition, the cost paid to the vendor or third-party service provider is recorded as a reduction to sales, resulting in net sales being equal to the gross profit on the transaction.

 

Some of our larger customers are offered the opportunity by certain of our vendors to purchase software licenses and SA under enterprise agreements (“EAs”). Under EAs, customers are considered to be compliant with applicable license requirements for the ensuing year, regardless of changes to their employee base. Customers are charged an annual true-up fee for changes in the number of users over the year. With most EAs, our vendors will transfer the license and invoice the customer directly, paying us an agency fee or commission on these sales. We record these fees as a component of net sales as earned and there is no corresponding cost of sales amount. In certain instances, we invoice the customer directly under an EA and account for the individual items sold based on the nature of the item. Our vendors typically dictate how the EA will be sold to the customer.

 

When a customer order contains multiple deliverables such as hardware, software and services which are delivered at varying times, we determine whether the delivered items can be considered separate units of accounting as prescribed under ASC 605-25, Revenue Recognition, Multiple-Element Arrangement. For arrangements with multiple units of accounting, arrangement consideration is allocated among the units of accounting, where separable, based on their relative selling price. Relative selling price is determined based on vendor-specific objective evidence, if it exists. Otherwise, third-party evidence of selling price is used, when it is available, and in circumstances when neither vendor-specific objective evidence nor third-party evidence of selling price is available, management’s best estimate of selling price is used.

 

Revenue from professional services is either recognized as incurred for services billed at an hourly rate or recognized using the proportional performance method for services provided at a fixed fee. Revenue for data center services, including internet connectivity, web hosting, server co-location and managed services, is recognized over the period the service is performed.

 

Sales are reported net of estimated returns and allowances, discounts, mail-in rebate redemptions and credit card chargebacks. If the actual sales returns, allowances, discounts, mail-in rebate redemptions or credit card chargebacks are greater than estimated by management, additional expense may be incurred.

 

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Vendor Consideration. We receive vendor consideration from our vendors in the form of cooperative marketing allowances, volume incentive rebates and other programs to support our marketing of their products. Most of our vendor consideration is accrued, when performance required for recognition is completed, as an offset to cost of sales in accordance with ASC 605-50, Customer Payments and Incentives since such funds are not a reimbursement of specific, incremental, identifiable costs incurred by us in selling the vendors’ products. At the end of any given period, billed or accrued receivables related to our vendor consideration are included in our “Accounts receivable, net of allowances.” Any change by the vendors of their program requirements or any changes in estimates of performance under such programs could have a material impact to our results of operations.

 

Goodwill and Intangible Assets. Goodwill and indefinite-lived intangible assets are carried at historical cost, subject to write-down, as needed, based upon an impairment analysis that we perform annually, or sooner if an event occurs or circumstances change that would more likely than not result in an impairment loss. We perform our annual impairment test for goodwill and indefinite-lived intangible assets as of October 1 of each year.

 

Goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. Events that may create an impairment include, but are not limited to, significant and sustained decline in our stock price or market capitalization, significant underperformance of operating units and significant changes in market conditions. Changes in estimates of future cash flows or changes in market values could result in a write-down of our goodwill in a future period. If an impairment loss results from any impairment analysis as described above, such loss will be recorded as a pre-tax charge to our operating income. Goodwill is allocated to various reporting units, which are generally an operating segment or one level below the operating segment. At October 1, 2016, our goodwill resided in our Abreon, Commercial Technology, Public Sector and Canada reporting units.

 

Goodwill impairment testing is a two-step process. Step one involves comparing the fair value of our reporting units to their carrying amount. If the fair value of the reporting unit is greater than its carrying amount, there is no impairment and no further testing is required. If the reporting unit’s carrying amount is greater than the fair value, the second step must be completed to measure the amount of impairment, if any. Step two calculates the implied fair value of goodwill by deducting the fair value of all tangible and intangible assets, excluding goodwill, of the reporting unit from the fair value of the reporting unit as determined in step one. The implied fair value of goodwill determined in this step is compared to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss is recognized equal to the difference.

 

We performed our annual impairment analysis of goodwill and indefinite-lived intangible assets for possible impairment as of October 1, 2016. Our annual impairment analysis excluded goodwill associated with the Stratiform acquisition made during the fourth quarter of 2016, as its purchase price allocation was completed subsequent to the analysis date, and no impairment triggering events have occurred. Our management, with the assistance of an independent third-party valuation firm, determined the fair values of our reporting units and their underlying assets, and compared them to their respective carrying values. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. The carrying value of goodwill was allocated to our reporting units pursuant to ASC 350. As a result of our annual impairment analysis as of October 1, 2016, we have determined that no impairment of goodwill and other indefinite-lived intangible assets existed.

 

Fair value was determined by using a weighted combination of a market-based approach and an income approach, as this combination was deemed to be the most indicative of fair value in an orderly transaction between market participants. Under the market-based approach, we utilized information regarding our company and publicly available comparable company and industry information to determine cash flow multiples and revenue multiples that are used to value our reporting units. Under the income approach, we determined fair value based on estimated future cash flows of each reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of a reporting unit and the rate of return an outside investor would expect to earn.

 

In addition, fair value of our indefinite-lived trademark was determined using the relief from royalty method under the income approach to value. This method applies a market based royalty rate to projected revenues that are associated with the trademarks. Applying the royalty rate to projected revenues resulted in an indication of the pre-tax royalty savings associated with ownership of the trademarks. Projected after-tax royalty savings were discounted to present value at the reporting unit’s weighted average cost of capital, and a tax amortization benefit (calculated based on a 15-year life for tax purposes) was added.

 

In conjunction with our annual assessment of goodwill, our valuation techniques did not indicate any impairment as of October 1, 2016. All reporting units with goodwill passed the first step of the goodwill evaluation, with the fair values of our Abreon, Commercial Technology, Public Sector and Canada reporting units exceeding their respective carrying values by 80%, 79%, 130% and 168% and, accordingly, we were not required to perform the second step of the goodwill evaluation. We had $7.2 million, $62.5 million, $8.3 million and $5.3 million of goodwill as of October 1, 2016 residing in our Abreon, Commercial Technology, Public Sector and Canada reporting units, respectively. In applying the market and income approaches to determining fair value of our reporting units, we rely on a number of significant assumptions and estimates including revenue growth rates and operating margins, discount rates and future market conditions, among others. Our estimates are based upon assumptions we believe to be reasonable, but which by nature are uncertain and unpredictable. Changes in one or more of these significant estimates or assumptions could affect the results of these impairment reviews.

 

20

 

 

As part of our annual review for impairment, we assessed the total fair values of the reporting units and compared total fair value to our market capitalization at October 1, 2016, including the implied control premium, to determine if the fair values are reasonable compared to external market indicators. When comparing our market capitalization to the discounted cash flow models for each reporting unit summed together, the implied control premium was approximately 15% as of October 1, 2016.

 

Given continuing economic uncertainties and related risks to our business, there can be no assurance that our estimates and assumptions made for purposes of our goodwill and indefinite-lived intangible assets impairment testing as of October 1, 2016 will prove to be accurate predictions of the future. We may be required to record additional goodwill impairment charges in future periods, whether in connection with our next annual impairment testing as of October 1, 2017 or prior to that, if any change constitutes a triggering event outside of the quarter from when the annual goodwill and indefinite-lived intangible assets impairment test is performed. It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material.

 

We amortize other intangible assets with definite lives generally on a straight-line basis over their estimated useful lives, or in the case of customer relationships, based on a relative percentage of annual discounted cash flows expected to be delivered by the asset over its estimated useful life.

 

RESULTS OF OPERATIONS

 

Consolidated Statements of Operations Data

 

The following table sets forth, for the periods indicated, our Condensed Consolidated Statements of Operations (in thousands, unaudited, except per share amounts) and information derived from our Condensed Consolidated Statements of Operations expressed as a percentage of net sales. There can be no assurance that trends in our net sales, gross profit or operating results will continue in the future.

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Net sales  $560,110   $580,994   $1,084,509   $1,079,023 
Cost of goods sold   474,739    497,995    920,933    925,717 
Gross profit   85,371    82,999    163,576    153,306 
Selling, general and administrative expenses   79,747    69,634    153,479    138,422 
Operating profit   5,624    13,365    10,097    14,884 
Interest expense, net   1,986    1,461    3,639    2,935 
Equity income from unconsolidated affiliate   135        273     
Income before income taxes   3,773    11,904    6,731    11,949 
Income tax expense   1,273    4,498    204    4,387 
Net income  $2,500   $7,406   $6,527   $7,562 
                     
Basic and Diluted Earnings Per Common Share                    
Basic  $0.20   $0.63   $0.52   $0.64 
Diluted   0.19    0.61    0.48    0.62 
                     
Weighted average number of common shares outstanding:                    
Basic   12,574    11,715    12,477    11,796 
Diluted   13,486    12,211    13,483    12,262 

 

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   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Net sales   100.0%   100.0%   100.0%   100.0%
Cost of goods sold   84.8    85.7    84.9    85.8 
Gross profit   15.2    14.3    15.1    14.2 
Selling, general and administrative expenses   14.2    12.0    14.2    12.8 
Operating profit   1.0    2.3    0.9    1.4 
Interest expense, net   0.4    0.3    0.3    0.3 
Equity income from unconsolidated affiliate                
Income before income taxes   0.6    2.0    0.6    1.1 
Income tax expense   0.2    0.7        0.4 
Net income   0.4%   1.3%   0.6%   0.7%

 

Three Months Ended June 30, 2017 Compared to the Three Months Ended June 30, 2016

 

Net Sales

 

The following table presents our net sales by segment for the periods presented (in thousands):

 

   Three Months Ended June 30,         
   2017   2016         
   Net Sales   Percentage of
Total Net Sales
   Net Sales   Percentage of
Total Net Sales
   Dollar Change   Percent
Change
 
Commercial  $439,538    78%  $445,022    77%  $(5,484)   (1)%
Public Sector   76,789    14    98,980    17    (22,191)   (22)
Canada    43,600    8    37,004    6    6,596    18 
United Kingdom    362                362     
Corporate & Other   (179)       (12)       (167)   NM (1) 
Consolidated  $560,110    100%  $580,994    100%  $(20,884)   (4)%

 

 

(1)Not meaningful.

 

Consolidated net sales were $560.1 million in the three months ended June 30, 2017 compared to $581.0 million in the three months ended June 30, 2016, a decrease of $20.9 million, or 4%. As previously announced, beginning in the first quarter of 2017, our financial results do not consolidate the financial results of sales made under some customer contracts we purchased in the En Pointe acquisition, which are now held by a partner which qualifies for certification as a minority and women owned business in accordance with customer supplier diversity policies. Our consolidated net sales for the three months ended June 30, 2017 do not include $27.6 million of net sales made under contracts held by the NCE, of which our equity in net income of this unconsolidated affiliate was $0.1 million for the three months ended June 30, 2017. Further, our consolidated net sales were impacted by a shift in sales mix in our Public Sector segment towards products reported on a net basis. Consolidated sales of services were $40.8 million in the three months ended June 30, 2017 compared to $34.1 million in the three months ended June 30, 2016, an increase of $6.7 million, or 20%, and represented 7% and 6% of consolidated net sales in each of the three months ended June 30, 2017 and 2016, respectively.

 

Commercial net sales were $439.5 million in the three months ended June 30, 2017 compared to $445.0 million in the three months ended June 30, 2016, a decrease of $5.5 million or 1%. Our Commercial net sales for the three months ended June 30, 2017 does not include $27.6 million of net sales made under contracts now held by the NCE. Sales of services were $27.6 million in the three months ended June 30, 2017 compared to $25.8 million in the three months ended June 30, 2016, an increase of $1.8 million, or 7%, and represented 6% of Commercial net sales in each of the three months ended June 30, 2017 and 2016, respectively.

