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, 2018

 

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 2, 2018, the registrant had 11,944,794 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, 2018 and December 31, 2017 2
     
  Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017 3
     
  Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017 4
     
  Condensed Consolidated Statements of Cash Flows for the Three and Six Months Ended June 30, 2018 and 2017 5
     
  Notes to the Condensed Consolidated Financial Statements 6
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 21
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk 37
   
Item 4. Controls and Procedures 38
   
PART II - OTHER INFORMATION  
   
Item 1. Legal Proceedings 39
   
Item 1A. Risk Factors 39
   
Item 6. Exhibits 54
   
Signature 55

 

 

 

 

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,   December 31, 
   2018   2017 
ASSETS          
Current assets:          
Cash and cash equivalents  $11,503   $9,113 
Accounts receivable, net of allowances of $1,908 and $2,181   522,072    439,658 
Inventories   78,491    103,471 
Prepaid expenses and other current assets   9,198    9,333 
Total current assets   621,264    561,575 
Property and equipment, net   69,707    71,551 
Goodwill   87,616    87,768 
Intangible assets, net   9,443    11,090 
Deferred income taxes   1,495    1,759 
Investment and other assets   5,193    6,509 
Total assets  $794,718   $740,252 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current liabilities:          
Accounts payable  $393,890   $289,201 
Accrued expenses and other current liabilities   54,413    55,040 
Deferred revenue   12,204    7,913 
Line of credit   149,300    213,778 
Notes payable — current   3,459    3,362 
Total current liabilities   613,266    569,294 
Notes payable   31,151    32,892 
Other long-term liabilities   7,710    7,338 
Deferred income taxes   3,836    3,102 
Total liabilities   655,963    612,626 
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; 17,285,019 and 17,170,273 shares issued; 11,894,367 and 11,779,621 shares outstanding   17    17 
Additional paid-in capital   135,899    134,646 
Treasury stock, at cost: 5,390,652 shares   (38,536)   (38,536)
Accumulated other comprehensive income (loss)   (567)   251 
Retained earnings   41,942    31,248 
Total stockholders’ equity   138,755    127,626 
Total liabilities and stockholders’ equity  $794,718   $740,252 

 

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,
 
   2018   2017   2018   2017 
Net sales  $546,430   $556,082   $1,089,262   $1,078,842 
Cost of goods sold   456,013    470,937    915,249    915,199 
Gross profit   90,417    85,145    174,013    163,643 
Selling, general and administrative expenses   77,222    79,741    154,576    153,528 
Operating profit   13,195    5,404    19,437    10,115 
Interest expense, net   2,315    1,986    4,777    3,639 
Equity income from unconsolidated affiliate   129    135    304    273 
Income before income taxes   11,009    3,553    14,964    6,749 
Income tax expense   3,126    1,187    4,270    211 
Net income  $7,883   $2,366   $10,694   $6,538 
                     
Basic and Diluted Earnings Per Common Share                    
Basic  $0.66   $0.19   $0.90   $0.52 
Diluted   0.64    0.18    0.88    0.48 
                     
Weighted average number of common shares outstanding:                    
Basic   11,912    12,574    11,878    12,477 
Diluted   12,259    13,486    12,145    13,483 

 

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,
 
   2018   2017   2018   2017 
Net income  $7,883   $2,366   $10,694   $6,538 
                     
Other comprehensive income (loss):                    
Foreign currency translation adjustments   (562)   208    (818)   316 
Total other comprehensive income (loss)   (562)   208    (818)   316 
Comprehensive income  $7,321   $2,574   $9,876   $6,854 

 

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, 
   2018   2017 
Cash Flows From Operating Activities          
Net income  $10,694   $6,538 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   6,913    6,913 
Equity income from unconsolidated affiliate   (304)   (273)
Distribution from equity method investee   162     
Provision for deferred income taxes   984    171 
Non-cash stock-based compensation   1,432    1,223 
Change in operating assets and liabilities:          
Accounts receivable   (82,414)   (83,825)
Inventories   24,980    5,988 
Prepaid expenses and other current assets   135    1,784 
Other assets   1,571    1,294 
Accounts payable   102,681    74,311 
Accrued expenses and other current liabilities   1,247    (4,363)
Deferred revenue   4,291    (3,453)
Total adjustments   61,678    (230)
Net cash provided by operating activities   72,372    6,308 
Cash Flows From Investing Activities          
Purchases of property and equipment   (2,358)   (9,056)
Acquisition of Stack Technology   (166)    
Net cash used in investing activities   (2,524)   (9,056)
Cash Flows From Financing Activities          
Net payments under line of credit   (64,478)   (86)
Borrowing under note payable       3,139 
Payments under notes payable   (1,638)   (1,992)
Change in book overdraft   1,952    5,038 
Payments of earn-out liability   (2,199)   (6,523)
Payments of obligations under capital lease   (349)   (860)
Proceeds from capital lease obligations       587 
Proceeds from stock issued under stock option plans   261    4,722 
Payment for deferred financing costs   (43)   (635)
Payment of taxes related to net-settled stock awards   (450)   (783)
Net cash provided by (used in) financing activities   (66,944)   2,607 
Effect of foreign currency on cash flow   (514)   274 
Net change in cash and cash equivalents   2,390    133 
Cash and cash equivalents at beginning of the period   9,113    7,172 
Cash and cash equivalents at end of the period  $11,503   $7,305 
Supplemental Cash Flow Information          
Interest paid  $4,579   $3,263 
Income taxes (refund) paid, net   (1,558)   3,314 
Supplemental Non-Cash Investing and Financing Activities          
Financed and accrued purchases of property and equipment   1,134    14 

 

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, ecommerce channels and technology services teams. Since our founding in 1987, we have served our customers by offering products and services from vendors such as Adobe, Apple, Cisco, Dell, Hewlett Packard Enterprise, HP Inc., Lenovo, Microsoft, Oracle, Symantec and VMware. We provide our customers with comprehensive solutions incorporating leading products and services across a variety of technology practices and platforms such as cloud, security, data center, networking, collaboration and mobility. 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, 2017 filed with the SEC.

 

We 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, Canada and the UK, and maintain offices in the United States, Canada and the UK, as well as in the Philippines. During the three months ended June 30, 2018, we generated approximately 75% of our revenue in our Commercial segment, 14% of our revenue in our Public Sector segment, 9% of our revenue in our Canada segment and 2% of our revenue in our United Kingdom segment. During the six months ended June 30, 2018, we generated approximately 76% of our revenue in our Commercial segment, 12% of our revenue in our Public Sector segment, 9% of our revenue in our Canada segment and 3% of our revenue in our United Kingdom segment.

 

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, as well as the acquisition of Stratiform in December 2016.

 

Our United Kingdom segment consists of results of our UK subsidiary, PCM Technology Solutions UK, Ltd. (“PCM UK”), and its wholly-owned subsidiaries, which serve as our hub for the UK and the rest of Europe. PCM UK commenced its sales operations in May 2017.

 

 6 

 

 

2. New Accounting Standards and Accounting Policies

 

In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” which simplified the testing of goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measured a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. ASU 2017-04 is effective for public companies for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. We are currently evaluating the effects that the adoption of ASU 2017-04 will have on our consolidated financial statements.

 

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business,” which provides a more robust framework to use in determining when a set of assets and activities is a business. ASU 2017-01 provides a more narrow definition of what is referred to as outputs and align it with how outputs are described in Topic 606 in order to narrow the broad interpretations of the definition of a business. ASU 2017-01 is effective for public companies in their annual periods beginning after December 15, 2017, including interim periods within those periods. We adopted ASU 2017-01 effective January 1, 2018 and it did not have a material effect on our consolidated financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments,” which aims to eliminate the diversity in practice related to classification of eight types of cash flows. ASU 2016-15 is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We adopted ASU 2016-15 effective January 1, 2018 and it did not have a material effect on our consolidated financial statements.

 

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.

 

Adoption of New Revenue Recognition Standard

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09” or “ASC 606”), which, along with amendments issued in 2015 and 2016, replaced most existing revenue recognition guidance under GAAP and eliminated 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 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). The ASU, as amended, was effective beginning in the first quarter of 2018. We adopted the guidance on January 1, 2018 using the full retrospective method and we have retrospectively adjusted our prior period financial information presented herein. See below for more information.

 

We have updated our accounting policies to conform with the new guidance, the adoption of which impacted two of our revenue streams as follows:

 

 

Timing of revenue recognition of product in transit to customers - different businesses within PCM have had varying terms of sale related to when title and risk of loss transfer to the customer, either upon shipment or delivery. Historically, regardless of the terms of sale, we have recorded revenue upon delivery to the customer. The adoption of ASU 2014-09 changes the way we recognize revenue for sales with terms where title and risk of loss transfer at shipping point, such that they are now to be recorded at shipment, which is when we transfer control, rather than upon delivery, to our customers. Given that we are migrating to a common ERP, and to ensure consistent application of the new revenue standard across all of our businesses, we changed the terms of sale in the fourth quarter of 2017 such that all of our businesses have terms where title and risk of loss transfer upon delivery to the customer. As a result, following our adoption of ASC 606 on January 1, 2018, we record all sales similar to how we have historically recorded them in 2017 and prior by recording them upon delivery to our customers. Since we have elected the retrospective method of adoption, the 2016 and 2017 results will reflect the impact of recording revenue at its historical stated terms and conditions. See below for more information.

