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 September 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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit 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 [X]
     
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 November 5, 2018, the registrant had 12,151,006 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 September 30, 2018 and December 31, 2017 2
   
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2018 and 2017 3
   
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017 4
   
Condensed Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 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 22
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk 39
   
Item 4. Controls and Procedures 39
   
PART II - OTHER INFORMATION  
   
Item 1. Legal Proceedings 40
   
Item 1A. Risk Factors 40
   
Item 6. Exhibits 55
   
Signature 56

 

   
 

 

PCM, INC.

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

CONDENSED CONSOLIDATED BALANCE SHEETS

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

 

   September 30,   December 31, 
   2018   2017 
ASSETS          
Current assets:          
Cash and cash equivalents  $8,549   $9,113 
Accounts receivable, net of allowances of $2,228 and $2,181   451,485    439,658 
Inventories   63,989    103,471 
Prepaid expenses and other current assets   8,989    9,333 
Total current assets   533,012    561,575 
Property and equipment, net   69,014    71,551 
Goodwill   87,505    87,768 
Intangible assets, net   8,848    11,090 
Deferred income taxes   1,274    1,759 
Investment and other assets   4,775    6,509 
Total assets  $704,428   $740,252 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current liabilities:          
Accounts payable  $312,079   $289,201 
Accrued expenses and other current liabilities   58,521    55,040 
Deferred revenue   8,077    7,913 
Line of credit   134,517    213,778 
Notes payable — current   3,284    3,362 
Total current liabilities   516,478    569,294 
Notes payable   30,330    32,892 
Other long-term liabilities   6,671    7,338 
Deferred income taxes   4,051    3,102 
Total liabilities   557,530    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; 17,534,250 and 17,170,273 shares issued; 12,143,598 and 11,779,621 shares outstanding   18    17 
Additional paid-in capital   137,785    134,646 
Treasury stock, at cost: 5,390,652 shares   (38,536)   (38,536)
Accumulated other comprehensive (loss) income   (282)   251 
Retained earnings   47,913    31,248 
Total stockholders’ equity   146,898    127,626 
Total liabilities and stockholders’ equity  $704,428   $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
September 30,
   Nine Months Ended
September 30,
 
   2018   2017   2018   2017 
Net sales  $510,580   $543,275   $1,599,842   $1,622,117 
Cost of goods sold   425,446    461,818    1,340,695    1,377,017 
Gross profit   85,134    81,457    259,147    245,100 
Selling, general and administrative expenses   74,580    79,951    229,156    233,479 
Operating profit   10,554    1,506    29,991    11,621 
Interest expense, net   2,273    1,950    7,050    5,589 
Equity income from unconsolidated affiliate   73    151    377    424 
Income (loss) before income taxes   8,354    (293)   23,318    6,456 
Income tax expense   2,383    474    6,653    685 
Net income (loss)  $5,971   $(767)  $16,665   $5,771 
                     
Basic and Diluted Earnings (Loss) Per Common Share                    
Basic  $0.50   $(0.06)  $1.40   $0.46 
Diluted   0.47    (0.06)   1.35    0.43 
                     
Weighted average number of common shares outstanding:                    
Basic   12,050    12,248    11,936    12,418 
Diluted   12,795    12,248    12,343    13,325 

 

See Notes to the Condensed Consolidated Financial Statements.

 

 3 
 

 

PCM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS

OF COMPREHENSIVE INCOME (LOSS)

(unaudited, in thousands)

 

  

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
   2018   2017   2018   2017 
Net income (loss)  $5,971   $(767)  $16,665   $5,771 
                     
Other comprehensive income (loss):                    
Foreign currency translation adjustments   285    750    (533)   1,066 
Total other comprehensive income (loss)   285    750    (533)   1,066 
Comprehensive income (loss)  $6,256   $(17)  $16,132   $6,837 

 

See Notes to the Condensed Consolidated Financial Statements.