 

Public Sector net sales were $76.8 million in the three months ended June 30, 2017 compared to $99.0 million in the three months ended June 30, 2016, a decrease of $22.2 million, or 22%. The decrease in Public Sector net sales was primarily due to a shift in sales mix towards products reported on a net basis. Net sales in our SLED portion of our Public Sector business decreased 21% primarily due to this shift in sales mix. Net sales in our federal business declined 25% primarily due to reductions in sales under certain federal contracts during the quarter. Sales of services in our Public Sector segment were $5.8 million in the three months ended June 30, 2017 compared to $2.2 million in the three months ended June 30, 2016, an increase of $3.6 million, or 158%, and represented 8% and 2% of Public Sector net sales in each of the three months ended June 30, 2017 and 2016, respectively.

 

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Canada net sales were $43.6 million in the three months ended June 30, 2017 compared to $37.0 million in the three months ended June 30, 2016, an increase of $6.6 million, or 18%, related to increased sales of products and services across all of our Canadian business units. Sales of services were $7.4 million in the three months ended June 30, 2017 compared to $6.0 million in the three months ended June 30, 2016, an increase of $1.4 million, or 23%, and represented 17% and 16% of Canada net sales in each of the three months ended June 30, 2017 and 2016, respectively.

 

Our United Kingdom segment, which we formed in the first quarter of 2017, generated net sales of approximately $362,000 in the three months ended June 30, 2017.

 

Gross Profit and Gross Profit Margin

 

Consolidated gross profit was $85.4 million in the three months ended June 30, 2017 compared to $83.0 million in the three months ended June 30, 2016, an increase of $2.4 million, or 3%. Consolidated gross profit margin increased to 15.2% in the three months ended June 30, 2017 from 14.3% in the same period last year. The increase in consolidated gross profit was primarily due to the increase in sales of services during the quarter, combined with incremental funding received from vendors during the quarter, which is included as an offset to cost of goods sold. The increase in consolidated gross profit margin was primarily due to an increase in higher margin sales in each of our segments, including the impact of the increased mix of sales reported on a net basis, increased sales of services and advanced solutions and increased vendor consideration as a percentage of our net sales. Our consolidated gross profit margin also benefited from the non-consolidation in 2017 of contracts now held by the NCE, as discussed above, which have historically had lower margins.

 

Selling, General & Administrative Expenses

 

Consolidated SG&A expenses were $79.7 million in the three months ended June 30, 2017 compared to $69.6 million in the three months ended June 30, 2016, an increase of $10.1 million, or 15%. Consolidated SG&A expenses as a percentage of net sales increased to 14.2% in the three months ended June 30, 2017 from 12.0% in the same period last year. The increase in consolidated SG&A expenses were primarily related to a $4.1 million increase in personnel costs, primarily related to the investments we made in our advanced technology solutions practices in areas of new strategic focus and field and inside account executives in the U.S. and Canada, $1.5 million of personnel and other startup costs associated with our new UK segment, a $1.3 million class action settlement received in the prior year quarter, a $1.2 million increase in M&A and related litigation costs and a $0.6 million increase in third-party service costs.

 

Operating Profit (Loss)

 

The following table presents our operating profit (loss) and operating profit margin, by segment, for the periods presented (in thousands):

 

   Three Months Ended June 30,       Change in 
   2017   2016   Change in   Operating 
   Operating
Profit
   Operating
Profit
   Operating
Profit
   Operating
Profit
   Operating
Profit (Loss)
   Profit
Margin
 
    (Loss)    Margin(1)    (Loss)    Margin(1)    $    %    % 
Commercial   $19,750    4.5%  $22,486    5.1%  $(2,736)   (12)%   (0.6)%
Public Sector    4,832    6.3    4,276    4.3    556    13       2.0      
Canada   291    0.7          824    2.2    (533)   (65)   (1.5)
United Kingdom   (1,585)   NM(1)                 (1,585)   NM (1)   NM(1)
Corporate & Other    (17,664)   (3.2)(2)    (14,221)   (2.4 )(2)    (3,443)   24    (0.8)(2)
Consolidated   $5,624    1.0%  $13,365    2.3%  $(7,741)   (58)%   (1.3)%

 

 

(1) Not meaningful.

(2)Operating profit margin for Corporate & Other is computed based on consolidated net sales. Operating profit margin for each of the other segments is computed based on the respective segment’s net sales.

 

Consolidated operating profit was $5.6 million in the three months ended June 30, 2017 compared to $13.4 million in the three months ended June 30, 2016, a decrease of $7.8 million or 58%.

 

Commercial operating profit was $19.8 million in the three months ended June 30, 2017 compared to $22.5 million in the three months ended June 30, 2016, a decrease of $2.7 million, or 12%. The decrease in Commercial operating profit was primarily due to a $0.5 million decrease in Commercial gross profit, an increase of $0.9 million in allocated costs associated with our advanced solutions practices and an increase in direct Commercial personnel costs of $0.7 million, primarily related to incremental inside and field account executive headcount.

 

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Public Sector operating profit was $4.8 million in the three months ended June 30, 2017 compared to $4.3 million in the three months ended June 30, 2016, an increase of $0.5 million, or 13%. The increase in Public Sector operating profit was primarily due to a $1.4 million increase in Public Sector gross profit, partially offset by an increase in personnel costs of $0.8 million primarily related to incremental account executive headcount.

 

Canada operating profit was $0.3 million in the three months ended June 30, 2017 compared to $0.8 million in the three months ended June 30, 2016, a decrease of $0.5 million, or 65%, which was primarily due to an increase in personnel costs of $1.8 million related to our investment in advanced solutions and sales account executive headcount, as well as the addition of costs resulting from the acquisition of Stratiform in December 2016, partially offset by a $1.6 million increase in Canada gross profit.

 

United Kingdom operating loss was $1.6 million in the three months ended June 30, 2017, representing the segment’s second quarter of operating expenses which include overhead support and consulting costs, as well as startup legal and litigation costs.

 

Corporate & Other operating expenses include corporate related expenses such as legal, accounting, information technology, product management and certain other administrative costs that are not otherwise included in our reportable operating segments. Corporate & Other operating expenses were $17.7 million in the three months ended June 30, 2017 compared to $14.2 million in the three months ended June 30, 2016, an increase of $3.5 million, or 24%. The increase in our Corporate & Other operating expenses was primarily due to a $1.3 million gain resulting from a class action settlement related to an industry wide DRAM indirect antitrust litigation received in the three months ended June 30, 2016, an increase in M&A and related litigation costs of $1.1 million and an increase in personnel costs of $0.9 million.

 

Net Interest Expense

 

Total net interest expense for the three months ended June 30, 2017 was $2.0 million compared with $1.5 million in the same period of 2016. The $0.5 million increase in interest expense during the three months ended June 30, 2017 was primarily due to a $0.3 million interest charge related to unclaimed property reports dating back to 2003 and an increase in the average interest rate during the three months ended June 30, 2017 compared to the same period in the prior year, partially offset by the effect of a lower average outstanding loan balance during the three months ended June 30, 2017 compared to the same period in the prior year.

 

Income Tax Expense

 

We recorded an income tax expense of $1.3 million in the three months ended June 30, 2017 compared to $4.5 million in the three months ended June 30, 2016, inclusive of discrete items. Our effective tax rates for the three months ended June 30, 2017 and 2016, inclusive of discrete items, were 33.7% and 37.8%, respectively. In the three months ended June 30, 2017, we benefited from $0.4 million in excess tax benefits related to the exercise of stock options, which was recorded as a discrete item credited to income tax expense as a result of adopting ASU 2016-09 during the first quarter of 2017. The decrease in the effective tax rate for the three months ended June 30, 2017 compared to 2016 was primarily related to the effect of excess tax benefits related to the exercise of stock options.

 

Six Months Ended June 30, 2017 Compared to the Six Months Ended June 30, 2016

 

Net Sales

 

The following table presents our net sales by segment for the periods presented (in thousands):

 

   Six Months Ended June 30,         
   2017   2016         
   Net Sales   Percentage of
Total Net Sales
   Net Sales   Percentage of
Total Net Sales
   Dollar Change   Percent
Change
 
Commercial  $848,011    78%  $829,427    77%  $18,584    2%
Public Sector   144,057    13    171,443    16    (27,386)   (16)
Canada   92,284    9    78,166    7    14,118    18 
United Kingdom   362                362    NM (1) 
Corporate & Other   (205)       (13)       (192)   NM (1)
Consolidated  $1,084,509    100%  $1,079,023    100%  $5,486    1%

 

 

(1) Not meaningful.

 

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Consolidated net sales were $1,084.5 million in the six months ended June 30, 2017 compared to $1,079.0 million in the six months ended June 30, 2016, an increase of $5.5 million, or 1%. Our consolidated net sales for the six months ended June 30, 2017 do not include $46.5 million of net sales made under contracts held by the NCE, of which our equity in net income of this unconsolidated affiliate was $0.3 million for the six months ended June 30, 2017. Consolidated sales of services were $77.6 million in the six months ended June 30, 2017 compared to $66.4 million in the six months ended June 30, 2016, an increase of $11.2 million, or 17%, and represented 7% and 6% of consolidated net sales in each of the six months ended June 30, 2017 and 2016, respectively.

 

Commercial net sales were $848.0 million in the six months ended June 30, 2017 compared to $829.4 million in the six months ended June 30, 2016, an increase of $18.6 million or 2%. Our Commercial net sales for the six months ended June 30, 2017 does not include $46.5 million of net sales made under contracts now held by the NCE. Sales of services were $54.8 million in the six months ended June 30, 2017 compared to $50.3 million in the six months ended June 30, 2016, an increase of $4.5 million, or 9%, and represented 6% of Commercial net sales in each of the six months ended June 30, 2017 and 2016.

 

Public Sector net sales were $144.1 million in the six months ended June 30, 2017 compared to $171.4 million in the six months ended June 30, 2016, a decrease of $27.3 million, or 16%. The decrease in Public Sector net sales was primarily due to a shift in sales mix towards products reported on a net basis and a reduction in spend from a large customer in our SLED business in the first quarter of 2017, which contributed to a 20% decline in the SLED portion of our Public Sector business. Sales in our federal business declined by 8% primarily due to reductions in sales under certain federal contracts during the current year period. Sales of services were $7.9 million in the six months ended June 30, 2017 compared to $4.4 million in the six months ended June 30, 2016, an increase of $3.5 million, or 82%, and represented 6% and 3% of Public Sector net sales in each of the six months ended June 30, 2017 and 2016, respectively.

 

Canada net sales were $92.3 million in the six months ended June 30, 2017 compared to $78.2 million in the six months ended June 30, 2016, an increase of $14.1 million, or 18%. The increase in our Canada net sales was related to increased sales of services and product, as well as the sales resulting from our Stratiform acquisition, which was completed in December 2016. Sales of services were $14.9 million in the six months ended June 30, 2017 compared to $11.8 million in the six months ended June 30, 2016, an increase of $3.1 million, or 26%, and represented 16% and 15% of Canada net sales in each of the six months ended June 30, 2017 and 2016, respectively.

 

Gross Profit and Gross Profit Margin

 

Consolidated gross profit was $163.6 million in the six months ended June 30, 2017 compared to $153.3 million in the six months ended June 30, 2016, an increase of $10.3 million, or 7%. Consolidated gross profit margin increased to 15.1% in the six months ended June 30, 2017 from 14.2% in the same period last year. The increase in consolidated gross profit was primarily due to the increase in net sales discussed above combined with incremental funding received from vendors during the period, which is included as an offset to cost of goods sold and the increase in sales of services during the period. The increase in consolidated gross profit margin was primarily due to an increase in higher margin sales in each of our segments, including the impact of the increased mix of sales reported on a net basis, increased sales of services and advanced solutions and increased vendor consideration as a percentage of our net sales. Our consolidated gross profit margin also benefited from the non-consolidation in 2017 of contracts now held by the NCE, as discussed above, which have historically had lower margins.