 

 7 

 

 

 

Gross vs. net treatment of certain security software revenues – in certain security software transactions when accompanying third-party delivered software assurance is deemed to be critical or essential to the core functionality of the software license, we have determined that the software license and the accompanying third-party delivered software assurance are a single performance obligation. The value of the product is primarily the accompanying support delivered by a third-party and therefore we act as an agent in these transactions, which are recognized on a net basis. Following our adoption of ASC 606 on January 1, 2018, we recognize revenue from the software license on a gross basis (i.e., acting as a principal) and accompanying third-party delivered software assurance on a net basis. This change reduces both net sales and cost of sales with no impact on reported gross profit.

 

  The accounting for revenue related to hardware, software (excluding the above) and services remains unchanged.

 

The adoption of ASU 2014-09 resulted in the following retrospective adjustments to our previously-reported financial statement amounts for the periods presented below (some items may not foot across due to rounding) (in thousands, except per share amounts):

 

   

Three Months Ended

March 31, 2017

   

Three Months Ended

June 30, 2017

   

Three Months Ended

September 30, 2017

   

Three Months Ended

December 31, 2017

 
    As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted     As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted     As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted     As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted  
Net sales   $ 524,399     $ (1,639 )   $ 522,760     $ 560,110     $ (4,028 )   $ 556,082     $ 545,479     $ (2,204 )   $ 543,275     $ 563,448     $ (18,678 )   $ 544,770  
Gross profit     78,205       293       78,498       85,371       (226 )     85,145       81,294       163       81,457       80,852       (1,224 )     79,628  
Gross profit margin     14.9 %     10 bps       15.0 %     15.2 %     7 bps       15.3 %     14.9 %     9 bps       15.0 %     14.3 %     27 bps       14.6 %
                                                                                                 
Operating profit (loss)     4,473       238       4,711       5,624       (220 )     5,404       1,385       121       1,506       (41 )     (952 )     (993 )
                                                                                                 
Income tax expense (benefit)     (1,069 )     93       (976 )     1,273       (86 )     1,187       427       47       474       353       (371 )     (18 )
                                                                                                 
Net income (loss)     4,027       145       4,172       2,500       (134 )     2,366       (841 )     74       (767 )     (2,595 )     (581 )     (3,176 )
                                                                                                 
Earnings (Loss) Per Share:                                                                                                
Basic     0.33       0.01       0.34       0.20       (0.01 )     0.19       (0.07 )     0.01       (0.06 )     (0.22 )     (0.05 )     (0.27 )
Diluted     0.30       0.01       0.31       0.19       (0.01 )     0.18       (0.07 )     0.01       (0.06 )     (0.22 )     (0.05 )     (0.27 )

 

    At March 31, 2017     At June 30, 2017     At September 30, 2017  
    As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted     As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted     As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted  
Accounts receivable   $ 354,301     $ 12,618     $ 366,919     $ 442,460     $ 12,269     $ 454,729     $ 412,733     $ 14,497     $ 427,230  
Inventory     66,417       (11,331 )     55,086       77,439       (11,208 )     66,231       74,871       (13,273 )     61,598  
Total current assets     446,602       1,287       447,889       541,735       1,061       542,796       506,011       1,224       507,235  
Total assets     611,045       1,287       612,332       710,041       1,061       711,102       678,537       1,224       679,761  
                                                                         
Accounts payable     241,470       236       241,706       355,834       229       356,063       271,841       271       272,112  
Total current liabilities     447,006       236       447,242       536,910       229       537,139       506,050       271       506,321  
                                                                         
Deferred income tax liability     1,556       410       1,966       3,758       324       4,082       3,819       371       4,190  
Total liabilities     473,698       646       474,344       569,386       554       569,940       548,548       643       549,191  
                                                                         
Retained Earnings     32,184       641       32,825       34,778       507       35,285       33,843       581       34,424  
Total stockholders’ equity     137,347       641       137,988       140,655       507       141,162       129,989       581       130,570  
Total liabilities and stockholders’ equity     611,045       1,287       612,332       710,041       1,061       711,102       678,537       1,224       679,761  

 

 8 

 

 

    Year Ended December 31, 2017     Year Ended December 31, 2016  
    As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted     As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted  
Net sales   $ 2,193,436     $      (26,549 )   $ 2,166,887     $ 2,250,587     $ (11,030 )   $ 2,239,557  
Gross profit     325,722       (994 )     324,728       318,801       126       318,927  
Gross profit margin     14.8 %     14 bps       15.0 %     14.2 %     8 bps       14.2 %
                                                 
Operating profit     11,441       (813 )     10,628       34,791       110       34,901  
                                                 
Income tax expense     984       (317 )     667       11,115       43       11,158  
                                                 
Net income     3,091       (496 )     2,595       17,593       67       17,660  
                                                 
Earnings Per Share:                                                
Basic     0.25       (0.04 )     0.21       1.49       0.01       1.49  
Diluted     0.24       (0.04 )     0.20       1.40       0.01       1.41  

 

    At December 31, 2017     At December 31, 2016  
    As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted     As Reported    

New Revenue Recognition Standard

Adjustment

    As Adjusted  
Accounts receivable   $ 439,658     $   -     $ 439,658     $ 358,949     $ 9,647     $ 368,596  
Inventory     103,471       -       103,471       80,872       (8,653 )     72,219  
Total current assets     561,575       -       561,575       469,055       994       470,049  
Total assets     740,252       -       740,252       629,810       994       630,804  
                                                 
Accounts payable     289,201       -       289,201       276,524       180       276,704  
Total current liabilities     569,294       -       569,294       474,052       180       474,232  
                                                 
Deferred income tax liability     3,102       -       3,102       1,498       317       1,815  
Total liabilities     612,626       -       612,626       501,339       498       501,837  
                                                 
Retained Earnings     31,248       -       31,248       28,251       496       28,747  
Total stockholders’ equity     127,626       -       127,626       128,471       496       128,967  
Total liabilities and stockholders’ equity     740,252       -       740,252       629,810       994       630,804  

 

Revenue Recognition Policy

 

We adhere to the guidelines and principles of revenue recognition described in ASC 606. Under ASC 606, we identify and account for a contract with a customer when it has written approval and commitment of the parties, the rights of the parties including payment terms are identified, the contract has commercial substance, and consideration is probable of collection. We recognize revenue upon delivery to the customer when control, title and risk of loss of a promised product or service transfers to a customer, as per our contractual agreement with customers, in an amount that reflects the consideration to which we expect to be entitled in exchange for transferring those products or services. In certain types of arrangements, as discussed more fully below, revenue from sales of third-party vendor products or services is recorded on a net basis when we act as an agent between the customer and the vendor, and on a gross basis when we act as the principal for the transaction. To determine whether the company is an agent or principal, we consider whether we obtain control of the products or services before they are transferred to the customer, as well as whether we have primary responsibility for fulfillment to the customer, inventory risk and pricing discretion.

 

Product and service revenues are recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. The following indicators are evaluated in determining when control has transferred to the customer: (i) the Company has a right to payment, (ii) the customer has legal title to the product, (iii) the Company has transferred physical possession of the product to the customer, (iv) the customer has the significant risk and rewards of ownership, and (v) the customer has accepted the product.

 

 9 

 

 

Products

 

Revenue from sales of product (hardware and software) is recognized at a point in time when the product has been delivered to the customer. The Company’s shipping terms are FOB destination and it is upon delivery that the Company has right to payment, the customer obtains legal title to the product, and physical possession of the product has transferred to the customer. We act as the principal in these transactions and, as such, record product revenue at gross sales amounts. 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 also recognized at gross sales amounts.

 

When product sales incorporate a bill and hold arrangement, whereby the customer agrees to purchase product but requests delivery at a later date, we have determined that control transfers when the product is ready for delivery, which occurs when the product has been set aside or obtained specifically to fulfill the contract with the customer. It is at this point that we have right to payment, the customer obtains legal title, and the customer has the significant risks and rewards of ownership.

 

We recognize certain products on a net basis, as an agent. Products in this category include the sale of third-party services, warranties, software assurance (“SA”), and subscriptions.

 

Warranties represent third-party product warranties. Warranties not sold separately are assurance-type warranties that only provide assurance that products will conform to the manufacturer’s specifications and are not considered separate performance obligations. Warranties that are sold separately, such as extended warranties, provide the customer with a service in addition to assurance that the product will function as expected. We consider these service-type warranties to be separate performance obligations from the underlying product. We arrange for a third-party to provide those services and therefore we act as an agent in the transaction and record revenue on a net basis at the point of sale.

 

SA is a product that allows customers to upgrade their software, at no additional cost, to the latest technology if new applications are introduced during the period that the SA is in effect. Most software licenses are sold with accompanying third-party delivered SA. The Company evaluates whether the SA is a separate performance obligation by assessing if the third-party delivered SA is critical to the core functionality of the software. This involves considering if the software provides its original intended functionality to the customer without the updates, if the customer would ascribe a higher value to the upgrades versus the initial software delivered, and if the customer would expect updates to the software to maintain the functionality. When the SA for a software product is deemed critical to maintaining the core functionality of the underlying software, the software license and SA are considered a single performance obligation and the value of the product is primarily the SA service delivered by a third-party. Therefore, the Company is acting as an agent in these transactions and the revenue is recognized on a net basis when the underlying software is delivered to the customer. 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. When the SA for a software product is deemed not critical to the core functionality of the underlying software, the SA is recognized as a separate performance obligation and the revenue is recognized on a net basis when the underlying software license is delivered to the customer.

 

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, and we act as a sales agent in the transaction. In addition to the vendor being primarily responsible for fulfilling the promise to the customer, they also assume the inventory risk as they are responsible for providing remedy or refund if the customer is not satisfied with the delivered services. At the time of sale, our obligation as an agent is fulfilled and we recognize revenue in the amount of an agency fee or commission. We record these fees as a component of net sales 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.