 

 4 
 

 

PCM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 

  

Nine Months Ended

September 30,

 
   2018   2017 
Cash Flows From Operating Activities          
Net income  $16,665   $5,771 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Depreciation and amortization   10,235    10,482 
Equity income from an unconsolidated affiliate   (377)   (424)
Distribution from equity method investee   225     
Provision for deferred income taxes   1,426    266 
Non-cash stock-based compensation   2,258    1,918 
Change in operating assets and liabilities:          
Accounts receivable   (11,827)   (55,566)
Inventories   39,482    10,621 
Prepaid expenses and other current assets   344    6,346 
Other assets   2,079    1,181 
Accounts payable   22,864    (7,145)
Accrued expenses and other current liabilities   4,373    3,547 
Deferred revenue   164    (6,438)
Total adjustments   71,246    (35,212)
Net cash provided by (used in) operating activities   87,911    (29,441)
Cash Flows From Investing Activities          
Purchases of property and equipment   (3,816)   (14,122)
Acquisition of Stack Technology, net of cash acquired   (35)   (1,723)
Net cash used in investing activities   (3,851)   (15,845)
Cash Flows From Financing Activities          
Net (payments) borrowings under line of credit   (79,261)   60,948 
Borrowings under notes payable       5,212 
Payments under notes payable   (2,631)   (2,777)
Change in book overdraft   (42)   1,885 
Payments of obligations under capital leases   (813)   (1,113)
Payments of earn-out liability   (2,199)   (11,058)
Proceeds from capital lease obligations       587 
Net proceeds from stock issued under stock option plans   1,409    5,007 
Payments for deferred financing costs   (273)   (669)
Common shares repurchased and held in treasury       (11,354)
Payment of taxes related to net-settled stock awards   (513)   (808)
Net cash (used in) provided by financing activities   (84,323)   45,860 
Effect of foreign currency on cash flow   (301)   600 
Net change in cash and cash equivalents   (564)   1,174 
Cash and cash equivalents at beginning of the period   9,113    7,172 
Cash and cash equivalents at end of the period  $8,549   $8,346 
Supplemental Cash Flow Information          
Interest paid  $6,726   $4,970 
Income taxes paid, net   1,306    3,826 
Supplemental Non-Cash Investing and Financing Activities          
Financed and accrued purchases of property and equipment  $1,560   $520 

 

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 September 30, 2018, we generated approximately 75% of our revenue in our Commercial segment, 13% 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. During the nine months ended September 30, 2018, we generated approximately 75% 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 August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, “Disclosure Update and Simplification,” amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement and present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. We anticipate that the first presentation of changes in stockholders’ equity required by these amendments will be included in our Form 10-Q for the quarter ending March 31, 2019.

 

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. In July 2018, the FASB issued ASU No. 2018-11, “Targeted Improvements” which provides entities with an additional transition method to adopt Topic 842. Under the new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. The new lease standard 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 transition methods available under the new standard and the effects that the adoption of the new lease standard will have on our consolidated financial statements. We expect that the primary effect of adopting the new lease standard on January 1, 2019 will be recording right-of-use assets and corresponding lease obligations for current operating leases on our balance sheet, which is expected to be material.

 

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.

 

 7 
 

 

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.
     
  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.

 

 8 
 

 

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 

 

 9 
 

 

   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.

 

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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.

 

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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.

 

 12 
 

 

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 September 30, 2018                              
Hardware & Software Products  $351,077   $63,024   $36,108   $15,806   $(155)  $465,860 
Services   30,487    5,254    7,753    1,226              —    44,720 
Total  $381,564   $68,278   $43,861   $17,032   $(155)  $510,580 
                               
Three Months Ended September 30, 2017                              
Hardware & Software Products  $393,814   $76,446   $30,245   $2,691   $(137)  $503,059 
Services   29,665    2,664    7,841    46        40,216 
Total  $423,479   $79,110   $38,086   $2,737   $(137)  $543,275 
                               
Nine Months Ended September 30, 2018                              
Hardware & Software Products  $1,114,361   $185,890   $122,596   $44,799   $(469)  $1,467,177 
Services   92,884    13,162    22,801    3,818        132,665 
Total  $1,207,245   $199,052   $145,397   $48,617   $(469)  $1,599,842 
                               