 

Selling, General & Administrative Expenses

 

Consolidated SG&A expenses were $153.5 million in the six months ended June 30, 2017 compared to $138.4 million in the six months ended June 30, 2016, an increase of $15.1 million, or 11%. Consolidated SG&A expenses as a percentage of net sales increased to 14.2% in the six months ended June 30, 2017 from 12.8% in the same period last year. The increase in consolidated SG&A expenses were primarily related to a $6.6 million increase in personnel costs, primarily related to the investments we made in our advanced technology solutions practices in areas of new strategic focus and field and inside account executives in the U.S. and Canada, $1.7 million of personnel and other startup costs associated with our new UK segment, a $1.6 million increase in third-party service costs, a $1.3 million class action settlement received in the prior year quarter, a $1.1 million increase relating to legal settlement costs and a $1.0 million increase in telecommunications expenses. Since 2015, we have implemented a number of cost reduction measures in an effort to improve our operating margins. Our historically reported cost savings have been achieved across many elements of the business, and were not based upon shifting resources to our outsourced service provider in Pakistan.

 

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Operating Profit (Loss)

 

The following table presents our operating profit (loss) and operating profit margin, by segment, for the periods presented (in thousands):

 

   Six Months Ended June 30,           Change in 
   2017   2016   Change in   Operating 
   Operating
Profit
   Operating
Profit
   Operating
Profit
   Operating
Profit
   Operating
Profit (Loss)
   Profit
Margin
 
    (Loss)    Margin(1)    (Loss)    Margin(1)    $    %    % 
Commercial   $37,960    4.5%  $38,714    4.7%  $(754)   (2)%   (0.2)%
Public Sector    6,226    4.3    5,723    3.3    503    9    1.0 
Canada    1,515    1.6         2,503    3.2    (988)   (39)   (1.6)      
United Kingdom    (1,737)   NM(1)            (1,737)   NM(1)    NM (1)
Corporate & Other    (33,867)   (3.1)(2)   (32,056)   (3.0)(2)    (1,811)   6    (0.1)
Consolidated   $10,097    0.9%  $14,884    1.4%  $(4,787)   (32)%   (0.5)%

 

 

(1)Not meaningful.
(2)Operating profit margin for Corporate & Other is computed based on consolidated net sales. Operating profit margin for each of the other segments is computed based on the respective segment’s net sales.

 

Consolidated operating profit was $10.1 million in the six months ended June 30, 2017 compared to $14.9 million in the six months ended June 30, 2016, a decrease of $4.8 million or 32%.

 

Commercial operating profit was $38.0 million in the six months ended June 30, 2017 compared to $38.7 million in the six months ended June 30, 2016, a decrease of $0.7 million, or 2%. The decrease in Commercial operating profit was primarily due to an increase in investments we made in our advanced solutions, field sales and inside sales and an increase in third-party service costs of $1.0 million, partially offset by a $5.2 million increase in Commercial gross profit.

 

Public Sector operating profit was $6.2 million in the six months ended June 30, 2017 2017 compared to $5.7 million in the six months ended June 30, 2016, an increase of $0.5 million, or 9%. The increase in Public Sector operating profit was primarily due to a $2.3 million increase in Public Sector gross profit, partially offset by a $1.2 million increase in personnel costs and an increase in various operating expenses.

 

Canada operating profit was $1.5 million in the six months ended June 30, 2017 compared to $2.5 million in the six months ended June 30, 2016, a decrease of $1.0 million, or 39%. This decrease in Canada operating profit was primarily due to an increase in personnel costs related to our investment in advanced solutions and sales account executive headcount, as well as the addition of costs resulting from the acquisition of Stratiform in December 2016, partially offset by a $2.9 million increase in Canada gross profit.

 

United Kingdom operating loss was $1.7 million in the six months ended June 30, 2017, representing the segment’s first six months of operating expenses which include overhead support and consulting costs.

 

Corporate & Other operating expenses include corporate related expenses such as legal, accounting, information technology, product management and certain other administrative costs that are not otherwise included in our reportable operating segments. Corporate & Other operating expenses were $33.9 million in the six months ended June 30, 2017 compared to $32.1 million in the six months ended June 30, 2016, an increase of $1.8 million, or 6%. The increase in our Corporate & Other operating expenses was primarily due to a $1.3 million gain resulting from a class action settlement related to an industry wide DRAM indirect antitrust litigation received in the three months ended June 30, 2016.

 

Net Interest Expense

 

Total net interest expense for the six months ended June 30, 2017 was $3.6 million compared with $2.9 million in the same period of 2016. The $0.7 million increase in interest expense during the six months ended June 30, 2017 was primarily related to an increase in the average interest rate during the three months ended June 30, 2017 compared to the same period in the prior year as well as a $0.3 million interest charge recorded in the second quarter of 2017 related to unclaimed property reports dating back to 2003.

 

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Income Tax Expense

 

We recorded an income tax expense of $0.2 million in the six months ended June 30, 2017 compared to $4.4 million in the six months ended June 30, 2016, inclusive of discrete items. Our effective tax rates for the six months ended June 30, 2017 and 2016, inclusive of discrete items, were 3% and 36.7%, respectively. In the six months ended June 30, 2017, we benefited from $2.7 million in excess tax benefits related to the exercise of stock options, which was recorded as a discrete item credited to income tax expense as a result of adopting ASU 2016-09 during the first quarter of 2017. In the six months ended June 30, 2016, we benefited from $0.1 million in research and development credits, which was also recorded as a discrete item. The decrease in the effective tax rate for the six months ended June 30, 2017 compared to 2016 was primarily related to the adoption of ASU 2016-09, offset by an increase in valuation allowance and the proportion of income taxed at higher U.S. rates.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Working Capital. Our primary capital needs have and we expect will continue to be the funding of our existing working capital requirements, capital expenditures for which we expect to include substantial investments in our new ERP system, eCommerce platform and other upgrades of our current IT infrastructure over the next several years, which are discussed further below in “Other Planned Capital Projects,” possible sales growth, possible acquisitions and new business ventures, and possible repurchases of our common stock under a discretionary repurchase program, which is also further discussed below. Our primary sources of financing have historically come from borrowings from financial institutions, public and private issuances of our common stock and cash flows from operations. Our continuing efforts to drive revenue growth from commercial customers could result in an increase in our accounts receivable as these customers are generally provided longer payment terms than consumers. We historically have increased our inventory levels from time to time to take advantage of strategic manufacturer promotions. We believe that our existing cash balance, together with our expected future cash flows from operations and available borrowing capacity under our line of credit, will be adequate to support our current operating plans for at least the next 12 months. However, the current uncertainty in the macroeconomic environment may limit our cash resources that could otherwise be available to fund capital investments, future strategic opportunities or growth beyond our current operating plans. We may in the future seek additional financing from public or private debt or equity financings to fund additional acquisitions or expansion, or take advantage of opportunities or favorable market conditions. If we raise additional financing through the issuance of equity, equity-related or debt securities, those securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders will experience dilution of their ownership interests.

 

There has been ongoing uncertainty in the global economic environment, which could cause disruptions in the capital and credit markets. While our revolving credit facility does not mature until March 2021, we believe problems in these areas could have a negative impact on our ability to obtain future financing if we need additional funds, such as for acquisitions or expansion, to fund a significant downturn in our sales or an increase in our operating expenses, or to take advantage of opportunities or favorable market conditions in the future. We may seek additional financing from public or private debt or equity issuances; however, there can be no assurance that such financing will be available at acceptable terms, if at all. Also, there can be no assurance that the cost or availability of future borrowings, if any, under our credit facility or in the debt markets will not be impacted by disruptions in the capital and credit markets.

 

We had cash and cash equivalents of $7.3 million at June 30, 2017 and $7.2 million at December 31, 2016. Our working capital increased by $9.8 million to a working capital of $4.8 million at June 30, 2017 from negative working capital of $5.0 million at December 31, 2016.

 

We have a board approved discretionary stock repurchase program under which shares may be repurchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending on market conditions. Our Board of Directors originally adopted the plan in October 2008 with an initial authorized maximum of $10 million. The plan was amended in September 2012 and increased to $20 million, and again amended in April 2015 and increased to a total of $30 million. Under the program, the shares may be repurchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending on market conditions. We expect that the repurchase of our common stock under the program will be financed with existing working capital and amounts available under our existing credit facility. The repurchased shares are held as treasury stock. No limit was placed on the duration of the repurchase program. There is no guarantee as to the exact number of shares that we will repurchase. Subject to applicable securities laws, repurchases may be made at such times and in such amounts as our management deems appropriate. The program can also be discontinued at any time management feels additional purchases are not warranted.

 

We did not repurchase any shares of our common stock under this program during the three months ended June 30, 2017. From the inception of the program in October 2008 through June 30, 2017, we have repurchased an aggregate of 4,081,687 shares of our common stock for a total cost of $25.9 million. At June 30, 2017, we had $4.1 million available in stock repurchases under the program, subject to any limitations that may apply from time to time under our existing credit facility.

 

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We maintain a Canadian sales center serving the U.S. market, which historically received the benefit of labor credits under the Investment Quebec Refundable Tax Credit for Major Employment Generating Projects (GPCE) program. In addition to other eligibility requirements under the program, which extended through fiscal year 2016, we were required to maintain a minimum of 317 eligible employees employed by our subsidiary PCM Sales Canada in the province of Quebec at all times to remain eligible to apply annually for these labor credits. As a result of this certification, we are eligible to make annual labor credit claims for eligible employees equal to 25% of eligible salaries, but not to exceed $15,000 (Canadian) per eligible employee per year, continuing through fiscal year 2016. In June 2014, the province of Quebec passed a budget that modified the annual labor credit, prospectively reducing the claim percentage from 25% to 20% of eligible salaries, and reducing the annual amount from $15,000 to $12,000 (Canadian) per eligible employee per year. As of June 30, 2017, we had a total accrued receivable of $1.9 million related to 2016. We expect to file our 2016 claim in late 2017. We expect to receive full payment under our remaining accrued labor credits receivable.

 

Cash Flows from Operating Activities. Net cash provided in operating activities was $6.3 million in the six months ended June 30, 2017 compared to $99.3 million in the six months ended June 30, 2016.

 

The $6.3 million of net cash provided in operating activities in the six months ended June 30, 2017 was primarily due to a $74.3 million increase in accounts payable as result of timing of our outstanding payables and our operating results, partially offset by an $81.2 million increase in accounts receivable.

 

The $99.3 million of net cash provided by operating activities in the six months ended June 30, 2016 was primarily due to a $154.0 million increase in accounts payable associated with the timing of outstanding payments in the respective periods, partially offset by a $55.5 million increase in accounts receivable and a $30.1 million increase in inventory primarily related to specific inventory purchases for several customer contracts as well as opportunistic buys on certain items from a manufacturer.

 

Cash Flows from Investing Activities. Net cash used in investing activities was $9.1 million in the six months ended June 30, 2017 compared to $3.0 million in the six months ended June 30, 2016.

 

The $9.1 million of net cash used in investing activities in the six months ended June 30, 2017 was primarily related to a purchase of real property in Woodridge, Illinois for $3.1 million, expenditures relating to investments in our IT infrastructure and leasehold improvements.

 

The $3.0 million of net cash used in investing activities in the six months ended June 30, 2016 was primarily related to $2.5 million of capital expenditures and $0.5 million of incremental acquisition-related investments.