 

Services

 

Service revenues are recognized over time since customers simultaneously receive and consume the benefits of the Company’s services as they are provided. The Company is the principal in service transactions and therefore recognizes revenue on a gross basis. 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 in the amount to which the Company has the right to invoice in accordance with the practical expedient in paragraph 606-10-55-18. Revenue for fixed fee services are recognized using an input method based on the total number of hours incurred for the period as a proportion of the total expected hours for the project. Total expected hours to complete the project is updated for each period and best represents the transfer of control of the service to the customer.

 

 10 

 

 

Bundled Arrangements

 

Bundled arrangements are contracts that can include various combinations of products and services. When a contract includes multiple performance obligations delivered at varying times, we determine whether the delivered items are distinct under ASC 606. For arrangements with multiple performance obligations, the transaction price is allocated among the performance obligations based on their relative standalone selling prices (“SSP”). When observable evidence from recent transactions exists, it is used to confirm that prices are representative of SSP. When evidence from recent transactions is not available, an expected cost plus a margin approach is used.

 

Sales In Transit

 

In order to recognize revenues in accordance with our revenue recognition policy under ASC 606, we perform an analysis to estimate the number of days that 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 that are initially recorded in our accounting records based on the estimated value of products that have shipped, but have not yet been delivered to 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 the timing of revenue recognized in future periods.

 

Freight Costs

 

The Company records freight billed to its customers on a gross basis to net sales and related freight costs to cost of sales when the product is delivered to the customer. For freight not billed to its customers, the Company records the freight costs as cost of sales. The Company’s shipping terms are FOB destination, which results in shipping being performed before the customer obtains control of the product, thus shipping activities are not a promised service to the customer. Rather, shipping is an activity to fulfill the promise to deliver the products.

 

Other

 

The Company’s contracts give rise to variable consideration in the form of sales returns and allowances which we estimate at the most likely amount to which we are expected to be entitled. This estimate is included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. The most likely amount estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based on an assessment of the Company’s anticipated performance and historical experience and are recorded at the time of sale.

 

Sales are reported net of estimated returns and allowances, discounts, mail-in rebate redemptions, credit card chargebacks, and taxes collected from customers. If the actual sales returns, allowances, discounts, mail-in rebate redemptions or credit card chargebacks are greater than estimated by management, additional reductions to revenue may be required.

 

Generally, the period between when control of the promised products or services transfer to the customer and when the customer pays for the product or service is one year or less. As such, we elected the practical expedient allowed in paragraph 606-10-32-18 and we do not adjust product and service consideration for the effects of a significant financing component.

 

The amortization period of any asset resulting from incremental costs of obtaining a contract would generally be one year or less. As such, we elected the practical expedient allowed in paragraph 340-40-25-4 and we expense these costs as incurred.

 

 11 

 

 

The following table presents our total net sales disaggregated by our major product line and our reportable segments (in thousands):

 

   Commercial   Public
Sector
   Canada   United Kingdom   Corporate  &
Other
   Consolidated 
Three Months Ended June 30, 2018                              
Hardware & Software Products  $381,515   $69,945   $39,888   $12,325   $(160)  $503,513 
Services   29,435    4,767    7,528    1,187        42,917 
Total  $410,950   $74,712   $47,416   $13,512   $(160)  $546,430 
                               
Three Months Ended June 30, 2017                              
Hardware & Software Products  $408,276   $70,648   $36,214   $362   $(179)  $515,321 
Services   27,617    5,779    7,365            40,761 
Total  $435,893   $76,427   $43,579   $362   $(179)  $556,082 
                               
Six Months Ended June 30, 2018                              
Hardware & Software Products  $763,284   $122,866   $86,488   $28,993   $(314)  $1,001,317 
Services   62,397    7,908    15,048    2,592        87,945 
Total  $825,681   $130,774   $101,536   $31,585   $(314)  $1,089,262 
                               
Six Months Ended June 30, 2017                              
Hardware & Software Products  $788,638   $135,084   $77,375   $362   $(205)  $1,001,254 
Services   54,775    7,949    14,864            77,588 
Total  $843,413   $143,033   $92,239   $362   $(205)  $1,078,842 

 

The change in our deferred revenue related to contracts with customers was as follows (in thousands):

 

   Current   Long-Term   Total 
Balance at December 31, 2017  $ 7,913(1)  $ 463(2)  $8,376 
Deferral of revenue   16,200    374    16,574 
Recognition of deferred revenue   (11,872)   (207)   (12,079)
Foreign currency translation   (37)       (37)
Balance at June 30, 2018  $ 12,204 (1)  $ 630(2)  $12,834 

 

 

(1)Presented as “Deferred revenue” on our consolidated balance sheets.
(2)Presented as part of “Other long-term liabilities” on our consolidated balance sheets.

 

At June 30, 2018, we had an immaterial amount of contract assets resulting from revenue being recognized in excess of the amount that we have the right to invoice the customer.

 

Revenue allocated to remaining performance obligations represents non-cancellable contracted revenue that has not yet been recognized, which includes unearned revenue and amounts that will be delivered and recognized as revenue in future periods. Contracted, but not recognized, revenue was $32.7 million as of June 30, 2018, of which we expect to recognize approximately 54% over the next 12 months and the remainder thereafter. We applied the practical expedient provided under ASC 606-10-50-14(a) and have not included information about remaining performance obligations that have original expected duration of one year or less.

 

 12 

 

 

3. Acquisition

 

On December 22, 2017, PCM UK, our UK based subsidiary, completed the acquisition of Provista Technology for an initial purchase price of £3.4 million, net of cash acquired and including £1.1 million of accrued earn-out liability (or $4.5 million, net of cash acquired and including $1.4 million of accrued earn-out liability). Provista Technology has expertise across a range of technologies and manufacturers including Cisco, Avaya, Cisco Meraki, Huawei, Checkpoint, and other leading vendors, with offerings encompassing all aspects of Cloud Networking, Cloud Video, Hyperconvergence, Security, Collaboration, Secure Wireless and IP LAN, WAN & Data Center Networks. We believe this acquisition will further enhance PCM UK’s expertise and vendor accreditations in the United Kingdom as a Cisco Gold Partner, allowing PCM UK and its subsidiaries to offer further consultancy, integration and supply of services and solutions across the UK marketplace while replicating many existing offerings from our North American organization. As part of the Provista acquisition, we agreed to pay certain contingent earn-out consideration related to years ending December 31, 2018, 2019 and 2020 (each year the “measurement period”), and payable 90 days in arrears following each measurement period. As of June 30, 2018, we have estimated that the fair value of contingent consideration to be paid throughout the earn-out periods to be approximately $1.4 million, of which we have included $0.5 million in “Accrued expenses and other current liabilities” and $0.9 million in “Other long-term liabilities” on our consolidated balance sheet. The accounting for the acquisition of Provista Technology is currently preliminary and we continue to obtain information relative to the fair values of certain assets acquired and certain liabilities assumed in the transaction.

 

4. 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   United Kingdom   Total 
Balance at December 31, 2017  $69,735   $8,322   $4,997   $4,714   $87,768 
Adjustment related to acquisition of Stack Technology               166    166 
Foreign currency translation           (211)   (107)   (318)
Balance at June 30, 2018  $69,735   $8,322   $4,786   $4,773   $87,616 

 

Intangible Assets

 

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

 

   Weighted
Average
Estimated
   At June 30, 2018   At December 31, 2017 
   Useful Lives
(years)
   Gross
Amount
   Accumulated
Amortization
   Net
Amount
   Gross
Amount
   Accumulated
Amortization
   Net
Amount
 
Patent, trademarks, trade names & URLs   5   $ 5,711 (1)  $1,633   $4,078   $ 7,739 (1)  $3,186   $4,553 
Customer relationships   15    13,424    8,555    4,869    13,533    7,799    5,734 
Non-compete agreements   4    2,366    1,870    496    2,377    1,574    803 
Total intangible assets       $21,501   $12,058   $9,443   $23,649   $12,559   $11,090 

 

 

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

 

Amortization expense for intangible assets was approximately $0.7 million and $1.0 million for the three months ended June 30, 2018 and 2017, respectively. Estimated amortization expense for intangible assets as of June 30, 2018 in each of the next five years and thereafter is as follows: $1.4 million in the remainder of 2018, $1.8 million in 2019, $1.3 million in 2020, $0.5 million in 2021, $0.4 million in 2022 and $1.1 million thereafter.