Nine Months Ended September 30, 2017                              
Hardware & Software Products  $1,182,452   $211,530   $107,620   $3,053   $(342)  $1,504,313 
Services   84,440    10,613    22,705    46        117,804 
Total  $1,266,892   $222,143   $130,325   $3,099   $(342)  $1,622,117 

 

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   22,855    391    23,246 
Recognition of deferred revenue   (22,638)   (837)   (23,475)
Foreign currency translation   (53)       (53)
Balance at September 30, 2018  $8,077(1)  $17(2)  $8,094 

 

 

(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 September 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 $28.9 million as of September 30, 2018, of which we expect to recognize approximately 59% 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.

 

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 September 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.

 

 13 
 

 

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               35    35 
Foreign currency translation           (127)   (171)   (298)
Balance at September 30, 2018  $69,735   $8,322   $4,870   $4,578   $87,505 

 

Intangible Assets

 

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

 

  

Weighted Average Estimated

Useful

   At September 30, 2018   At December 31, 2017 
   Lives (years)   Gross Amount   Accumulated Amortization   Net Amount   Gross Amount   Accumulated Amortization   Net Amount 
Patent, trademarks, trade names & URLs  5   $5,701(1)  $1,771   $3,930   $7,739(1)  $3,186   $4,553 
Customer relationships  14    13,597    9,026    4,571    13,533    7,799    5,734 
Non-compete agreements  4    2,371    2,024    347    2,377    1,574    803 
Total intangible assets      $21,669   $12,821   $8,848   $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 September 30, 2018 and 2017, respectively, and $2.3 million and $3.1 million for the nine months ended September 30, 2018 and 2017, respectively. Estimated amortization expense for intangible assets as of September 30, 2018 in each of the next five years and thereafter is as follows: $0.7 million in the remainder of 2018, $1.9 million in 2019, $1.3 million in 2020, $0.5 million in 2021, $0.4 million in 2022 and $1.1 million thereafter.

 

5. Debt

 

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

 

   At September 30,   At December 31, 
   2018   2017 
Revolving credit facility, LIBOR plus 1.50%, maturing in March 2021  $134,517   $213,778 
Note payable, LIBOR plus 1.50%, maturing in March 2021   9,691    11,032 
Note payable, LIBOR plus 1.50%, maturing in March 2021   1,706    1,943 
Note payable, greater of 2% or LIBOR plus 2.15%, maturing in April 2022   4,256    4,404 
Note payable, LIBOR plus 2.25%, maturing in January 2022   3,736    3,908 
Note payable, LIBOR plus 2.25%, maturing in January 2020   6,566    6,798 
Note payable, Prime rate plus 0.375% or LIBOR plus 2.375%, maturing in January 2020   7,409    7,710 
Note payable, LIBOR plus 3.2%, maturing in May 2025   250    284 
Other note payable, matured in August 2018       175 
Total   168,131    250,032 
Less: Total current debt   137,801    217,140 
Total non-current debt  $30,330   $32,892

 

 14 
 

 

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

 

   Remainder of
2018
   2019   2020   2021   2022   Thereafter   Total 
Total long-term debt obligations  $819   $3,275   $15,651   $10,118   $3,654   $97   $33,614 
Revolving credit facility   134,517                             —    134,517 
Total  $135,336   $3,275   $15,651   $10,118   $3,654   $97   $168,131 

 

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.

 

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 September 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 September 30, 2018, we had $169.0 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.

 

 15 
 

 

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 September 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 September 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 3.78%.

 

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.

 

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. During the three months ended September 30, 2018, we recorded an incremental charge of $0.3 million against 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. We expect to finalize our remaining provisional estimates, which primarily relate to the state impact of tax reform, during the three months ending December 31, 2018. Further, we are continuing to evaluate the provisions related to global intangible low tax income (GILTI) and expect to make a policy election to account for GILTI as a period expense during the three months ending December 31, 2018. For additional information regarding 2017 U.S. tax reform, see Note 9 of the notes to our consolidated financial statements included in our 2017 Form 10-K.