 

Cash Flows from Financing Activities. Net cash provided by financing activities in the six months ended June 30, 2017 was $2.6 million compared to $98.5 million of net cash used in financing activities in the six months ended June 30, 2016.

 

The $2.6 million of net cash provided by financing activities in the six months ended June 30, 2017 was primarily related to a $5.0 million increase in book overdraft, $4.7 million of proceeds from stock issued under stock option plans and $3.1 million of borrowings under notes payable, partially offset by $6.5 million of earn-out liability payments and $2.0 million of payments under notes payable.

 

The $98.5 million of net cash used in financing activities in the six months ended June 30, 2016 was primarily related to $69.1 million of net payments on our line of credit, a $16.3 million decrease in book overdraft, $5.9 million of earn-out liability payments and $3.6 million of payments related to repurchases of our common stock during that period.

 

Line of Credit and Notes Payable. We maintain a credit facility, which functions as a working capital line of credit with a borrowing base of inventory and accounts receivable, including certain credit card receivables, and a portion of the value of certain real estate. On January 19, 2016, we entered into a Fourth Amended and Restated Loan and Security Agreement (the “Fourth Amended Loan Agreement”) with certain lenders and Wells Fargo Capital Finance, LLC as administrative and collateral agent (the “Lenders”). On July 7, 2016, we entered into a First Amendment to the Fourth Amended Loan Agreement (the “First Amendment”) with the Lenders and on February 24, 2017, we entered into a Second Amendment to the Fourth Amended Loan Agreement (the “Second Amendment”) with the Lenders.

 

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As amended to date, the terms of our credit facility provide for (i) a Maximum Credit, as defined in the credit facility, of $345,000,000; (ii) a sub-line of up to C$40,000,000 as the Canadian Maximum Credit ((i) and (ii) collectively the “Revolving Line”); (iii) a Maturity Date of March 19, 2021; (iv) interest on outstanding balance under the Canadian Maximum Credit based on the Canadian Base Rate (calculated as the greater of CDOR plus one percentage point and the “prime rate” for Canadian Dollar commercial loans, as further defined in the Fourth Amended Loan Agreement) or at the election of the Borrowers, based on the CDOR Rate, plus a margin, depending on average excess availability under the Revolving Line, ranging from 1.50% to 1.75%; and (v) interest on outstanding balance under the Maximum Credit based on the Eurodollar Rate plus a margin, depending on average excess availability under the revolving line, ranging from 1.50% to 1.75%. The credit facility also includes a monthly unused line fee of 0.25% per year on the amount, if any, by which the Maximum Credit, then in effect, exceeds the average daily principal balance of outstanding borrowings during the immediately preceding month.

 

The credit facility is collateralized by substantially all of our assets. In addition to the security interest required by the credit facility, certain of our vendors have security interests in some of our assets related to their products. The credit facility has as its single financial covenant a minimum fixed charge coverage ratio (FCCR) requirement in the event an FCCR triggering event has occurred. An FCCR triggering event is comprised of maintaining certain specified daily and average excess availability thresholds. In the event the FCCR covenant applies, the fixed charge coverage ratio is 1.0 to 1.0 calculated on a trailing four-quarter basis as of the end of the last quarter immediately preceding such FCCR triggering event date. At June 30, 2017, we were in compliance with our financial covenant under the credit facility.

 

Loan availability under the line of credit fluctuates daily and is affected by many factors, including eligible assets on-hand, opportunistic purchases of inventory and availability and our utilization of early-pay discounts. At June 30, 2017, we had $166.5 million available to borrow for working capital advances under the line of credit.

 

In connection with, and as part of, our revolving credit facility, we maintain sub-line with a limit of $12.5 million secured by our properties located in Santa Monica, California and has a monthly principal amortization of $149,083.

 

Also on July 7, 2016, we entered into a Credit Agreement with Castle Pines Capital LLC (“Castle Pines”), which provides for a credit facility (“Channel Finance Facility”) to finance the purchase of inventory from a list of approved vendors. The aggregate availability under the Channel Finance Facility is variable and discretionary, but has initially been set at $35 million. Each advance under the Channel Finance Facility will be made directly to an approved vendor and must be repaid on the earlier of (i) the payment due date as set by Castle Pines or (ii) the date (if any) when the inventory is lost, stolen or damaged. No interest accrues on advances paid on or prior to payment due date. The Channel Finance Facility is secured by a lien on certain of our assets, subject to an intercreditor arrangement with the Lenders. The Channel Finance Facility has an initial term of one year, but shall be automatically renewed for one year periods from year to year thereafter unless terminated earlier by either party within reasonable notice periods.

 

Other Notes Payable

 

In March 2015, we completed the purchase of real property in Irvine, California for approximately $5.8 million and financed $4.9 million with a long-term note. The loan agreement provides for a seven-year term and a 25 year straight-line, monthly principal repayment amortization period that began on May 1, 2015 with a balloon payment at maturity in April 2022. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility. In September 2015, we listed the Irvine Property for sale.

 

In January 2015, we completed the purchase of certain real property in Lewis Center, Ohio for approximately $6.6 million and financed $4.575 million with a long-term note. The $4.575 million term note provides for a seven-year term and a 25 year straight-line, monthly principal repayment amortization period that began in February 2015 with a balloon payment at maturity in January 2022. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

Throughout 2014, we entered into three financing arrangements with a bank to finance the costs of equipment, software and professional services related to our ERP upgrade. The total amount financed was $5.6 million, with a quarterly repayment schedule which matured in March 2017.

 

In December 2012, we completed the purchase of 7.9 acres of land for approximately $1.1 million and have incurred additional costs of $12.2 million through December 31, 2014 towards the construction of a new cloud data center that we opened in June 2014. In July 2013, we entered into a loan agreement for with a bank for draws up to $7.725 million to finance the build out of the new data center. The loan agreement provides for a five-year term and a 25 year straight-line, monthly principal repayment amortization period with a balloon payment at maturity in January 2020. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

In June 2011, we entered into a credit agreement to finance a total of $10.1 million of the acquisition and improvement costs for the real property we purchased in March 2011 in El Segundo, California. The credit agreement provides for a five-year term and a 25 year straight-line, monthly principal repayment amortization period with a balloon payment at maturity in September 2016. In August 2016, we entered into an amendment with the lender extending the term of the loan to November 30, 2017. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

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At June 30, 2017, the effective weighted average annual interest rate on our outstanding amounts under the credit facility, term note and variable interest rate notes payable was 2.85%.

 

The carrying amounts of our line of credit borrowings and notes payable approximate their fair value based upon the current rates offered to us for obligations of similar terms and remaining maturities.

 

As part of our growth strategy, we may, in the future, make acquisitions in the same or complementary lines of business, and pursue other business ventures. Any launch of a new business venture or any acquisition and the ensuing integration of the acquired operations would place additional demands on our management, and our operating and financial resources.

 

Other Planned Capital Projects

 

ERP Upgrades

 

In October 2015, our management determined, and our Board of Directors approved such determination, to adopt the SAP platform acquired with the En Pointe transaction across all of our business units. We have made significant progress in the configuration and implementation of the SAP platform. We anticipate migration of a significant portion of our legacy systems to the SAP platform throughout the remainder of 2017 and completion of the project in 2018 with a total expected capitalized cost of under $5 million.

 

In addition to costs related to the upgrade of our ERP systems, we expect to make periodic upgrades to our IT systems on an ongoing basis.

 

Inflation

 

Inflation has not had a material impact on our operating results; however, there can be no assurance that inflation will not have a material impact on our business in the future.

 

Dividend Policy

 

We have never paid cash dividends on our capital stock and our credit facility prohibits us from paying any cash dividends on our capital stock. Therefore, we do not currently anticipate paying dividends; we intend to retain any earnings to finance the growth and development of our business.

 

Off-Balance Sheet Arrangements

 

Our off-balance sheet arrangements are fully described in our Annual Report on Form 10-K for the year ended December 31, 2016. As of June 30, 2017, there has been no material change in any off-balance sheet arrangements since December 31, 2016.

 

Contingencies

 

For a discussion of contingencies, see Part I, Item 1, Note 11 of the Notes to the Condensed Consolidated Financial Statements of this report, which is incorporated herein by reference.

 

RELATED-PARTY TRANSACTIONS

 

There were no material related-party transactions during the three and six months ended June 30, 2017 other than compensation arrangements in the ordinary course of business.

 

RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS

 

For a discussion of recently issued financial accounting standards, see Part I, Item 1, Note 2 of the Notes to the Condensed Consolidated Financial Statements of this report, which is incorporated herein by reference.

 

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FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such statements include statements regarding our expectations, hopes or intentions regarding the future, including but not limited to, statements regarding our strategies, competition, markets, vendors, expenses, new services and technologies, growth prospects, financing, revenue, margins, operations, litigation and compliance with applicable laws. In particular, the following types of statements are forward-looking:

 

  our ability to execute and benefit from our business strategies, including but not limited to, business strategies related to and strategic investments in our internal organization and focus on practice groups and sales of end-point solutions, advanced technologies, managed services and software solutions, leveraging our key vendor partner relationships, identifying and driving further operational efficiencies or successfully effecting our acquisition strategies including integrating our most recent acquisitions, and expanding our international capabilities;
  our use of management information systems and their need for future support or upgrade;
  our expectations regarding the timing, costs and benefits of our ongoing or planned IT systems and communications infrastructure upgrades;
  our expectations regarding the business impact and accounting treatment of recent acquisitions, including any additional charges that may be taken in future periods;
  our expectations that the transfer of certain customer contracts to potentially non-consolidated partners may have a negative impact on our consolidated net sales in future periods;
  our expectations regarding key personnel and our ability to hire new and retain such individuals;
  our expectations regarding the impact of our transition of certain outsourced services to our captive support operations;
  our expectations regarding our operations in newly opened geographies, including the United Kingdom;
  our competitive advantages and growth opportunities;
  our ability to increase revenues and profitability;
  our expectation regarding general economic uncertainties and the related potential negative impact on our profit and profit margins, as well as our financial condition, liquidity and future cash flows;
  our expectations to continue our efforts to increase the productivity of our sales force and reduce costs;
  our plans to invest in and enhance programs and training to align us with our key vendor partners;
  our ability to generate vendor supported marketing;
  our expectations regarding our future capital needs and the availability of working capital, liquidity, cash flows from operations and borrowings under our credit facility and other long-term debt;
  the expected results or profitability of any of our individual business units in future periods;
  the impact on accounts receivable from our efforts to focus on sales in our Commercial and Public Sector segments;
  our ability to penetrate the public sector market;
  our beliefs relating to the benefits to be received from our international operations, including in Canada, the Philippines, the UK and Pakistan, including the impact of taxes and labor costs in such operations;
  our expectations regarding the impact of our transition from outsourced operations in Pakistan to our captive BPO operations including our captive BPO operations in the Philippines;
  our belief regarding our exposure to currency exchange and interest rate risks;
  our ability to attract new customers and stimulate additional purchases from existing customers, including our expectations regarding future marketing and advertising levels and the effect on sales;
  our ability to leverage our market position and purchasing power and offer a wide selection of products at competitive prices;
  our expectations regarding the ability of our marketing programs or campaigns to stimulate additional purchases or to maximize product sales;
  our ability to limit risk related to price reductions;
  our belief regarding the effect of seasonal trends and general economic conditions on our business and results of operations across all of our segments;
  our expectations regarding competition and the industry trend toward consolidation;
  the anticipated impact of reductions in sales to certain large enterprise customers;
  our expectations regarding the impact of investments we are making in the area of sales headcount, software and advanced technology solutions;
  our expectations regarding the payment of dividends and our intention to retain any earnings to finance the growth and development of our business;
  our expectations with respect to changes in our unrecognized tax benefits;
  our compliance with laws and regulations;
  our beliefs regarding the applicability of tax statutes, regulations and governmental tax regulatory positions;
  our expectations regarding the impact of accounting pronouncements;
  our expectations regarding any future repurchases of our common stock, including the financing of any such repurchases;
  our belief that backlog is not useful for predicting our future sales;
  our expectations regarding the impact and outcome of pending litigation and other dispute resolution proceedings;
  our belief that our existing distribution facilities are adequate for our current and foreseeable future needs; and
  the likelihood that new laws and regulations will be adopted with respect to the Internet, privacy and data security that may impose additional restrictions or burdens on our business.