 

 13 

 

 

5. Debt

 

The following table sets forth our outstanding debt balances (in thousands):

 

   At June 30,   At December 31, 
   2018   2017 
Revolving credit facility, LIBOR plus 1.50%, maturing in March 2021  $149,300   $213,778 
Note payable, LIBOR plus 1.50%, maturing in March 2021    10,138    11,032 
Note payable, LIBOR plus 1.50%, maturing in March 2021   1,785    1,943 
Note payable, greater of 2% or LIBOR plus 2.15%, maturing in April 2022    4,306    4,404 
Note payable, LIBOR plus 2.25%, maturing in January 2022    3,793    3,908 
Note payable, LIBOR plus 2.25%, maturing in January 2020    6,643    6,798 
Note payable, Prime rate plus 0.375% or LIBOR plus 2.375%, maturing in January 2020    7,509    7,710 
Note payable, LIBOR plus 3.2%, maturing in May 2025   261    284 
Other note payable, maturing in August 2018    175    175 
Total    183,910    250,032 
Less: Total current debt    152,759    217,140 
Total non-current debt   $31,151   $32,892 

 

The following table sets forth the maturities of our outstanding debt balance as of June 30, 2018 (in thousands):

 

   Remainder of 2018   2019   2020   2021   2022   Thereafter   Total 
Total long-term debt obligations  $1,813   $3,277   $15,653   $10,120   $3,655   $92   $34,610 
Revolving credit facility   149,300                        149,300 
Total  $151,113   $3,277   $15,653   $10,120   $3,655   $92   $183,910 

 

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 with the Lenders and on February 24, 2017, we entered into a Second Amendment to the Fourth Amended Loan Agreement with the Lenders. On October 24, 2017, PCM, all of its wholly-owned domestic subsidiaries (collectively with PCM, the “US Borrowers”), all of its Canadian subsidiaries (collectively, the “Canadian Borrowers”) and its PCM UK subsidiary (together with the US Borrowers and the Canadian Borrowers, the “Borrowers”), entered into a Fifth Amended and Restated Loan and Security Agreement (the “Fifth Amended Loan Agreement”) with the Lenders. The Fifth Amended Loan Agreement amends and restates the Fourth Amended Loan Agreement.

 

The terms of our credit facility, as amended, 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 and a sub-line of up to £25,000,000 as the UK 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 Fifth 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%; (v) interest on outstanding UK balances based on LIBOR plus a margin, depending on average excess availability under the Revolving Line, ranging from 1.50% to 1.75%; (vi) 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%; and (vii) 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 terms of our credit facility are more fully described in the Fifth Amended Loan Agreement.

 

 14 

 

 

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, 2018, 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, 2018, we had $158.3 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 a sub-line with a limit of $12.5 million secured by our properties located in Santa Monica, California, with a monthly principal amortization of $149,083 and a sub-line with a limit of $2.2 million secured by our property in Woodridge, Illinois, with a monthly principal amortization of $26,250.

 

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. As of June 30, 2018, we had no outstanding balance under the Channel Finance Facility.

 

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 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.

 

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, as amended, 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 September 2017, we entered into an amendment with the lender extending the maturity of the loan to January 31, 2020. 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, 2018, the effective weighted average annual interest rate on our outstanding amounts under the credit facility, term note and variable interest rate notes payable was 3.66%.

 

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.

 

 15 

 

 

6. 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 occurs during the interim period.

 

On December 22, 2017, U.S. tax legislation was enacted containing a broad range of tax reform provisions. The SEC staff concurrently issued Staff Accounting Bulletin No.118, providing additional guidance on accounting for the financial statement effects of U.S. tax reform and allowing companies to record provisional amounts during a one-year measurement period, not to extend beyond one year from the enactment date. As of June 30, 2018, we have not recorded incremental accounting adjustments to our provisional net tax benefit of $1.2 million recorded in December 2017 related to the impact on our deferred tax balances and the additional tax resulting from the mandatory deemed repatriation of foreign earnings. Further, we are continuing to evaluate the provisions related to global intangible low tax income (GILTI) and have not yet made a policy election to account for GILTI as a period expense or to recognize the impact of GILTI in our deferred taxes. We expect to finalize our provisional estimates before the end of 2018 as additional data is prepared and analyzed, interpretations and assumptions are refined, and any additional guidance is issued. For additional information regarding 2017 U.S. tax reform, see Note 9 to our consolidated financial statements included in our Form 10-K for the year ended December 31, 2017.

 

Accounting for Uncertainty in Income Taxes

 

We had unrecognized tax benefits of $0.5 million related to research credits at June 30, 2018 and December 31, 2017. During the three and six months ended June 30, 2018 and 2017, we did not recognize any interest or penalties for uncertain tax positions, nor were there any interest or penalties accrued at June 30, 2018 and December 31, 2017. We do not anticipate any significant increases or decreases in our unrecognized tax benefits within the next twelve months.

 

We are subject to U.S. and foreign income tax examinations for years subsequent to 2013, and state income tax examinations for years subsequent to 2012. 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.

 

7. 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, again amended in April 2015 and increased to a total of $30 million, and again amended in August 2017 and increased to a total of $40 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 made no repurchase of shares of our common stock under this program during the three and six months ended June 30, 2018. At June 30, 2018, we had $2.5 million available for 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.

 

 16 

 

 

8. Earnings Per Share

 

Basic earnings (loss) per share (“EPS”) is computed by dividing net income (loss) 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, 2018 and 2017, approximately 988,000 and 114,000 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, 2018 and 2017, approximately 775,000 and 107,000 common shares, respectively, have been excluded from the calculation of diluted EPS because the effect of their inclusion would have been antidilutive.

 

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

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2018   2017   2018   2017 
Numerator:                    
Net income  $7,883   $2,366   $10,694   $6,538 
Denominator:                    
Basic EPS - Weighted average number of common shares outstanding   11,912    12,574    11,878    12,477 
Dilutive effect of stock awards   347    912    267    1,006 
Diluted EPS - Weighted average number of common shares outstanding   12,259    13,486    12,145    13,483 
Net earnings per share:                    
Basic  $0.66   $0.19   $0.90   $0.52 
Diluted   0.64    0.18    0.88    0.48 

 

9. Segment Information

 

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

 

   Commercial   Public
Sector
   Canada   United Kingdom   Corporate &
Other
   Consolidated 
Three Months Ended June 30, 2018                              
Net sales  $410,950   $74,712   $47,416   $13,512   $(160)  $546,430 
Gross profit   70,147    10,377    7,378    2,672    (157)   90,417 
Depreciation and amortization expense(1)   1,255    123    231    73    1,626    3,308 
Operating profit (loss)   25,492    4,633    1,166    (1,102)   (16,994)   13,195 
                               
Three Months Ended June 30, 2017                              
Net sales  $435,893   $76,427   $43,579   $362   $(179)  $556,082 
Gross profit   66,992    11,064    7,185    53    (149)   85,145 
Depreciation and amortization expense(1)   1,430    207    198        1,556    3,391 
Operating profit (loss)   19,530    4,832    291    (1,585)   (17,664)   5,404 
                               
Six Months Ended June 30, 2018                              
Net sales  $825,681   $130,774   $101,536   $31,585   $(314)  $1,089,262 
Gross profit   135,995    16,401    15,739    6,187    (309)   174,013 
Depreciation and amortization expense(1)   2,618    298    497    122    3,378    6,913 
Operating profit (loss)   47,209    4,683    2,628    (1,394)   (33,689)   19,437 
                               
Six Months Ended June 30, 2017                              
Net sales  $843,413   $143,033   $92,239   $362   $(205)  $1,078,842 
Gross profit   131,109    17,959    14,727    53    (205)   163,643 
Depreciation and amortization expense(1)   2,824    414    505        3,170    6,913 
Operating profit (loss)   37,978    6,226    1,515    (1,737)   (33,867)   10,115 

 

 

(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.

 

 17 

 

 

As of June 30, 2018 and December 31, 2017, we had total consolidated assets of $794.7 million and $740.3 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.

 

10. Commitments and Contingencies

 

Total rent expense under our operating leases, net of sublease income, was $1.9 million and $1.5 million in the three month periods ended June 30, 2018 and 2017, respectively, and $4.0 million and $2.9 million in the six month periods ended June 30, 2018 and 2017, 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.

 

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 alleged 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 alleged 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 did not specify the amount of damages Collab9 is seeking, but asserted 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 March 5, 2018, Collab9 filed a motion for leave to amend its pleadings to add new allegations in support of its earn-out claim and to advance additional theories of recovery. Collab9’s Second Amended Complaint was accepted for filing on June 20, 2018. In it, Collab9 advances four counts, or “causes of action,” in which it alleges that the Company (i) failed to include in the earn-out payments a portion of internally delivered services revenue calculated across all consolidated Company businesses rather than the acquired En Pointe business; (ii) transferred accounts and sales persons away from the En Pointe business for the purpose of reducing the earn-out payment calculation; (iii) had an implied duty to maintain a separate financial accounting system for the purpose of tracking earn-out payment calculations; (iv) failed to provide Collab9 with a sublicense to certain SAP software acquired by the Company under the APA; (v) obtained and modified certain data that Collab9 delivered to the Company; and (vi) failed to cooperate with Collab9 to indemnify it in connection with the foregoing claims. Collab9 further asserts breaches of the APA and the implied covenant of good faith and fair dealing, and that the Company’s certification of earn-out payments other than in accordance with these new allegations was fraudulent. On June 27, 2018, the Company moved to dismiss two of the four counts and otherwise answered the complaint. 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.

 

 18 

 

 

In its June 27, 2018 answer, the Company also included 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.

 

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 alleged 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 alleged 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. 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. Collab9 did not include these claims in its Second Amended Complaint in the Delaware Litigation described above, and we do not know whether Collab9 will refile the claims in a Delaware court. The Company believes the claims are wholly without merit, and if pursued by Collab9 in Delaware, the Company intends to vigorously defend against them.

 

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. 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. In November 2017, we voluntarily dismissed the action without prejudice in order to seek resolution of disputes regarding data ownership and use rights in the pending Delaware Litigation with Collab9 described above. Depending on the outcome of the Delaware case, we may decide to reinstate this action in California.

