PCM Claims En Pointe Overstated Profits, Stock Drops After Allegations Revealed

PCM claimed in court filings last month that it wouldn't have carried out its April 2015 acquisition of En Pointe if it had known the solution provider's true financial situation.

The El Segundo, Calif.-based company, No. 28 on the CRN Solution Provider 500, filed a lawsuit counterclaim April 11 alleging that En Pointe materially overstated the profitability of its business and that breaches by an En Pointe subsidiary have damaged PCM's goodwill with many customers. PCM said the total damages exceed $57 million, or more than triple the company's 2016 net income.

"Had it known the truth about [En Pointe's] finances, it would not have entered into the Purchase Agreement," PCM wrote in its April 11 counterclaim, filed with the Superior Court in the State of Delaware.

[Related: Crossing the Pond: PCM Set to Expand Into Europe To Better Serve Multinational Firms]

A Seeking Alpha article published Tuesday publicly revealed PCM's April 11 allegations, which the company has not disclosed in filings with the U.S. Securities and Exchange Commission (SEC). The article was written by an investor, under a pseudonym, who claims to be shorting PCM's stock, meaning that the investor will potentially profit as the shares fall. Since the Seeking Alpha article appeared midday Tuesday, PCM's stock has dropped $4.25 (18.3%) to $19 per share.

The author of the article said PCM's stock should be valued at just $15 per share since Seeking Alpha believes the entirety of the company's $14 million of cost savings achieved from the En Pointe acquisition are in jeopardy.

PCM did not respond to requests for comment.

Since the Seeking Alpha article appeared online, three law firms have announced investigations into whether PCM violated federal securities laws by issuing materially misleading business information to investors.

PCM agreed in March 2015 to pay $15 million upfront for the IT solutions business of Gardena, Calif.-based En Pointe, No. 42 on the 2014 CRN SP 500, as well as 22.5 percent of future adjusted gross profit and 10 percent of certain service revenue for the next three years. PCM CEO Frank Khulusi told Wall Street analysts in February 2016 that En Pointe is "executing at a very high level."

The first signs of trouble came in December 2016, when an En Pointe subsidiary filed a lawsuit against PCM in Delaware Superior Court for allegedly underpaying its agreed-upon earn-out payments. PCM disclosed this lawsuit to the SEC in March 2017, and said it was assessing a number of counterclaims around intentional breaches of representations and warranties.

When PCM filed its counterclaims the followed month, it alleged that the En Pointe subsidiary improperly used vendor rebates and marketing-related vendor credits attributable to prior accounting periods to understate the cost of the goods it was selling. PCM said it believes En Pointe's earnings were millions of dollars less than they reported.

PCM also alleged that En Pointe misled the company with assurances that certain customer relationships weren't dependent on En Pointe's minority-owned status. But after closing, PCM said it discovered several acquired customers were unwilling to transfer their business to PCM since it isn't certified as being minority-owned.

The company disclosed in March that it had to transfer at least $65 million in En Pointe to a minority and woman-owned PCM partner in which the company holds at 49 percent passive equity interest. PCM said the transfers would have a negative effect on its future consolidated net sales.

PCM additionally claims that En Pointe breached its obligation to assist in transferring customer accounts that require consent agreements. That breach has caused potentially lasting damage to important PCM customer relationships, the company said.

More importantly, En Pointe allegedly failed to disclose that related parties still control a Pakistani business process outsourcing partner that represents a substantial portion of En Pointe's workforce. En Pointe crated BPO solution provider Ovex Technologies Ltd. in 2003 to establish a captive supplier of services at a significantly reduced cost, PCM said, and acquired a 70 percent stake in the firm in 2006.

A 2008 SEC filing by En Pointe showed that 80 percent of Ovex's workforce was dedicated to En Pointe and a related startup, provided sales, purchasing, operations, help desk, accounting and IT functions. The most recent contract between En Pointe and Ovex was inked on July 1, 2014, and expires on June 30 of this year.

PCM said in its April 2017 counterclaims that Ovex creates operational cost efficiencies that are unique in the industry, and is critical to En Pointe's ability to competitively price its products and services. En Pointe shares all of its confidential and trade secret information with Ovex, PCM claims, including customer lists, purchasing information, business templates and pricing strategies.

"Essentially, Ovex is given access to all the day-to-day information that En Pointe uses to run its business," PCM wrote in its legal filing.

The investor who wrote the Seeking Alpha article believes that the entirety of PCM's $14 million of cost savings in the six months following the En Pointe acquisition came from shifting operations and workers to Ovex. Therefore, the author writes that the most financially damaging allegation made by PCM is that parties related to En Pointe still control Ovex and have used that control to obstruct PCM's access to critical data.

Specifically, emails from PCM's attorney alleges that the company lacks the same control over a significant portion of Ovex's workforce that has historically benefitted En Pointe's subsidiary. The single biggest risk to PCM's earnings growth, according to the Seeking Alpha article, is the potential for those Ovex-related cost savings to disappear.

"By its [PCM's] own admission, the success of its largest acquisition relies on a contract with a Pakistani BPO that expires on June 30 and that PCM alleges is being controlled … to the detriment of PCM," the anonymous investor, writing on Seeking Alpha, concluded.

PCM's shares, even after slipping to $19 on Wednesday, are up more than 90 percent from their year-ago price.