 

Forward-looking statements involve certain risks and uncertainties, and actual results may differ materially from those discussed in any such statement. Factors that could cause actual results to differ materially from such forward-looking statements include the risks described under the heading “Risk Factors” in Part II, Item 1A of this report. All forward-looking statements in this document are made as of the date hereof, based on information available to us as of the date hereof, and, except as otherwise required by law, we assume no obligation to update any forward-looking statement or other information contained herein to reflect new information, events or circumstances after the date hereof.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and other current liabilities, and debt. At June 30, 2017, the carrying values of our financial instruments approximated their fair values based on current market prices and rates.

 

We have not entered into derivative financial instruments as of June 30, 2017. However, from time-to-time, we contemplate and may enter into derivative financial instruments related to interest rate, foreign currency, and other market risks.

 

Interest Rate Risk

 

We have exposure to the risks of fluctuating interest rates on our line of credit and notes payable. The variable interest rates on our line of credit and notes payable are tied to the prime rate or the LIBOR, at our discretion. At June 30, 2017, we had $107.3 million outstanding under our line of credit and $35.7 million outstanding under our notes payable with variable interest rates. As of June 30, 2017, the hypothetical impact of a one percentage point increase in interest rate related to the outstanding borrowings under our line of credit and such notes payable would be to increase our annual interest expense by approximately $1.4 million.

 

Foreign Currency Exchange Risk

 

We have operation centers in Canada and the Philippines that provide back-office administrative support and customer service support. We have also recently commenced operations in the United Kingdom. In each of these countries, transactions are primarily conducted in the respective local currencies. In addition, our two foreign subsidiaries that operate the operation centers have intercompany accounts with our U.S. subsidiaries that eliminate upon consolidation. However, transactions resulting in such accounts expose us to foreign currency rate fluctuations. We record gains and losses resulting from exchange rate fluctuations on our short-term intercompany accounts in “Selling, general and administrative expenses” in our Consolidated Statements of Operations and translation gains and losses resulting from exchange rate fluctuations on local currency based assets and liabilities in “Accumulated other comprehensive income,” a separate component of stockholders’ equity on our Consolidated Balance Sheets. As such, we have foreign currency translation exposure for changes in exchange rates for these currencies and any significant changes in exchange rates between foreign currencies in which we transact business and the U.S. dollar may adversely affect our Consolidated Statements of Operations and Consolidated Balance Sheets. As of June 30, 2017, we did not have material foreign currency or overall currency exposure.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2017.

 

Changes in Internal Control Over Financial Reporting

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the second quarter of 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

We are not currently a party to any material legal proceedings, other than ordinary routine litigation incidental to the business and certain other noteworthy proceedings described under the heading “Legal Proceedings” in Part I, Item 1, Note 11 to the Notes to the Condensed Consolidated Financial Statements of this report.

 

From time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other litigation related to the conduct of our business. Any such litigation could be costly and time consuming and could divert our management and key personnel from our business operations. In connection with any such litigation, we may be subject to significant damages or equitable remedies relating to the operation of our business. Any such litigation may materially harm our business, results of operations and financial condition.

  

ITEM 1A. RISK FACTORS

 

This report and other documents we file with the Securities and Exchange Commission contain forward looking statements that are based on current expectations, estimates, forecasts and projections about us, our future performance, our business, our beliefs and our management’s assumptions. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. You should carefully consider the risks and uncertainties facing our business which are set forth below. The risks described below are not the only ones facing us. Our business is also subject to risks that affect many other companies, such as employment relations, general economic conditions, geopolitical events and international operations. Further, additional risks not currently known to us or that we currently believe are immaterial also may impair our business, operations, liquidity and stock price materially and adversely.

 

Our success is in part dependent on the accuracy and proper utilization of our management information and communications systems.

 

We have committed significant resources to the development of sophisticated systems that are used to manage our business. Our systems support phone and web-based sales, marketing, purchasing, accounting, customer service, warehousing and distribution, and facilitate the preparation of daily operating control reports which are designed to provide concise and timely information regarding key aspects of our business. The systems allow us to, among other things, monitor sales trends, make informed purchasing decisions, and provide product availability and order status information. In addition to the main computer systems, we have systems of networked computers across all of our locations. We also use our management information systems to manage our inventory. We believe that in order to remain competitive, we will need to upgrade our management information and communications systems on a regular basis, which could require significant capital expenditures.

 

Our success is dependent on the accuracy and proper utilization of our management information systems and our communications systems. In addition to the costs associated with system upgrades, the transition to and implementation of new or upgraded solutions can result in system delays or failures. We currently operate one of our management information systems using an HP3000 Enterprise System, which was supported by HP until December 2010. We currently contract with a third party service provider specializing in maintenance and support of this system to provide us adequate support until we finalize the upgrade of this system to the SAP platform historically utilized by the En Pointe business. Any interruption, corruption, degradation or failure of our management information systems or communications systems could adversely impact our ability to receive and process customer orders on a timely basis.

 

In addition to our systems upgrades that are currently being implemented, we also regularly upgrade our systems in an effort to better meet the information requirements of our users, and believe that to remain competitive, it will be necessary for us to upgrade these systems on a regular basis in the future. The implementation of any upgrades is complex, in part, because of the wide range of processes and the multiple systems that may need to be integrated across our business.

 

In connection with any system upgrades, we generally create a project plan to provide a reasonable allocation of resources to the project; however, execution of any such plan, or a divergence from it, may result in cost overruns, project delays or business interruptions. Furthermore, any divergence from any such project plan could affect the timing or the extent of benefits we may expect to achieve from the system or any process efficiencies. Any such project delays, business interruptions or loss of expected benefits could have a material adverse effect on our business, financial condition or results of operations.

 

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Any disruptions, delays or deficiencies in the design, operation or implementation of our various systems, or in the performance of our systems, particularly any disruptions, delays or deficiencies that impact our operations, could adversely affect our ability to effectively run and manage our business, including our ability to receive, process, ship and bill for orders in a timely manner or our ability to properly manage our inventory or accurately present our inventory availability or pricing. We do not currently have a redundant or back-up telephone system, nor do we have complete redundancy for our management information systems. Any interruption, corruption, deficiency or delay in our management information systems, including those caused by natural disasters, could have a material adverse effect on our business, financial condition or results of operations.

 

Changes and uncertainties in the economic climate could negatively affect the rate of information technology spending by our customers, which would likely have an impact on our business.

 

As a result of the ongoing economic uncertainties, the direction and relative strength of the U.S. and Canadian economies remain a considerable risk to our business, operating results and financial condition. This economic uncertainty could also increase the risk of uncollectible accounts receivable from our customers. During previous economic downturns in the U.S., Canada, the UK and elsewhere, customers generally reduced, often substantially, their rate of information technology spending. Additionally, economic conditions and the level of consumer confidence has limited technology spending. Future changes and uncertainties in the economic climate in the U.S., Canada, the UK and elsewhere could have a similar negative impact on the rate of information technology spending of our current and potential customers, which would likely have a negative impact on our business, operating results and financial condition, and could significantly hinder our growth and prevent us from achieving our financial performance goals.

 

Our earnings and growth rate could be adversely affected by negative changes in economic or geopolitical conditions.

 

We are subject to risks arising from adverse changes in domestic and global economic conditions and unstable geopolitical conditions. If economic growth in the United States, Canada, the UK or other countries slows or declines, current and prospective customer spending rates could be significantly reduced. This could result in reductions in sales of our products, longer sales and payment cycles, slower adoption of new technologies and increased price competition, any of which could materially and adversely affect our business, results of operations and financial condition. Weak general economic conditions or uncertainties in geopolitical conditions could adversely impact our revenue, expenses and growth rate. In addition, our revenue, margins and earnings could deteriorate in the future as a result of unfavorable economic or geopolitical conditions.

 

Our revenue is dependent on sales of products from a small number of key manufacturers, and a decline in sales of products from these manufacturers could materially harm our business.

 

Our revenue is dependent on sales of products from a small number of key manufacturers and software publishers, including Adobe, Apple, Cisco, Dell, Hewlett Packard Enterprise, HP Inc., Lenovo, Microsoft, Oracle, Samsung, Symantec and VMware. For example, products manufactured by Microsoft represented approximately 20% and 20 % of our net sales in the three months ended June 30, 2017 and 2016, HP Inc. represented approximately 9 % and 9 % of our net sales in the three months ended June 30, 2017 and 2016, and products manufactured by Dell represented approximately 9 % and 9 % of our net sales in the three months ended June 30, 2017 and 2016. A decline in sales of any of our key manufacturers’ products, whether due to decreases in supply of or demand for their products, termination of any of our agreements with them, or otherwise, could have a material adverse impact on our sales and operating results.

 

Certain of our vendors provide us with incentives and other assistance that reduce our operating costs, and any decline in these incentives and other assistance could materially harm our operating results.

 

Certain of our vendors, including OEMs, software publishers and distribution partners, provide us with trade credit or substantial incentives in the form of discounts, credits and cooperative advertising. We have agreements with many of our vendors under which they provide us, or they have otherwise consistently provided us, with market development funds to finance portions of our advertising, marketing and distribution costs based upon the amount of coverage we give to their respective products in our catalogs or other advertising and marketing mediums. Any termination or interruption of our relationships with one or more of these vendors, or modification of the terms or discontinuance of our agreements and market development fund programs and arrangements with these vendors, could adversely affect our operating income and cash flow. For example, the amount of vendor consideration we receive from a particular vendor may be impacted by a number of events outside of our control, including acquisitions, divestitures, management changes or economic pressures affecting such vendor, any of which could materially affect the amount of vendor consideration we receive from such vendor.

 

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We do not have long-term supply agreements or guaranteed price or delivery arrangements with our vendors.

 

In most cases we have no guaranteed price or delivery arrangements with our vendors. As a result, we have experienced and may in the future experience inventory shortages on certain products. Furthermore, our industry occasionally experiences significant product supply shortages and customer order backlogs due to the inability of certain manufacturers to supply certain products as needed. We cannot assure you that suppliers will maintain an adequate supply of products to fulfill our orders on a timely basis, or at all, or that we will be able to obtain particular products on favorable terms or at all. Additionally, we cannot assure you that product lines currently offered by suppliers will continue to be available to us. A decline in the supply or continued availability of the products of our vendors, or a significant increase in the price of those products, could reduce our sales and negatively affect our operating results.

 

Substantially all of our agreements with vendors are terminable within 30 days.

 

Substantially all of our vendor agreements are terminable upon 30 days’ notice or less. Vendors that currently sell their products or services through us could decide to sell, or increase their sales of, their products or services directly or through other resellers or channels. Any termination, interruption or adverse modification of our relationship with a key vendor or a significant number of other vendors would likely adversely affect our operating income, cash flow and future prospects.

 

Our success is dependent in part upon the ability of our vendors to develop and market products that meet changes in market demand, as well as our ability to sell popular products from new vendors.

 

The products and services we sell are generally subject to rapid technological change and related changes in marketplace demand. Our success is dependent in part upon the ability of our vendors to develop and market products and services that meet these changes in market demand. Our success is also dependent on our ability to develop relationships with and sell products and services from new vendors that address these changes in market demand. To the extent products that address changes in marketplace demand are not available to us, or are not available to us in sufficient quantities or on acceptable terms, we could encounter increased price and other competition, which would likely adversely affect our business, financial condition and results of operations.