 

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 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 were 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. On October 10, 2017 the Civil court in Pakistan dismissed the case on grounds of the exclusive venue provision of the contract which requires the case to be litigated in arbitration in California. Ovex appealed the decision of the Civil Court to the High Court in Islamabad Pakistan. The High Court heard arguments by Ovex on the appeal in early November 2017. The case was temporarily adjourned by request to the High Court by Ovex with the consent of En Pointe and has been refixed for a hearing on August 13, 2018. The Company believes the claims by Ovex are speculative and wholly without merit, and intends to vigorously defend the claims on jurisdictional grounds. 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 3, 2018, the sole shareholder of Ovex filed an action in Pakistan purportedly on behalf of Ovex against certain officers and directors of En Pointe, PCM and PCM’s subsidiary in Pakistan claiming that Ovex was harmed as a result of an alleged scheme to drive Ovex employees to leave Ovex and join Pakistan-based direct competitors of PCM and affiliates of PCM. No relief has been sought against PCM or any of its subsidiaries in the action. We believe that the claims in this action lack merit and intend to vigorously defend the claims on jurisdictional grounds. On July 5, 2018, the U.S. District Court for the Central District of California entered another Order confirming that the pending proceedings in Pakistan are barred by the arbitration requirement and by the Court’s previous anti-suit injunction.

 

 19 

 

 

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 and the arbitrator held an in-person, live, evidentiary hearing on November 28, 2017. On March 9, 2018, the arbitrator in the primary arbitration proceeding entered a partial final award in favor of En Pointe. In the award, the arbitrator found, among other things, that: (1) En Pointe had not breached the service contract and owes nothing to Ovex; (2) Ovex materially breached the service agreement and owes En Pointe $990,586 in actual damages plus attorneys’ fees in an amount to be determined later; and (3) the service agreement was properly terminated by En Pointe with no further obligations to En Pointe. Additional claims and damages against Ovex will be decided in a later phase of the arbitration.

 

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 in California for claims relating to the services contract with Ovex and for an anti-suit injunction against Ovex. In this action, En Pointe 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. On September 11, 2017 the U.S. District Court issued an order compelling arbitration in California and granting the anti-suit injunction as requested in En Pointe’s petition. Ovex and its sole shareholder have continued to litigate in Pakistan in violation of the U.S. District Court’s order. On July 5, 2018, the U.S. District Court for the Central District of California entered another Order confirming that the pending proceedings in Pakistan are barred by the arbitration requirement and by the Court’s anti-suit injunction and directing Ovex and its shareholder, Sheikh Khawar Latif, to appear before the Federal Court on August 13, 2018 to show cause why they should not be held in contempt for continuing to litigate in Pakistan in violation of this Order.

 

***

 

 20 

 

 

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, ecommerce channels and technology services teams. Since our founding in 1987, we have served our customers by offering products and services from vendors such as Adobe, Apple, Cisco, Dell, Hewlett Packard Enterprise, HP Inc., Lenovo, Microsoft, Oracle, Symantec, Synnex and VMware. We provide our customers with comprehensive solutions incorporating leading products and services across a variety of technology practices and platforms such as cloud, security, data center, networking, collaboration and mobility. 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 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, Canada and the UK, and maintain offices in the United States, Canada and the UK, as well as in the Philippines. During the three months ended June 30, 2018, we generated approximately 75% of our revenue in our Commercial segment, 14% of our revenue in our Public Sector segment, 9% of our revenue in our Canada segment and 2% of our revenue in our United Kingdom segment. During the six months ended June 30, 2018, we generated approximately 76% of our revenue in our Commercial segment, 12% of our revenue in our Public Sector segment, 9% of our revenue in our Canada segment and 3% of our revenue in our United Kingdom segment.

 

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, as well as the acquisition of Stratiform in December 2016.

 

Our United Kingdom segment consists of results of our UK subsidiary, PCM Technology Solutions UK, Ltd. (“PCM UK”), and its wholly-owned subsidiaries, which serve as our hub for the UK and the rest of Europe. PCM UK commenced its sales operations in May 2017.

 

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.

 

 21 

 

 

A substantial portion of our business is dependent on sales of Microsoft and HP Inc. products as well as products purchased from other vendors including Apple, Cisco, Dell, Hewlett Packard Enterprise, Ingram Micro, Lenovo, Synnex 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,
 
   2018   2017   2018   2017 
Microsoft   20%   20%   17%   17%
HP Inc.   10    9    11    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, 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

 

On December 22, 2017, PCM UK, our UK based subsidiary, completed the acquisition of Provista Technology for an initial purchase price of £3.4 million, net of cash acquired and including £1.1 million of accrued earn-out liability (or $4.5 million, net of cash acquired and including $1.4 million of accrued earn-out liability). Provista Technology has expertise across a range of technologies and manufacturers including Cisco, Avaya, Cisco Meraki, Huawei, Checkpoint, and other leading vendors, with offerings encompassing all aspects of Cloud Networking, Cloud Video, Hyperconvergence, Security, Collaboration, Secure Wireless and IP LAN, WAN & Data Center Networks. We believe this acquisition will further enhance PCM UK’s expertise and vendor accreditations in the United Kingdom as a Cisco Gold Partner, allowing PCM UK and its subsidiaries to offer further consultancy, integration and supply of services and solutions across the UK marketplace while replicating many existing offerings from our North American organization.

 

We are currently involved in several disputes related to our acquisition of En Pointe Technologies completed in April 2015. These proceedings are described under the heading “Legal Proceedings” in Part I, Item 1, Note 10 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.

 

We adopted ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09” or “ASC 606”) effective January 1, 2018, utilizing the full retrospective method as discussed in Note 2 of the Notes to the Condensed Consolidated Financial Statements of this report. Our prior period amounts presented herein have been adjusted accordingly. See below under Critical Accounting Policies and Estimates - Revenue Recognition – for more information.

 

 22 

 

 

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 and have begun the migration process. The migration process started in the second quarter of 2017 and it will continue through 2018. We anticipate completion of migration of a significant portion of our legacy systems to the SAP platform 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.

 

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.

 

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, 2017.

 

Revenue Recognition. We adhere to the guidelines and principles of revenue recognition described in ASC 606. Under ASC 606, we identify and account for a contract with a customer when it has written approval and commitment of the parties, the rights of the parties including payment terms are identified, the contract has commercial substance, and consideration is probable of collection. We recognize revenue upon delivery to the customer when control, title and risk of loss of a promised product or service transfers to a customer, as per our contractual agreement with customers, in an amount that reflects the consideration to which we expect to be entitled in exchange for transferring those products or services. In certain types of arrangements, as discussed more fully below, revenue from sales of third-party vendor products or services is recorded on a net basis when we act as an agent between the customer and the vendor, and on a gross basis when we act as the principal for the transaction. To determine whether the company is an agent or principal, we consider whether we obtain control of the products or services before they are transferred to the customer, as well as whether we have primary responsibility for fulfillment to the customer, inventory risk and pricing discretion.

 

Product and service revenues are recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. The following indicators are evaluated in determining when control has transferred to the customer: (i) the Company has a right to payment, (ii) the customer has legal title to the product, (iii) the Company has transferred physical possession of the product to the customer, (iv) the customer has the significant risk and rewards of ownership, and (v) the customer has accepted the product.

 

Products

 

Revenue from sales of product (hardware and software) is recognized at a point in time when the product has been delivered to the customer. The Company’s shipping terms are FOB destination and it is upon delivery that the Company has right to payment, the customer obtains legal title to the product, and physical possession of the product has transferred to the customer. We act as the principal in these transactions and, as such, record product revenue at gross sales amounts. 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 also recognized at gross sales amounts.

 

 23 

 

 

When product sales incorporate a bill and hold arrangement, whereby the customer agrees to purchase product but requests delivery at a later date, we have determined that control transfers when the product is ready for delivery, which occurs when the product has been set aside or obtained specifically to fulfill the contract with the customer. It is at this point that we have right to payment, the customer obtains legal title, and the customer has the significant risks and rewards of ownership.

 

We recognize certain products on a net basis, as an agent. Products in this category include the sale of third-party services, warranties, software assurance (“SA”), and subscriptions.

 

Warranties represent third-party product warranties. Warranties not sold separately are assurance-type warranties that only provide assurance that products will conform to the manufacturer’s specifications and are not considered separate performance obligations. Warranties that are sold separately, such as extended warranties, provide the customer with a service in addition to assurance that the product will function as expected. We consider these service-type warranties to be separate performance obligations from the underlying product. We arrange for a third-party to provide those services and therefore we act as an agent in the transaction and record revenue on a net basis at the point of sale.

 

SA is a product that allows customers to upgrade their software, at no additional cost, to the latest technology if new applications are introduced during the period that the SA is in effect. Most software licenses are sold with accompanying third-party delivered SA. The Company evaluates whether the SA is a separate performance obligation by assessing if the third-party delivered SA is critical to the core functionality of the software. This involves considering if the software provides its original intended functionality to the customer without the updates, if the customer would ascribe a higher value to the upgrades versus the initial software delivered, and if the customer would expect updates to the software to maintain the functionality. When the SA for a software product is deemed critical to maintaining the core functionality of the underlying software, the software license and SA are considered a single performance obligation and the value of the product is primarily the SA service delivered by a third-party. Therefore, the Company is acting as an agent in these transactions and the revenue is recognized on a net basis when the underlying software is delivered to the customer. 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. When the SA for a software product is deemed not critical to the core functionality of the underlying software, the SA is recognized as a separate performance obligation and the revenue is recognized on a net basis when the underlying software license is delivered to the customer.

 

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, and we act as a sales agent in the transaction. In addition to the vendor being primarily responsible for fulfilling the promise to the customer, they also assume the inventory risk as they are responsible for providing remedy or refund if the customer is not satisfied with the delivered services. At the time of sale, our obligation as an agent is fulfilled and we recognize revenue in the amount of an agency fee or commission. We record these fees as a component of net sales 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.