 

 16 
 

 

Accounting for Uncertainty in Income Taxes

 

At September 30, 2018 and December 31, 2017, we had unrecognized tax benefits of $0.3 million and $0.5 million, respectively, related to research credits. For the three and nine months ended September 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 September 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 2014, 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 nine months ended September 30, 2018. At September 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.

 

8. Earnings (Loss) 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 September 30, 2018, approximately 135,000 common shares have been excluded from the calculation of diluted EPS because the effect of their inclusion would have been antidilutive. For the three months ended September 30, 2017, since we reported a net loss, all potential shares totaling approximately 634,000 were excluded from the computation of diluted EPS as their inclusion would have been antidilutive. For the three months ended September 30, 2017, had we reported net income, approximately 229,000 common shares would have been excluded from the calculation of diluted EPS because the effect of their inclusion would have been antidilutive. For the nine months ended September 30, 2018 and 2017, approximately 649,000 and 142,000 common shares, respectively, have been excluded from the calculation of diluted EPS because the effect of their inclusion would have been antidilutive.

 

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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
September 30,
   Nine Months Ended
September 30,
 
   2018   2017   2018   2017 
Numerator:                    
Net income (loss)  $5,971   $(767)  $16,665   $5,771 
Denominator:                    
Basic EPS - Weighted average number of common shares outstanding   12,050    12,248    11,936    12,418 
Dilutive effect of stock awards   745        407    907 
Diluted EPS - Weighted average number of common shares outstanding   12,795    12,248    12,343    13,325 
Net earnings (loss) per share:                    
Basic  $0.50   $(0.06)  $1.40   $0.46 
Diluted   0.47    (0.06)   1.35    0.43 

 

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 September 30, 2018                              
Net sales  $381,564   $68,278   $43,861   $17,032   $              (155)  $510,580 
Gross profit (loss)   65,627    9,808    6,682    3,168    (151)   85,134 
Depreciation and amortization expense(1)   1,266    124    261    113    1,558    3,322 
Operating profit (loss)   23,212    4,189    306    (758)   (16,395)   10,554 
                               
Three Months Ended September 30, 2017                              
Net sales  $423,479   $79,110   $38,086   $2,737   $(137)  $543,275 
Gross profit (loss)   64,943    9,647    6,554    448    (135)   81,457 
Depreciation and amortization expense(1)   1,423    208    278    21    1,639    3,569 
Operating profit (loss)   19,172    2,901    (830)   (1,467)   (18,270)   1,506 
                               
Nine Months Ended September 30, 2018                              
Net sales  $1,207,245   $199,052   $145,397   $48,617   $(469)  $1,599,842 
Gross profit (loss)   201,622    26,209    22,421    9,355    (460)   259,147 
Depreciation and amortization expense(1)   3,884    422    758    235    4,936    10,235 
Operating profit (loss)   70,421    8,872    2,934    (2,152)   (50,084)   29,991 
                               
Nine Months Ended September 30, 2017                              
Net sales  $1,266,892   $222,143   $130,325   $3,099   $(342)  $1,622,117 
Gross profit (loss)   196,052    27,606    21,281    501    (340)   245,100 
Depreciation and amortization expense(1)   4,247    622    783    21    4,809    10,482 
Operating profit (loss)   57,150    9,127    685    (3,204)   (52,137)   11,621 

 

 

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

 

As of September 30, 2018 and December 31, 2017, we had total consolidated assets of $704.4 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 $1.8 million in the three month periods ended September 30, 2018 and 2017, respectively, and $5.8 million and $4.7 million in the nine month periods ended September 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.

 

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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 was fraudulent. On June 27, 2018, the Company moved to dismiss two of the four counts and otherwise answered the complaint. In response to the Company’s motion, Collab9 filed a Third Amended Complaint on September 10, 2018 for the stated purpose of addressing the Company’s arguments. On October 23, 2018, the Company again 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.