 

We may not be able to maintain existing vendor relationships or preferred provider status with our vendors, which may affect our ability to offer a broad selection of products at competitive prices and negatively impact our results of operations.

 

We purchase products and services for resale both directly from manufacturers and software publishers and indirectly through distributors and other sources, all of whom we consider our vendors. We also maintain certain qualifications and preferred provider status with several of our vendors, which provides us with preferred pricing, vendor training and support, preferred access to products and services, and other significant benefits. In many cases, vendors require us to meet certain minimum standards in order to retain these qualifications and preferred provider status. If we do not maintain our existing relationships or preferred provider certifications or authorizations, or if we fail to build new relationships with vendors on acceptable terms, including favorable pricing, vendor consideration or reseller qualifications, we may not be able to offer a broad selection of products and services or continue to offer products and services from these vendors at competitive prices or at all. From time to time, vendors may be acquired by other companies, terminate our right to sell some or all of their products, modify or terminate our preferred provider or qualification status, change the applicable terms and conditions of sale or reduce or discontinue the incentives or vendor consideration that they offer us. For example, one of our major vendors adopted heightened sales growth and dedicated sales personnel standards for its preferred provider designation. Our failure to meet these heightened standards could cause us to lose preferred provider status with the vendor. Any termination of our preferred provider status with any of our major vendors, or our failure to build new vendor relationships, could have a negative impact on our operating results. Additionally, some products are subject to manufacturer, publisher or distributor allocation, which limits the number of units of those products that are available to us and may adversely affect our operating results.

 

Part of our business strategy includes the opportunistic acquisition of other companies, and we may have difficulties integrating acquired companies into our operations in a cost-effective manner, if at all.

 

One element of our business strategy involves the potential expansion through opportunistic acquisitions of businesses, assets, personnel or technologies that allow us to complement our existing operations, expand our market coverage, enter new geographic markets, or add new business capabilities. We continually evaluate and explore strategic opportunities as they arise, including business combination transactions, strategic partnerships, and the purchase or sale of assets. Our acquisition strategy depends on the availability of suitable acquisition candidates at reasonable prices and our ability to resolve challenges associated with integrating acquired businesses into our existing business. Since 2015, we completed four strategic acquisitions and are focused on integrating these acquisitions into our operations. No assurance can be given that the benefits or synergies we may expect from acquisitions will be realized to the extent or in the time frame we anticipate. We may lose key employees, customers, distributors, vendors and other business partners of the companies we acquire after announcement of acquisition plans. In addition, acquisitions may involve a number of risks and difficulties, including expansion into new geographic markets and business areas in which our management has limited prior experience, the diversion of management’s attention to the operations and personnel of the acquired company, the integration of the acquired company’s personnel, operations and management information (ERP) systems, changing relationships with customers, suppliers and strategic partners, differing regulatory requirements in new geographic markets and new business areas, and potential short-term adverse effects on our operating results. These challenges can be magnified as the size of the acquisition increases. Any delays or unexpected costs incurred in connection with the integration of acquired companies or otherwise related to acquisitions could have a material adverse effect on our business, financial condition and results of operations.

 

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Acquisitions may require large one-time charges and can result in increased debt or other contingent liabilities, adverse tax consequences, deferred compensation charges, the recording and later amortization of amounts related to deferred compensation and certain purchased intangible assets, and the refinement or revision of fair value acquisition estimates following the completion of acquisitions, any of which items could negatively impact our business, financial condition and results of operations. In addition, we may record goodwill in connection with an acquisition and incur goodwill impairment charges in the future. Any of these charges could cause the price of our common stock to decline.

 

An acquisition could absorb substantial cash resources, require us to incur or assume debt obligations, or involve our issuance of additional equity securities. If we issue equity securities in connection with an acquisition, we may dilute our common stock with securities that have an equal or a senior interest in our company. If we incur additional debt to pay for an acquisition, it may significantly reduce amounts that would otherwise be available under our credit facility, increase our interest expense, leverage and debt service requirements and could negatively impact our ability to comply with applicable financial covenants in our credit facility or limit our ability to obtain credit from our vendors. Acquired entities also may be highly leveraged or dilutive to our earnings per share, or may have unknown liabilities. In addition, the combined entity may have lower revenues or higher expenses and therefore may not achieve the anticipated results. Any of these factors relating to acquisitions could have a material adverse impact on our business, financial condition and results of operations.

 

We cannot assure you that we will be able to identify suitable acquisition opportunities, consummate any pending or future acquisitions or that we will realize any anticipated benefits from any such acquisitions. Even if we do find suitable acquisition opportunities, we may not be able to consummate the acquisitions on commercially acceptable terms, and any decline in the price of our common stock may make it significantly more difficult and expensive to initiate or consummate additional acquisitions. We cannot assure you that we will be able to implement or sustain our acquisition strategy or that our strategy will ultimately prove profitable.

 

Narrow margins magnify the impact of variations in operating costs and of adverse or unforeseen events on operating results.

 

We are subject to intense price competition with respect to the technology offerings we provide. As a result, our gross and operating margins have historically been narrow, and we expect them to continue to be narrow. We have recently experienced increasing price competition, which has a negative impact on our margins. Narrow margins magnify the impact of variations in operating costs and of adverse or unforeseen events on operating results. Future increases in costs such as the cost of merchandise, wage levels, shipping rates, freight costs and fuel costs may negatively impact our margins and profitability. We are not always able to raise the sales price to offset cost increases. If we are unable to maintain our margins in the future, it could have a material adverse effect on our business, financial condition or results of operations. In addition, because price is an important competitive factor in our industry, we cannot assure you that we will not be subject to increased price competition in the future. If we become subject to increased price competition in the future, we cannot assure you that we will not lose market share, that we will not be forced to reduce our prices and further reduce our margins, or that we will be able to compete effectively.

 

We experience variability in our net sales and net income on a quarterly basis as a result of many factors.

 

We experience variability in our net sales and net income on a quarterly basis as a result of many factors. These factors include:

 

  the relative mix of hardware products, software and services sold during the period;
  the general economic environment and competitive conditions, such as pricing;
  the timing of procurement cycles by our business, government and educational institution customers;
  seasonality in customer spending and demand for technology offerings we provide;
  variability in vendor programs;
  the introduction of new and upgraded products, services or solutions;
  changes in prices from our suppliers;
  promotions;
  the loss or consolidation of significant suppliers or customers;
  our ability to control costs;
  the timing of our capital expenditures;
  the condition of our industry in general;

  

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  customer acceptance of new purchasing models;
  deferral of customer orders in anticipation of new offerings;
  product or solution enhancements or operating system changes;
  any inability on our part to obtain adequate quantities of products, services or solutions;
  delays in the release by suppliers of new products, services or solutions and inventory adjustments;
  our expenditures on new business ventures and acquisitions;
  performance of acquired businesses;
  adverse weather conditions that affect supply or customer response;
  distribution or shipping to our customers; and
  geopolitical events.

 

Our planned operating expenditures each quarter are based on sales forecasts for the quarter. If our sales do not meet expectations in any given quarter, our operating results for the quarter may be materially adversely affected. Our narrow margins may magnify the impact of these factors on our operating results. We believe that period-to-period comparisons of our operating results are not necessarily a good indication of our future performance. In addition, our results in any quarterly period are not necessarily indicative of results to be expected for a full fiscal year. In future quarters, our operating results may be below the expectations of public market analysts or investors and as a result the market price of our common stock could be materially adversely affected.

 

Our focus on commercial and public sector sales presents numerous risks and challenges, and may not improve our profitability or result in expanded market share.

 

An important element of our business is focused on commercial and public sector sales and related market share growth. In competing in these markets, we face numerous risks and challenges, including competition from a wider range of sources and the need to continually develop and enhance strategic relationships. We cannot assure you that our focus on commercial and public sector sales will result in expanded market share or increased profitability. Furthermore, revenue from our public sector business is derived from sales to federal, state and local governmental departments and agencies, as well as to educational institutions, through various contracts and open market sales. Government contracting is a highly regulated area, and noncompliance with government procurement regulations or contract provisions could result in civil, criminal, and administrative liability, including substantial monetary fines or damages, termination of government contracts, and suspension, debarment or ineligibility from doing business with the government. The effect of any of these possible actions by any governmental department or agency with which we contract could adversely affect our business or results of operations. Moreover, contracting with governmental departments and agencies involves additional risks, such as longer payment terms, limited recourse against the government agency in the event of a business dispute, requirements that we provide representations, warranties and indemnities related to our offerings, the potential lack of a limitation of our liability for damages from our product sales or our provision of services to the department or agency, and the potential for changes in statutory or regulatory provisions that negatively affect the profitability of such contracts. Similarly, many large commercial businesses also require us to regularly enter into complex contractual relationships involving various risks and uncertainties such as requirements that we provide representations, warranties and indemnities to our customers and potential lack of limitation of our liability for damages under some of such contracts. Additionally, our operating results from our Commercial segment are impacted by certain commercial customer diverse supplier requirements and relationships we maintain with third party diverse supplier partners. Changes in any of these diverse supplier customer requirements or failure of our diverse supplier relationships to satisfy any such requirements at any time could have a material adverse effect on our results of operations or financial condition.

 

Our strategy and investments in increasing the productivity of our account executives, and our focus on sales and delivery of technology solutions may not improve our profitability or result in expanded market share.

 

We have made and are currently making efforts to increase our market share by investing in training and retention of our sales force. We have also incurred, and expect to continue to incur, significant expenses resulting from infrastructure investments related to our sales force. Our customers are increasingly consuming IT in different and evolving ways and utilizing more elaborate solutions. In response, we are investing in our capabilities and portfolio and are working with our customers to identify areas where they can gain efficiencies by outsourcing to us traditional technology functions. Specifically, we are focused on and investing in solutions, including around centers (which includes storage and security solutions), cloud computing, collaboration, virtualization, secure mobility, borderless networks and enterprise software solutions. We cannot assure you that any of our investments in our sales force or sales support resources or our focus on our services and solutions capabilities and portfolio will result in expanded market share or increased profitability in the near or long term.

 

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Our financial performance could be adversely affected if we are not able to retain and increase the experience of our sales force or if we are not able to maintain or increase their productivity.

 

Our sales and operating results may be adversely affected if we are unable to increase the average tenure of our account executives or if the sales volumes and profitability achieved by our account executives do not increase with their increased experience.

 

Existing or future government and tax laws and regulations and related risks could expose us to liabilities or costly changes in our business operations, and could reduce demand for our products and services.

 

We may be subject to state or local taxes on income, gross receipts, sales or use or a similar measure. State and local governments may seek to impose such taxes in cases where they believe the taxpayer may have a significant economic presence by reason of significant sales to customers located in the states. The responsibility to pay or collect taxes has also been the subject of court actions and various legislative efforts. There can be no assurance that these taxes will not be imposed upon us and our subsidiaries in a manner that could materially adversely impact our financial condition or results of operations.

 

We are subject to a number of general business laws and regulations, including laws and regulations specifically governing companies that do business over the Internet. These laws and regulations may cover user privacy, marketing and promotional practices (including electronic communications with our customers and potential customers), data protection and privacy, pricing, content, copyrights, distribution, contracts and other communications, consumer protection, product safety, the provision of online payment services, copyrights, patents and other intellectual property rights, unauthorized access (including the Computer Fraud and Abuse Act), and the characteristics and quality of products and services. Additionally, some of our subsidiaries which are government contractors or subcontractors are subject to laws and regulations related to companies that sell to the government, including but not limited to regulations of the Department of Labor and laws and regulations related to our procurement of products and services and our sales to the government.