 

Services

 

Service revenues are recognized over time since customers simultaneously receive and consume the benefits of the Company’s services as they are provided. The Company is the principal in service transactions and therefore recognizes revenue on a gross basis. 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 in the amount to which the Company has the right to invoice in accordance with the practical expedient in paragraph 606-10-55-18. Revenue for fixed fee services are recognized using an input method based on the total number of hours incurred for the period as a proportion of the total expected hours for the project. Total expected hours to complete the project is updated for each period and best represents the transfer of control of the service to the customer.

 

Bundled Arrangements

 

Bundled arrangements are contracts that can include various combinations of products and services. When a contract includes multiple performance obligations delivered at varying times, we determine whether the delivered items are distinct under ASC 606. For arrangements with multiple performance obligations, the transaction price is allocated among the performance obligations based on their relative standalone selling prices (“SSP”). When observable evidence from recent transactions exists, it is used to confirm that prices are representative of SSP. When evidence from recent transactions is not available, an expected cost plus a margin approach is used.

 

 24 

 

 

Sales In Transit

 

In order to recognize revenues in accordance with our revenue recognition policy under ASC 606, we perform an analysis to estimate the number of days that 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 that are initially recorded in our accounting records based on the estimated value of products that have shipped, but have not yet been delivered to 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 the timing of revenue recognized in future periods.

 

Freight Costs

 

The Company records freight billed to its customers on a gross basis to net sales and related freight costs to cost of sales when the product is delivered to the customer. For freight not billed to its customers, the Company records the freight costs as cost of sales. The Company’s shipping terms are FOB destination, which results in shipping being performed before the customer obtains control of the product, thus shipping activities are not a promised service to the customer. Rather, shipping is an activity to fulfill the promise to deliver the products.

 

Other

 

The Company’s contracts give rise to variable consideration in the form of sales returns and allowances which we estimate at the most likely amount to which we are expected to be entitled. This estimate is included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. The most likely amount estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based on an assessment of the Company’s anticipated performance and historical experience and are recorded at the time of sale.

 

Sales are reported net of estimated returns and allowances, discounts, mail-in rebate redemptions, credit card chargebacks, and taxes collected from customers. If the actual sales returns, allowances, discounts, mail-in rebate redemptions or credit card chargebacks are greater than estimated by management, additional reductions to revenue may be required.

 

Generally, the period between when control of the promised products or services transfer to the customer and when the customer pays for the product or service is one year or less. As such, we elected the practical expedient allowed in paragraph 606-10-32-18 and we do not adjust product and service consideration for the effects of a significant financing component.

 

The amortization period of any asset resulting from incremental costs of obtaining a contract would generally be one year or less. As such, we elected the practical expedient allowed in paragraph 340-40-25-4 and we expense these costs as incurred.

 

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 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, 2017, our goodwill resided in our Abreon, Commercial Technology, Public Sector, Canada and United Kingdom reporting units.

 

 25 

 

 

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, net of any assumed liabilities, 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, 2017. Our annual impairment analysis excluded goodwill associated with acquisitions made during the third and fourth quarter of 2017, as their purchase price allocations were completed subsequent to the analysis date, and their operations have not had sufficient operating time to suggest any triggering event would 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, 2017, 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, the 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, 2017. 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 56%, 46%, 63% and 103% 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 $6.5 million of goodwill as of October 1, 2017 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.

 

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, 2017, 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 34% as of October 1, 2017. We believe several factors are contributing to our low market capitalization, including the lack of trading volume in our stock and the recent significant investments made in various parts of our business and their effects on analyst earnings models.

 

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, 2017 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, 2018 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.

 

 26 

 

 

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,
 
   2018   2017   2018   2017 
Net sales  $546,430   $556,082   $1,089,262   $1,078,842 
Cost of goods sold   456,013    470,937    915,249    915,199 
Gross profit   90,417    85,145    174,013    163,643 
Selling, general and administrative expenses   77,222    79,741    154,576    153,528 
Operating profit   13,195    5,404    19,437    10,115 
Interest expense, net   2,315    1,986    4,777    3,639 
Equity income from unconsolidated affiliate   129    135    304    273 
Income before income taxes   11,009    3,553    14,964    6,749 
Income tax expense   3,126    1,187    4,270    211 
Net income  $7,883   $2,366   $10,694   $6,538 
                     
Basic and Diluted Earnings Per Common Share                    
Basic  $0.66   $0.19   $0.90   $0.52 
Diluted   0.64    0.18    0.88    0.48 
                     
Weighted average number of common shares outstanding:                    
Basic   11,912    12,574    11,878    12,477 
Diluted   12,259    13,486    12,145    13,483 

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2018   2017   2018   2017 
Net sales   100.0%   100.0%   100.0%   100.0%
Cost of goods sold   83.5    84.7    84.0    84.9 
Gross profit   16.5    15.3    16.0    15.1 
Selling, general and administrative expenses   14.1    14.3    14.2    14.2 
Operating profit   2.4    1.0    1.8    0.9 
Interest expense, net   0.4    0.4    0.4    0.3 
Equity income from unconsolidated affiliate   0.0    0.0    0.0    0.0 
Income before income taxes   2.0    0.6    1.4    0.6 
Income tax expense   0.6    0.2    0.4     
Net income   1.4%   0.4%   1.0%   0.6%

 

 27 

 

 

Three Months Ended June 30, 2018 Compared to the Three Months Ended June 30, 2017

 

Net Sales

 

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

 

   Three Months Ended June 30,         
   2018   2017         
   Net Sales   Percentage of Total Net Sales   Net Sales   Percentage of Total Net Sales   Dollar Change   Percent Change 
Commercial  $410,950    75%  $435,893    78%  $(24,943)   (6)%
Public Sector   74,712    14    76,427    14    (1,715)   (2)
Canada   47,416    9    43,579    8    3,837    9 
United Kingdom   13,512    2    362        13,150    NM(1)
Corporate & Other   (160)       (179)       19    NM(1)
Consolidated  $546,430    100%  $556,082    100%  $(9,652)   (2)

 

 

(1)Not meaningful.

 

Consolidated net sales were $546.4 million in the three months ended June 30, 2018 compared to $556.1 million in the three months ended June 30, 2017, a decrease of $9.7 million or 2%. Consolidated sales of services were $42.9 million in the three months ended June 30, 2018 compared to $40.8 million in the three months ended June 30, 2017, an increase of $2.1 million, or 5%, and represented 8% and 7% of consolidated net sales in the three months ended June 30, 2018 and 2017, respectively.

 

Commercial net sales were $411.0 million in the three months ended June 30, 2018 compared to $435.9 million in the three months ended June 30, 2017, a decrease of $24.9 million or 6%. Sales of services in our Commercial segment were $29.4 million in the three months ended June 30, 2018 compared to $27.6 million in the three months ended June 30, 2017, an increase of $1.8 million or 7%, and represented 7% and 6% of Commercial net sales in the three months ended June 30, 2018 and 2017, respectively. The decrease in our Commercial segment net sales in the three months ended June 30, 2018 was impacted by a large, low-margin enterprise customer project in the prior year that did not reoccur, as well as several specific customer deals we elected not to pursue based on our focus on profitable growth.

 

Public Sector net sales were $74.7 million in the three months ended June 30, 2018 compared to $76.4 million in the three months ended June 30, 2017, a decrease of $1.7 million or 2%, primarily due to a 22% decrease in our federal sales, partially offset by a 5% increase in our SLED sales. Sales of services in our Public Sector segment were $4.8 million in the three months ended June 30, 2018 compared to $5.8 million in the three months ended June 30, 2017, a decrease of $1.0 million or 18%, and represented 6% and 8% of Public Sector net sales in the three months ended June 30, 2018 and 2017, respectively. Our federal business net sales were negatively impacted in the quarter by the loss of a Federal contract, which we were unwilling to rebid at a loss as disclosed in prior periods. Our SLED sales increase included approximately $14.4 million related to lower sales reported on a net basis over the prior year.

 

Canada net sales were $47.4 million in the three months ended June 30, 2018 compared to $43.6 million in the three months ended June 30, 2017, an increase of $3.8 million, or 9%. Sales of services in our Canada segment were $7.5 million in the three months ended June 30, 2018 compared to $7.4 million in the three months ended June 30, 2017, and represented 16% and 17% of Canada net sales in the three months ended June 30, 2018 and 2017, respectively.

 

Our United Kingdom segment, which officially launched in the second quarter of 2017, generated net sales of $13.5 million in the three months ended June 30, 2018 compared to $0.4 million in the three months ended June 30, 2017, an increase of $13.1 million.

 

Gross Profit and Gross Profit Margin

 

Consolidated gross profit was $90.4 million in the three months ended June 30, 2018 compared to $85.1 million in the three months ended June 30, 2017, an increase of $5.3 million, or 6%. Consolidated gross profit margin increased to 16.5% in the three months ended June 30, 2018 from 15.3% in the same period last year. The increase in consolidated gross profit and gross profit margin was primarily due to a shift in mix toward higher margin solutions and service sales.

 

Selling, General & Administrative Expenses

 

Consolidated SG&A expenses were $77.2 million in the three months ended June 30, 2018 compared to $79.7 million in the three months ended June 30, 2017, a decrease of $2.5 million or 3%. Consolidated SG&A expenses as a percentage of net sales decreased slightly to 14.1% in the three months ended June 30, 2018 from 14.3% in the same period last year. The decrease in consolidated SG&A expenses was primarily related to a $2.0 million decrease in outside service costs primarily related to the termination of the service contract with our prior BPO service provider in Pakistan and a decrease in third party logistics costs, and a $1.0 million decrease in telecommunication costs, partially offset by an increase in personnel costs of $1.2 million, which was primarily due to the growth of our new United Kingdom segment.