 

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. The sellers filed a motion to dismiss portions of the Company’s counterclaims on October 17, 2018, to which the Company’s response or amended pleading is due November 16, 2018. 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 or Third Amended Complaints 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.

 

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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, En Pointe 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 Islamabad Pakistan against PCM’s subsidiary 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 Islamabad 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. 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, was then refixed for a hearing in August 2018 and is currently awaiting a hearing date to be set by the High Court for further argument on the appealed decision of the Civil Court. The Company believes the claims by Ovex are speculative and wholly without merit, and continues to vigorously defend the claims on jurisdictional grounds. However, the outcome of this matter in Pakistan 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 in the Pakistan courts. Accordingly, no amounts have been accrued for any liability that may result from the resolution of this matter. In addition to the action by Ovex against En Pointe in Islamabad, on April 3, 2018, the sole shareholder of Ovex filed an action in Lahore 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 directly against PCM or any of its subsidiaries in the action. We believe that the claims in this action lack merit and continue to vigorously defend the claims on jurisdictional grounds. On September 11, 2017, July 5, 2018, and again on August 17, 2018, the U.S. District Court for the Central District of California entered orders confirming that the pending proceedings in Islamabad and Lahore Pakistan are barred by the arbitration requirements of the applicable service contract between the parties. Despite the orders by the U.S. District Court for the Central District of California, Ovex and its shareholder continue to pursue the litigation in Islamabad and Lahore.

 

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. En Pointe has submitted support for the award of attorneys’ fees and is awaiting the Arbitrator’s ruling on the amount of the award. Additional claims and damages against Ovex will be decided in a later phase of the arbitration.

 

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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 to appear before the Federal Court to show cause why they should not be held in contempt for continuing to litigate in Pakistan in violation of this order. On August 17, 2018, the U.S. District Court for the Central District of California entered another order finding each of Ovex and its shareholder in contempt for continuing to litigate in Pakistan.

 

***

 

 21 
 

 

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 September 30, 2018, we generated approximately 75% of our revenue in our Commercial segment, 13% 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. During the nine months ended September 30, 2018, we generated approximately 75% 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.

 

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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
September 30,
   Nine Months Ended
September 30,
 
   2018   2017   2018   2017 
Microsoft   14%   14%   16%   16%
HP Inc.   10    11    11    10 

 

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.

 

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ERP Upgrades

 

We have made significant progress in the configuration, implementation and successful migration of a large number of our customers to our new ERP platform. We will continue to make progress throughout the remainder of 2018. We currently expect to have the vast majority of our business transitioned to the new platform by mid-2019 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.

 

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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.

 

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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.

 

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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 other periods, 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.

 

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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
September 30,
   Nine Months Ended
September 30,
 
   2018   2017   2018   2017 
Net sales  $510,580   $543,275   $1,599,842   $1,622,117 
Cost of goods sold   425,446    461,818    1,340,695    1,377,017 
Gross profit   85,134    81,457    259,147    245,100 
Selling, general and administrative expenses   74,580    79,951    229,156    233,479 
Operating profit   10,554    1,506    29,991    11,621 
Interest expense, net   2,273    1,950    7,050    5,589 
Equity income from unconsolidated affiliate   73    151    377    424 
Income (loss) before income taxes   8,354    (293)   23,318    6,456 
Income tax expense   2,383    474    6,653    685 
Net income (loss)  $5,971   $(767)  $16,665   $5,771 
                     
Basic and Diluted Earnings (Loss) Per Common Share                    
Basic  $0.50   $(0.06)  $1.40   $0.46 
Diluted   0.47    (0.06)   1.35    0.43 
                     
Weighted average number of common shares outstanding:                    
Basic   12,050    12,248    11,936    12,418 
Diluted   12,795    12,248    12,343    13,325 

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2018   2017   2018   2017 
Net sales   100.0%   100.0%   100.0%   100.0%
Cost of goods sold   83.3    85.0    83.8    84.9 
Gross profit   16.7    15.0    16.2    15.1 
Selling, general and administrative expenses   14.6    14.7