 

In addition, we may be subject to federal, state or local taxes on income, gross receipts, sales or use or a similar measure. State and local governments may seek to impose such taxes in cases where they believe the taxpayer may have a sufficient economic presence by reason of sales or services to customers located in the applicable jurisdiction. The responsibility to pay or collect taxes has been the subject of court actions and various legislative efforts. There can be no assurance that these taxes or tax collection obligations will not be imposed upon us and our subsidiaries in a manner that could materially adversely impact our financial condition or results of operations.

 

While we have sought to implement processes, programs and systems in an effort to achieve compliance with existing laws and regulations applicable to our business, many of these laws and regulations are unclear and have yet to be interpreted by courts, or may be subject to conflicting interpretations by courts or regulatory agencies. Further, no assurances can be given that new laws or regulations will not be enacted or adopted, or that our processes, programs and systems will be sufficient to comply with present or future laws or regulations, which might adversely affect our business, financial condition or results of operations.

 

Such existing and future laws and regulations may also impede our business. Additionally, it is not always clear how existing laws and regulations apply to our businesses. Unfavorable resolution of these issues may expose us to liability and costly changes in our business operations, and could reduce customer demand for our offerings.

 

Additionally, although historically only a small percentage of our total sales in any given quarter or year are made to customers outside of the continental United States, we recently entered the Canadian market with our acquisitions in Canada, which subjected us to laws and regulations applicable to companies doing business in the multiple Canadian provinces. We also commenced operations in the United Kingdom in the first quarter of 2017. Further, there is a possibility that other foreign jurisdictions may take the position that our business is subject to their laws and regulations, which could impose restrictions or burdens on us and expose us to tax and other potential liabilities and could also require costly changes to our business operations with respect to those jurisdictions. In some cases, our sales related to foreign jurisdictions could also be subject to export control laws and foreign corrupt practice laws and there is a risk that we could face allegations from U.S. or foreign governmental authorities alleging our failure to comply with the requirements of such laws subjecting us to costly litigation and potential significant governmental penalties or fines.

 

If goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings.

 

The purchase price allocation for our historical acquisitions resulted in a material amount allocated to goodwill and intangible assets. In accordance with GAAP, we review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We review the fair values of our goodwill and intangible assets with indefinite useful lives and test them for impairment annually or whenever events or changes in circumstances indicate an impairment may have occurred. Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or intangible assets may not be recoverable include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant non-cash charge to earnings in our consolidated financial statements during the period in which any impairment of our goodwill or intangible assets is determined, which could have a material adverse effect on our results of operations.

 

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If significant negative industry or economic trends, including decreases in our market capitalization, slower growth rates or lack of growth in our business occurs in the future it may indicate that impairment charges are required. If we are required to record any impairment charges, this could have a material adverse effect on our consolidated financial statements. In addition, the testing of goodwill for impairment requires us to make significant estimates about the future performance and cash flows of our company, as well as other assumptions. These estimates can be affected by numerous factors, including changes in economic, industry or market conditions, changes in underlying business operations, future reporting unit operating performance, existing or new product market acceptance, changes in competition, or changes in technologies. Any changes in key assumptions, or actual performance compared with those assumptions, about our business and future prospects or other assumptions could affect the fair value of one or more reporting units, resulting in an impairment charge.

 

We may not be able to maintain profitability on a quarterly or annual basis.

 

Our ability to maintain profitability on a quarterly or annual basis given our planned business strategy depends upon a number of factors discussed in these risk factors, including our ability to effectively compete in the marketplace with our competitors. Our ability to maintain profitability on a quarterly or annual basis will also depend on our ability to manage and control operating expenses and to generate and sustain adequate levels of revenue. Many of our expenses are fixed in the short term, and we may not be able to quickly reduce spending if our revenue is lower than what we project. In addition, we may find that our business plan costs more to execute than what we currently anticipate. Some of the factors that affect our ability to maintain profitability on a quarterly or annual basis are beyond our control, including general economic trends and uncertainties.

 

Our operating results are difficult to predict and may adversely affect our stock price.

 

Our operating results have fluctuated in the past and are likely to vary significantly in the future based upon a number of factors, many of which we cannot control. We operate in a highly dynamic industry and future results could be subject to significant fluctuations. These fluctuations could cause us to fail to meet or exceed financial expectations of investors or analysts, which could cause our stock price to decline rapidly and significantly. Revenue and expenses in future periods may be greater or less than revenue and expenses in the immediately preceding period or in the comparable period of the prior year. Therefore, period-to-period comparisons of our operating results are not necessarily a good indication of our future performance. Some of the factors that could cause our operating results to fluctuate include:

 

  changes in the mix of products, services or solutions that we sell;
  the amount and timing of operating costs and capital expenditures relating to any expansion of our business operations and infrastructure;
  price competition that results in lower sales volumes, lower profit margins, or net losses;
  the availability of vendor programs, authorizations or certifications;
  our ability to attract and retain key personnel and the related costs,
  fluctuations in the demand for our products, services or solutions or overstocking or under-stocking of our products;
  economic conditions;
  changes in the amounts of information technology spending by our customers;
  the amount and timing of advertising and marketing costs;
  fluctuations in levels of inventory theft, damage or obsolescence that we incur;
  our ability to successfully integrate operations and technologies from any past or future acquisitions or other business combinations;
  revisions or refinements of fair value estimates relating to acquisitions or other business combinations;
  changes in the number of visitors to our websites or our inability to convert those visitors into customers;
  technical difficulties, including system or Internet failures;
  introduction of new or enhanced products, services or solutions;
  fluctuations in warehousing and our shipping costs; and
  foreign currency exchange rates.

 

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If we fail to accurately predict and manage our inventory risks, our margins may decline as a result of required inventory write downs due to lower prices obtained from older or obsolete products.

 

We derive a significant amount of our gross sales from products sold out of owned inventory at our directly operated and distributor partner warehouse and distribution facilities. We assume the inventory damage, theft and obsolescence risks, as well as price erosion risks for products that are sold out of such inventory. These risks are especially significant because many of the products we sell are characterized by rapid technological change, obsolescence and price erosion, and because at times we may stock large quantities of particular types of inventory. There can be no assurance that we will be able to identify and offer products necessary to remain competitive, maintain our margins, or avoid or minimize losses related to excess and obsolete inventory. We currently have limited return rights with respect to products we purchase from some of our largest vendor partners, but these rights vary by product line, are subject to specified conditions and limitations and can be terminated or changed at any time. We also recently have decided to move more of our inventory warehousing and distribution functions to third party distributor partners in replacement of our historic directly operated facility in Memphis Tennessee. Moving these operations to third party facilities will result in greater dependence on these third parties for portions of our warehousing and distribution needs. As a result, we will now be subject to third party contractual relationships for these replaced operations, which could result in future cost increases and other contractual risk allocations which we have not historically faced and may not be able control.

 

We may need additional financing and may not be able to raise additional financing on favorable terms or at all, which could increase our costs, limit our ability to grow and dilute the ownership interests of existing stockholders.

 

We require substantial working capital to fund our business. We believe that our current working capital, including our existing cash balance, together with our expected future cash flows from operations and available borrowing capacity under our existing credit facility, which functions as a working capital line of credit, will be adequate to support our current operating plans for at least the next twelve months. However, if we need additional financing, such as for acquisitions or expansion of our business or the businesses of our subsidiaries or to finance our operations during a significant downturn in sales or an increase in operating expenses, there are no assurances that adequate financing will be available on acceptable terms, if at all. We may in the future seek additional financing from public or private debt or equity financings to fund additional expansion, or take advantage of strategic opportunities or favorable market conditions. There can be no assurance such financings will be available on terms favorable to us or at all. To the extent any such financings involve the issuance of equity securities, existing stockholders could suffer dilution. If we raise additional financing through the issuance of equity, equity-related or debt securities, those securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders will experience dilution of their ownership interests. If additional financing is required but not available, we would have to implement further measures to conserve cash and reduce costs. However, there is no assurance that such measures would be successful. Our failure to raise required additional financing could adversely affect our ability to maintain, develop or enhance our product offerings, take advantage of future strategic opportunities, respond to competitive pressures or continue operations.

 

Economic volatility and geopolitical uncertainty could result in disruptions of the capital and credit markets. Problems in these areas could have a negative impact on our ability to obtain future financing if we need additional funds, such as for acquisitions or expansion, to fund changes in our sales or an increase in our operating expenses, or to take advantage of strategic opportunities or favorable market conditions. We may seek additional financing from public or private debt or equity issuances; however, there can be no assurance that such financing will be available at acceptable terms, if at all. Also, there can be no assurance that the cost or availability of future borrowings, if any, under our credit facility or in the debt markets will not be impacted by disruptions in the capital and credit markets.

 

Rising interest rates could negatively impact our results of operations and financial condition.

 

A significant portion of our working capital requirements and our real estate acquisitions have historically been funded through borrowings under our working capital credit facility or through long term notes. These facilities bear interest at variable rates tied to the LIBOR or prime rate, and the long term notes generally have initial terms of between five and seven years. If the variable interest rates on our borrowings increase, we could incur greater interest expense than we have in the past. Rising interest rates, and our increased interest expense that would result from them, could negatively impact our results of operations and financial condition.

 

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We may be subject to claims regarding our intellectual property, including our business processes, or the products, services or solutions we sell, any of which could result in expensive litigation, distract our management or force us to enter into costly royalty or licensing agreements.

 

Third parties have asserted, and may in the future assert, that our business or the technologies we use or sell infringe on their intellectual property rights. As a result, we may be subject to intellectual property legal proceedings and claims in the ordinary course of our business. We cannot predict whether third parties will assert additional claims of infringement against us in the future or whether any future claims will prevent us from offering popular products or operating our business as planned. If we are forced to defend against any third-party infringement claims, whether they are with or without merit or are determined in our favor, we could face expensive and time-consuming litigation, which could result in the imposition of a preliminary injunction preventing us from continuing to operate our business as currently conducted throughout the duration of the litigation or distract our technical and management personnel. If we are found to infringe, we may be required to pay monetary damages, which could include treble damages and attorneys’ fees for any infringement that is found to be willful, and either be enjoined or required to pay ongoing royalties with respect to any technologies found to infringe. Further, as a result of infringement claims either against us or against those who license technology to us, we may be required, or deem it advisable, to develop non-infringing technology, which could be costly and time consuming, or enter into costly royalty or licensing agreements. Such royalty or licensing agreements, if required, may be unavailable on terms that are acceptable to us, or at all. If a third party successfully asserts an infringement claim against us and we are enjoined or required to pay monetary damages or royalties or we are unable to develop suitable non-infringing alternatives or license the infringed or similar technology on reasonable terms on a timely basis, our business, results of operations and financial condition could be materially harmed. Similarly, we may be required incur substantial monetary and diverted resource costs in order to protect our intellectual property rights against infringement by others.

 

Furthermore, we sell products, services and solutions manufactured, published and distributed by third parties, some of which may be defective. If any product, service or solution that we sell were to cause physical injury or damage to property, the injured party or parties could bring claims against us as the retailer of the product or solution. Our insurance coverage may not be adequate to cover every claim that could be asserted. If a successful claim were brought against us in excess of our insurance coverage, it could expose us to significant liability. Even unsuccessful claims could result in the expenditure of funds and management time and could decrease our profitability.

 

Costs and other factors associated with pending or future litigation could materially harm our business, results of operations and financial condition.