 

 28 

 

 

Operating Profit (Loss)

 

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

 

   Three Months Ended June 30,       Change in 
   2018   2017   Change in   Operating 
   Operating   Operating
Profit (Loss)
   Operating   Operating
Profit (Loss)
   Operating
Profit (Loss)
   Profit (Loss)
Margin
 
   Profit (Loss)   Margin(1)   Profit (Loss)   Margin(1)   $   %   % 
Commercial  $25,492    6.2%  $19,530    4.5%  $5,962    31%   1.7%
Public Sector   4,633    6.2    4,832    6.3    (199)   (4)   (0.1)
Canada   1,166    2.5    291    0.7    875    301    1.8 
United Kingdom   (1,102)   (8.2)   (1,585)   NM (2)   483    (30)   NM (2)
Corporate & Other   (16,994)   (3.1 )(1)   (17,664)   (3.2)(1)   670    (4)   0.1 (1)
Consolidated  $13,195    2.4   $5,404    1.0   $7,791    144    1.4 

 

 

(1)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.
(2)Not meaningful

 

Consolidated operating profit was $13.2 million in the three months ended June 30, 2018 compared to $5.4 million in the three months ended June 30, 2017, an increase of $7.8 million or 144%.

 

Commercial operating profit was $25.5 million in the three months ended June 30, 2018 compared to $19.5 million in the three months ended June 30, 2017, an increase of $6.0 million or 31%. The increase in Commercial operating profit was primarily due to a $3.2 million increase in Commercial gross profit, a decrease of $0.7 million in each of outside service costs and telecommunication costs, a $0.5 million decrease in net advertising expenses and a $0.4 million decrease in credit card processing costs.

 

Public Sector operating profit was $4.6 million in the three months ended June 30, 2018 compared to $4.8 million in the three months ended June 30, 2017, a decrease of $0.2 million or 4%. The decrease in Public Sector operating profit was primarily due to a $0.7 million decrease in Public Sector gross profit, partially offset by a $0.4 million decrease in personnel costs.

 

Canada operating profit was $1.2 million in the three months ended June 30, 2018 compared to $0.3 million in the three months ended June 30, 2017, an increase of $0.9 million or 301%. The increase in Canada operating profit was primarily due to a $0.8 million decrease in personnel costs and a $0.2 million increase in Canada gross profit.

 

United Kingdom operating loss was $1.1 million in the three months ended June 30, 2018 compared to $1.6 million in the three months ended June 30, 2017, a decrease of $0.5 million. The decrease in United Kingdom operating loss was primarily due to a $2.6 million increase in United Kingdom gross profit, partially offset by a $2.0 million increase in personnel 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 $17.0 million in the three months ended June 30, 2018 compared to $17.7 million in the three months ended June 30, 2017, a decrease of $0.7 million or 4%, which was primarily due to a $1.3 million decrease in outside service costs and a $0.4 million decrease in M&A expenses, partially offset by a $0.4 million increase in lease costs and a $0.3 million increase in each of personnel costs and consulting fees.

 

Net Interest Expense

 

Total net interest expense for the three months ended June 30, 2018 was $2.3 million compared with $2.0 million in the same period of 2017, an increase of $0.3 million or 17%. The increase in net interest expense in the three months ended June 30, 2018 was primarily due to higher average interest rate and higher average loan balance outstanding in the three months ended June 30, 2018 compared to the same period in the prior year.

 

 29 

 

 

Income Taxes

 

We recorded an income tax expense of $3.1 million in the three months ended June 30, 2018 compared to $1.2 million in the three months ended June 30, 2017. Our effective tax rate was 28.4% compared to 33.4% in the prior year. Income taxes in the three months ended June 30, 2018 reflected the new lower Federal income tax rate and other factors within tax reform, compared to income taxes in the three months ended June 30, 2017 benefiting from a credit to income tax expense of $0.4 million related to the excess tax benefits associated with the exercise of stock options and vesting of restricted stock units.

 

Six Months Ended June 30, 2018 Compared to the Six Months Ended June 30, 2017

 

Net Sales

 

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

 

   Six Months Ended June 30,         
   2018   2017         
   Net Sales  

Percentage of

Total Net Sales

   Net Sales  

Percentage of

Total Net Sales

   Dollar Change   Percent Change 
Commercial  $825,681    76%  $843,413    78%  $(17,732)   (2)%
Public Sector   130,774    12    143,033    13    (12,259)   (9)
Canada   101,536    9    92,239    9    9,297    10 
United Kingdom   31,585    3    362        31,223    NM (1) 
Corporate & Other   (314)       (205)       (109)   NM (1) 
Consolidated  $1,089,262    100%  $1,078,842    100%  $10,420    1%

 

 

(1) Not meaningful.

 

Consolidated net sales were $1,089.3 million in the six months ended June 30, 2018 compared to $1,078.8 million in the six months ended June 30, 2017, an increase of $10.4 million or 1%. Consolidated sales of services were $87.9 million in the six months ended June 30, 2018 compared to $77.6 million in the six months ended June 30, 2017, an increase of $10.3 million, or 13%, and represented 8% and 7% of consolidated net sales in the six months ended June 30, 2018 and 2017, respectively.

 

Commercial net sales were $825.7 million in the six months ended June 30, 2018 compared to $843.4 million in the six months ended June 30, 2017, a decrease of $17.7 million or 2%. Sales of services in our Commercial segment were $62.4 million in the six months ended June 30, 2018 compared to $54.8 million in the six months ended June 30, 2017, an increase of $7.6 million or 14%, and represented 8% and 6% of Commercial net sales in the six months ended June 30, 2018 and 2017, respectively. The decrease in our Commercial segment net sales in the six months ended June 30, 2018 was impacted by a large, low-margin enterprise customer project in the prior year that did not reoccur, several specific customer deals that we elected not to pursue based on our focus on profitable growth and a $13.8 million increase in sales reported on a net basis.

 

Public Sector net sales were $130.8 million in the six months ended June 30, 2018 compared to $143.0 million in the six months ended June 30, 2017, a decrease of $12.2 million or 9%. Sales of services in our Public Sector segment was $7.9 million in each of the six months ended June 30, 2018 and 2017, and represented 6% of Public Sector net sales in each of the six months ended June 30, 2018 and 2017. Our federal sales decreased by 20% in the six months ended June 30, 2018 compared to the same period last year primarily due to the negative impact of a loss of a Federal contract, which we were unwilling to rebid at a loss as disclosed in prior periods. Our SLED sales decreased by 3%, partially offset by a $4.4 million decrease in sales reported on a net basis.

 

Canada net sales were $101.5 million in the six months ended June 30, 2018 compared to $92.2 million in the six months ended June 30, 2017, an increase of $9.3 million, or 10%, despite a $1.1 million increase in sales reported on a net basis. Sales of services in our Canadian segment were $15.0 million in the six months ended June 30, 2018 compared to $14.9 million in the six months ended June 30, 2017, and represented 15% and 16% of Canada net sales in the six months ended June 30, 2018 and 2017, respectively.

 

United Kingdom net sales were $31.6 million in the six months ended June 30, 2018 compared to $0.4 million in the six months ended June 30, 2017, an increase of $31.2 million reflecting the growth of our United Kingdom segment since its launch in the second quarter of 2017.

 

 30 

 

 

Gross Profit and Gross Profit Margin

 

Consolidated gross profit was $174.0 million in the six months ended June 30, 2018 compared to $163.6 million in the six months ended June 30, 2017, an increase of $10.4 million, or 6%. Consolidated gross profit margin increased to 16.0% in the six months ended June 30, 2018 from 15.2% in the same period last year. The increase in consolidated gross profit was primarily due to the increase in net sales, partially offset by a decrease in vendor consideration. The increase in consolidated gross profit margin was primarily due to an increase in selling margins driven by a shift in mix toward higher margin solutions and service sales and a $12.9 million increase in sales reported on a net basis, partially offset by a reduction in vendor consideration received as a percentage of net sales.

 

Selling, General & Administrative Expenses

 

Consolidated SG&A expenses were $154.6 million in the six months ended June 30, 2018 compared to $153.5 million in the six months ended June 30, 2017, an increase of $1.1 million or 1%. Consolidated SG&A expenses as a percentage of net sales remained relatively flat at 14.2% in the six months ended June 30, 2018 and 2017. The increase in consolidated SG&A expenses was primarily related to a $5.8 million increase in personnel costs, of which $5.1 million related to the growth of our new United Kingdom segment, which was launched in the second quarter of 2017. The increase in consolidated SG&A expenses was also impacted by a $1.0 million increase in lease expenses and a $0.7 million increase in bad debt expense, partially offset by a $3.7 million decrease in outside service costs primarily related to the termination of the Pakistani BPO service contract, a $0.8 million decrease in net advertising expenses, a $0.7 million decrease in credit card processing costs and a $0.6 million decrease in telecommunication costs.

 

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 
   2018   2017   Change in   Operating 
   Operating  

Operating

Profit

  

Operating

Profit
  

Operating

Profit

   Operating
Profit (Loss)
   Profit
Margin
 
   Profit (Loss)  

Margin(1)

   (Loss)  

Margin(1)

   $   %   % 
Commercial  $47,209    5.7%  $37,978    4.5%  $9,231    24%   1.2%
Public Sector   4,683    3.6    6,226    4.4    (1,543)   (25)   (0.8)
Canada   2,628    2.6    1,515    1.6    1,113    73    1.0 
United Kingdom   (1,394)   (4.4)   NM(2)   (479.8)   343    (20)   NM (2) 
Corporate & Other   (33,689)   (3.1 )(1)   (33,867)   (3.1 )(1)   178    (1)    
Consolidated  $19,437    1.8%  $10,115    0.9%  $9,322    92%   9%

 

 

(1) 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.
(2) Not meaningful.

 

Consolidated operating profit was $19.4 million in the six months ended June 30, 2018 compared to $10.1 million in the six months ended June 30, 2017, an increase of $9.3 million or 92%.

 

Commercial operating profit was $47.2 million in the six months ended June 30, 2018 compared to $38.0 million in the six months ended June 30, 2017, an increase of $9.2 million or 24%. The increase in Commercial operating profit was primarily due to a $4.9 million increase in Commercial gross profit, a $1.1 million decrease in outside service costs, a $0.8 million decrease in net advertising expenses and a $0.7 million decrease in credit card processing costs.

 

Public Sector operating profit was $4.7 million in the six months ended June 30, 2018 compared to $6.2 million in the six months ended June 30, 2017, a decrease of $1.5 million or 25%. The decrease in Public Sector operating profit was primarily due to a $1.6 million decrease in Public Sector gross profit and a $0.3 million increase in personnel costs, partially offset by a $0.1 million decrease in each of outside service costs, advertising expenses, amortization expense and variable fulfillment costs.

 

Canada operating profit was $2.6 million in the six months ended June 30, 2018 compared to $1.5 million in the six months ended June 30, 2017, an increase of $1.1 million or 73%. The increase in Canada operating profit was primarily due to a $1.0 million increase in Canada gross profit and a $0.5 million decrease in personnel costs, partially offset by a $0.2 million increase in consulting expenses and a $0.1 million increase in lease costs.

 

 31 

 

 

United Kingdom operating loss was $1.4 million in the six months ended June 30, 2018 compared to a loss of $1.7 million in the six months ended June 30, 2017, a decrease of $0.3 million. The decrease in United Kingdom operating loss was primarily due to a $6.1 million increase in United Kingdom gross profit, partially offset by a $5.1 million increase in personnel costs and other SG&A expenses incurred since launch of its operations in the second quarter of 2017.

 

Corporate & Other operating expenses were $33.7 million in the six months ended June 30, 2018 compared to $33.9 million in the six months ended June 30, 2017, a decrease of $0.2 million or 1%, which was primarily due to a $2.4 million decrease in outside services, partially offset by a $1.1 million increase in personnel costs and a $1.0 million increase in lease expenses.

 

Net Interest Expense

 

Total net interest expense for the six months ended June 30, 2018 was $4.8 million compared with $3.6 million in the same period of 2017. The $1.2 million increase in interest expense during the six months ended June 30, 2018 was primarily due to a higher average interest rate and a higher average loan balance outstanding in the three months ended June 30, 2018 compared to the same period in the prior year.

 

Income Tax Expense

 

We recorded an income tax expense of $4.3 million in the six months ended June 30, 2018 compared to $0.2 million in the six months ended June 30, 2017. Our effective tax rates for the six months ended June 30, 2018 and 2017 were 28.5% and 3%, respectively. Income taxes for the six months ended June 30, 2018 reflect the new lower Federal income tax rate and other factors within tax reform. Income taxes for the six months ended June 30, 2017 include the benefit of $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.

 

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 and cyclical 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 $11.5 million at June 30, 2018 and $9.1 million at December 31, 2017. Our working capital increased by $15.7 million to a working capital of $8.0 million at June 30, 2018 from negative working capital of $7.7 million at December 31, 2017.

 

 32 

 

 

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, again amended in April 2015 and increased to a total of $30 million, and again amended in August 2017 and increased to a total of $40 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 made no repurchases of shares of our common stock under this program during the three and six months ended June 30, 2018. At June 30, 2018, we had $2.5 million available for stock repurchases under the program, subject to any limitations that may apply from time to time under our existing credit facility.

 

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. The labor credits program ended at the end of fiscal year 2016. We have received full payment under all of our outstanding claims for labor credits under this program as of June 30, 2018.

 

Cash Flows from Operating Activities. Net cash provided by operating activities was $72.4 million in the six months ended June 30, 2018 compared to $6.3 million in the six months ended June 30, 2017.

 

The $72.4 million of net cash provided by operating activities in the six months ended June 30, 2018 was primarily due to a $102.7 million increase in accounts payable and a $25.0 million decrease in inventory, partially offset by an $82.4 million increase in accounts receivable. The increase in our accounts payable and accounts receivable was primarily due to seasonally strong sales and related purchase volumes toward the end of the second quarter of 2018. The decrease in our inventory balance was due to our sell through of certain purchases we made in the fourth quarter of 2017.

 

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 $83.8 million increase in accounts receivable.

 

Cash Flows from Investing Activities. Net cash used in investing activities was $2.5 million in the six months ended June 30, 2018 compared to $9.1 million in the six months ended June 30, 2017.

 

The $2.5 million of net cash used in investing activities in the six months ended June 30, 2018 was primarily related to investments in our IT infrastructure and leasehold improvements.

 

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.

 

Cash Flows from Financing Activities. Net cash used in financing activities in the six months ended June 30, 2018 was $66.9 million compared to net cash provided by financing activities of $2.6 million in the six months ended June 30, 2017.

 

The $66.9 million of net cash used in financing activities in the six months ended June 30, 2018 was primarily related to $64.5 million of net payments made on our line of credit and $2.2 million of earn-out liability payments.

 

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.

 

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 with the Lenders and on February 24, 2017, we entered into a Second Amendment to the Fourth Amended Loan Agreement with the Lenders. On October 24, 2017, PCM, all of its wholly-owned domestic subsidiaries (collectively with PCM, the “US Borrowers”), all of its Canadian subsidiaries (collectively, the “Canadian Borrowers”) and its PCM UK subsidiary (together with the US Borrowers and the Canadian Borrowers, the “Borrowers”), entered into a Fifth Amended and Restated Loan and Security Agreement (the “Fifth Amended Loan Agreement”) with the Lenders. The Fifth Amended Loan Agreement amends and restates the Fourth Amended Loan Agreement.

 

 33 

 

 

The terms of our credit facility, as amended, 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 and a sub-line of up to £25,000,000 as the UK 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 Fifth 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%; (v) interest on outstanding UK balances based on LIBOR plus a margin, depending on average excess availability under the Revolving Line, ranging from 1.50% to 1.75%; (vi) 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%; and (vii) 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 terms of our credit facility are more fully described in the Fifth Amended Loan Agreement.

 

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, 2018, 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, 2018, we had $158.3 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 a sub-line with a limit of $12.5 million secured by our properties located in Santa Monica, California, with a monthly principal amortization of $149,083 and a sub-line with a limit of $2.2 million secured by our property in Woodridge, Illinois, with a monthly principal amortization of $26,250.

 

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. As of June 30, 2018, we had no outstanding balance under the Channel Finance Facility.

 

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 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.

 

 34 

 

 

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, as amended, 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 September 2017, we entered into an amendment with the lender extending the maturity of the loan to January 31, 2020. 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, 2018, the effective weighted average annual interest rate on our outstanding amounts under the credit facility, term note and variable interest rate notes payable was 3.66%.

 

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

 

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 and have begun the migration process. The migration process started in the second quarter of 2017 and it will continue through 2018. We anticipate completion of migration of a significant portion of our legacy systems to the SAP platform 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, 2017. As of June 30, 2018, there has been no material change in any off-balance sheet arrangements since December 31, 2017.

 

Contingencies

 

For a discussion of contingencies, see Part I, Item 1, Note 10 of the Notes to the Condensed Consolidated Financial Statements of this report, which is incorporated herein by reference.

 

 35 

 

 

RELATED-PARTY TRANSACTIONS

 

There were no material related-party transactions during the three months ended June 30, 2018 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.

 

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 the impact of cost reductions on our results in future periods;
  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 expected impact of customer implementations or rollouts on 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, and the UK, 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;

 

 36 

 

 

  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, and our implementation of compliance procedures and the costs associated with compliance with such laws and regulations.

 

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.

 

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, 2018 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, 2018. 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, 2018, we had $149.3 million outstanding under our line of credit and $34.2 million outstanding under our notes payable with variable interest rates. At June 30, 2018, 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 $1.8 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, 2018, we did not have material foreign currency or overall currency exposure.

 

 37 

 

 

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, 2018.

 

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 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 38 

 

 

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 10 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.

 

 39 

 

 

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% of our net sales in each of the three months ended June 30, 2018 and 2017, and HP Inc. represented approximately 10% and 9% of our net sales in the three months ended June 30, 2018 and 2017, respectively. 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.

 

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.

 

 40 

 

 

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.

 

 41 

 

 

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;
  customer acceptance of new purchasing models;
  deferral of customer orders in anticipation of new offerings;

 

 42 

 

 

  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.

 

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.

 

 43 

 

 

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.

 

The Tax Cuts and Jobs Act of 2017 was approved by Congress and signed into law in December 2017. This legislation made significant changes to the U.S. Internal Revenue Code. Such changes include a reduction in the corporate tax rate and limitations on certain corporate deductions and credits, among other changes. Certain of these changes could have a negative impact on our business. Moreover, further legislative and regulatory changes may be more likely in the current political environment, particularly to the extent that Congress and the U.S. presidency are controlled by the same political party and significant reform of the tax code has been described publicly as a legislative priority. Significant further changes to the tax code could have an adverse impact on our business, financial condition and 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.

 

 44 

 

 

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 shipping costs; and
  foreign currency exchange rates.

 

 45 

 

 

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 advantag