 

From time to time we receive claims and become subject to litigation, including consumer protection, employment, intellectual property and other litigation and government or third party audits related to the conduct of our business. Additionally, we may from time to time institute legal proceedings against third parties to protect our interests. For example, we are currently involved in several disputes related to the En Pointe acquisition. These proceedings are described under the heading “Legal Proceedings” in Part I, Item 1, Note 11 to the Notes to the Condensed Consolidated Financial Statements of this report. Any litigation, arbitration, audit, investigation or other dispute resolution process that we become a party to could be costly and time consuming and could divert our management and key personnel from our business operations. In connection with any such matters, we may be subject to significant damages or equitable remedies relating to the operation of our business and could incur significant costs in asserting, defending, or settling any such matters. We cannot determine with any certainty the costs or outcome of such pending or future matters, and they may materially harm our business, results of operations or financial condition.

 

We have been named as defendants in a purported securities class action, and this action could adversely affect our reputation, divert significant management time and attention, and result in significant expenses.

 

On May 3, 2017, a purported securities class action was filed in the United States District Court for the Central District of California, entitled Miller v. PCM Inc., Case No. 2:17-cv-03364 (C.D. Cal. filed May 3, 2017). In this action, plaintiff, purportedly on behalf of a putative class of purchasers of PCM securities from June 17, 2015 through May 2, 2017, alleges that the Company, its chief executive officer and chief financial officer violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by intentionally or recklessly making false and/or misleading statements and/or failing to disclose that the financial statements of En Pointe, a company we acquired in 2015, materially overstated the profitability of En Pointe’s business. We believe that the allegations lack merit and intend to defend against this action vigorously.

 

We cannot predict the outcome of this lawsuit. In addition, we and our current or former officers and directors may in the future be subject to additional litigation relating to the same or similar alleged matter. Regardless of the merits or outcome, this lawsuit, and any other similar or related lawsuit that may be brought against us, or our current or former directors or officers, could be time-consuming, result in significant expense, divert the attention and resources of our management and other key employees, and adversely affect our reputation. An unfavorable outcome could exceed coverage provided under potentially applicable insurance policies. Any such unfavorable outcome could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

We may fail to expand our hardware product, software or service categories and offerings, our websites or our processing systems in a cost-effective and timely manner as may be required to efficiently operate our business.

 

We may be required to expand or change our hardware product, software or service categories or offerings, our websites or our processing systems in order to compete in our highly competitive and rapidly changing industry or to efficiently operate our business. Any failure on our part to expand or change the way we do business in a cost-effective and timely manner in response to any such requirements would likely adversely affect our operating results, financial condition or future prospects. Additionally, we cannot assure you that we will be successful in implementing any such changes when and if they are required.

 

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We have generated substantial portions of our revenue in the past from the sale of computer hardware, software and accessories and consumer electronics products. Expansion into new hardware product, software and service categories, including for example our efforts to grow managed and advanced technology services and solutions, may require us to incur significant marketing expenses, develop relationships with new vendors and comply with new regulations. We may lack the necessary expertise in a new category or offering to realize the expected benefits of that new category or offering. These requirements could strain our managerial, financial and operational resources. Additional challenges that may affect our ability to expand into new hardware product, software or service categories and offerings include our ability to:

 

  establish or increase awareness of our new brands and categories and offerings;
  acquire, attract and retain customers at a reasonable cost;
  achieve and maintain a critical mass of customers and orders across all of our categories and offerings;
  attract a sufficient number of new customers to whom any new categories and offerings are targeted;
  successfully market our new categories or offerings to existing customers;
  maintain or improve our margins and fulfillment costs;
  attract and retain vendors to provide expanded lines of business to our customers on terms that are acceptable to us; and
  manage our inventory in new categories and offerings.

 

We cannot be certain that we will be able to successfully address any or all of these challenges in a manner that will enable us to expand our business in a cost-effective or timely manner. If our new categories or offerings are not received favorably, or if our suppliers fail to meet our customers’ expectations, our results of operations would suffer and our reputation and the value of the applicable new brand and our other brands could be damaged. The lack of market acceptance of our new categories or our inability to generate satisfactory revenue from any such expanded categories or offerings to offset their cost could harm our business, financial condition or results of operations.

 

The evolution of cloud-based offerings may negatively impact our sales of hardware products, software and related services.

 

Our customers are increasingly able to access technology solutions necessary to their operations through cloud-based offerings. Increasing demand for cloud-based offerings may reduce demand for certain of our existing technology solution offerings. We are investing in our cloud-based capabilities, including products and services related to our own direct and third-party cloud-based offerings, such as our hybrid cloud data center and NOC services, Azure Cloud solutions, Office 365 and Enterprise Mobility Suite. We expect to continue to increasingly invest in our cloud-based capabilities in support of anticipated customer evolution towards cloud-based solutions. There can be no assurance that our investments in cloud-based offerings will result in improved sales or profitability or allow us to offset any reductions in sales of our more traditional hardware product, software and related service offerings which may result from our customers’ increased adoption of cloud-based solutions. Any such reductions in sales may have a material adverse effect on our business, financial condition or results of operations.

 

We may not be able to attract and retain key personnel such as senior management, sales and services personnel or information technology specialists.

 

Our future performance will depend to a significant extent upon the efforts and abilities of certain key management and other personnel, including Frank F. Khulusi, our Chairman of the Board and Chief Executive Officer, as well as other executive officers and senior management. The loss of service of one or more of our key management members could have a material adverse effect on our business. Our success and plans for future growth will also depend in part on our management’s continuing ability to hire, train and retain skilled personnel in all areas of our business such as sales, services and IT personnel. For example, our management information systems and processes require the services of employees with extensive knowledge of these systems and processes and the business environment in which we operate, and in order to successfully implement and operate our systems and processes we must be able to attract and retain a significant number of information technology specialists. We may not be able to attract, train and retain the skilled personnel required to, among other things, implement, maintain, and operate our information systems and processes or to offer and support our managed and advanced technology solutions, and any failure to do so would likely have a material adverse effect on our operations.

 

If we fail to achieve and maintain adequate internal controls, we may not be able to produce reliable financial reports in a timely manner or prevent financial fraud.

 

We monitor and periodically test our internal control procedures. We may from time to time identify deficiencies which we may not be able to remediate in a timely or cost-effective manner. In addition, if we fail to achieve and maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting. Effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important in helping prevent financial fraud. If we cannot provide reliable financial reports on a timely basis or prevent financial fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price of our stock could drop significantly.

 

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Any inability to effectively manage our growth and achieve economies of scale may prevent us from successfully expanding our business.

 

The growth of our business has required us to make significant additions in personnel and has significantly increased our working capital requirements. Although we have experienced significant sales growth in the past, such growth should not be considered indicative of future sales growth. Such growth has resulted in new and increased responsibilities for our management personnel and has placed and continues to place significant strain upon our management, operating and financial systems, and other resources. Any future growth, whether organic or through acquisition, may result in increased strain. There can be no assurance that current or future strain will not have a material adverse effect on our business, financial condition, and results of operations. Also crucial to our success in managing our growth will be our ability to achieve additional economies of scale. We cannot assure you that we will be able to achieve such economies of scale, and the failure to do so could have a material adverse effect upon our business, financial condition or results of operations.

 

Our advertising and marketing efforts may be costly and may not achieve desired results.

 

We incur substantial expense in connection with our advertising and marketing efforts. Although we target our advertising and marketing efforts on current and potential customers who we believe are likely to be in the market for the products we sell, we cannot assure you that our advertising and marketing efforts will achieve our desired results. In addition, we periodically adjust our advertising expenditures in an effort to optimize the return on such expenditures. Any decrease in the level of our advertising expenditures which may be made to optimize such return could adversely affect our sales.

 

We are exposed to the credit risk of some of our customers and to credit exposures in weakened markets, which could negatively impact our business, operating results and financial condition.

 

Business customers who qualify are provided credit terms and while we monitor individual customer payment capability and maintain reserves we believe are adequate to cover exposure for doubtful accounts, we have exposure to credit risk in the event that customers fail to meet their payment obligations. Additionally, to the degree that there may be tightness in the credit markets that makes it more difficult for some customers to obtain financing, those customers’ ability to meet their payment obligations to us could be adversely impacted, which in turn could have a material adverse impact on our business, operating results, and financial condition.

 

Increased product returns or a failure to accurately predict product returns could decrease our revenue and impact profitability.

 

We make allowances for product returns in our consolidated financial statements based on historical return rates. We are responsible for returns of certain products shipped from our distribution center, as well as products that are shipped to our customers directly from our vendors. If our actual product returns significantly exceed our allowances for returns, our revenue and profitability could decrease. In addition, because our allowances are based on historical return rates, the introduction of new merchandise categories, new products, changes in our product mix, or other factors may cause actual returns to exceed return allowances, perhaps significantly. In addition, any policies that we adopt that are intended to reduce the number of product returns may result in customer dissatisfaction and fewer repeat customers.

 

Our business may be harmed by fraudulent activities.

 

We have received in the past, and anticipate that we will receive in the future, communications from customers due to purported fraudulent activities, including fraudulent activities on our websites such as fraudulent credit card transactions. Negative publicity generated as a result of fraudulent conduct by third parties could damage our reputation and diminish the value of our brand name. Fraudulent activities could also subject us to losses and could lead to scrutiny from lawmakers and regulators regarding the operation of our businesses, including the operation of our websites. We expect to continue to receive requests from customers for reimbursement due to purportedly fraudulent activities or threats of legal action against us if no reimbursement is made.

 

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Breaches of data security could significantly impact our business and expose us to material costs and liability.

 

Data security laws are becoming more widespread and burdensome and increasingly require notification of affected individuals and, in some instances, regulators. Moreover, third parties are engaging in increased cyber attacks and other data theft efforts, and individuals are increasingly subjected to theft of identity, medical or credit card or other financial account information. In addition to risks we face from cyber attacks or data theft efforts directly targeted at our systems, we offer our products, services and solutions to companies, such as healthcare or financial institutions, under contracts which may expose us to significant liabilities for data breaches or losses which could arise out of or result from products, services or solutions we may sell to these institutions. There is a risk that we may fail to prevent such data theft or data breaches and that our customers or others may assert claims against us as a result. In addition, the FTC and state consumer protection authorities have brought a number of enforcement actions against U.S. companies for alleged deficiencies in those companies’ data security practices, and they may continue to bring such actions. Enforcement actions, which may or may not be based upon actual cyber attacks or other breaches in data security, present an ongoing risk to us, could result in a loss of customers, damage to our reputation and monetary damages. This liability could also include claims for other misuses of personal information, including for unauthorized marketing purposes. Other liability could include claims alleging misrepresentation of our privacy and data security practices. Any such liability could decrease our profitability and materially adversely affect our financial condition.

 

Laws or regulations relating to privacy and data protection may adversely affect the growth of our business or our marketing efforts and expose us to material costs and liability.

 

We market to names in our proprietary customer database and to potential customers whose names we obtain from rented or exchanged mailing lists. Worldwide public concern regarding personal privacy has subjected the rental and use of customer mailing lists and other customer information to increased scrutiny and regulation. As a result, we are subject to increasing regulation relating to privacy and the use of personal information. For example, we are subject to various telemarketing and anti-spam laws that regulate the manner in which we may solicit future suppliers and customers. Such regulations, along with increased governmental or private enforcement, may increase the cost of operating and growing our business. In addition, several states have proposed legislation that would limit the uses of personal information gathered online or require online services to establish privacy policies. The Federal Trade Commission has adopted regulations regarding the collection and use of personal identifying information obtained from children under 13 years of age. Bills proposed in Congress would expand online privacy protections already provided to adults. Moreover, in the United States, Canada, the United Kingdom and elsewhere, laws and regulations are becoming increasingly protective of consumer privacy, with a trend toward requiring companies to establish procedures to notify users of privacy and security policies, to obtain consent from users for collection and use of personal information, and to provide users with the ability to access, correct and delete personal information stored by companies. Such privacy and data protection laws and regulations, and efforts to enforce such laws and regulations, may restrict our ability to collect, use or transfer demographic and personal information from users, which could be costly or harm our marketing efforts. Further, an