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PCM INC ( ?????? : PCMI)
Q1 2019 Earnings Call
April 25, 2019, 9:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning. My name is Rusty, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2019 PCM Incorporated Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions)
I would like to turn the call over to Ms. Kim Rogers, Hayden IR. Ms. Rogers, you may begin.
Kim Rogers -- Investor Relations
Thank you, Rusty. Good morning, everyone. We appreciate you joining us today to discuss PCM's first quarter 2019 financial results. Joining me on the call today are Frank Khulusi, PCM's Chairman and Chief Executive Officer; Jay Miley, President; and Brandon LaVerne, Chief Financial Officer. Following their prepared comments, we will open the call to your questions.
At this time, I'd like to refer to the safe harbor statement under the Private Securities Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information or expectations about the company's products or markets or otherwise make statements about the future which statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from statements made. These risks and uncertainties are detailed in the company's filings with the Securities and Exchange Commission.
Now I'd like to turn the call over to Frank Khulusi. Please go ahead, Frank.
Frank F. Khulusi -- Chairman and Chief Executive Officer
Thank you, Kim, and good morning, everyone. Thank you for joining us today. 2019 is off to a strong start. We grew our adjusted EPS by 35% to $0.46 a share. Our commercial segment sales grew by 3% even though we exited certain non-strategic lower margin sales as anticipated and despite the quarter having one less shipping day. I'm also pleased with the gross margin improvement of 20 basis points to a first quarter record 15.6%, driven by the increase in sales from our higher margin Commercial segment, as well as an increase in higher margin solution sales. Our team also maintained a strong focus on tight expense management, which drove a 3% reduction in SG&A. Further, after coming off a great year of cash flow in 2018, we drove an additional $18 million in cash flow from operations. Our first quarter results affirm the effectiveness of our strategy to leverage our investments and further optimize our sales mix, while maintaining our costs in order to drive shareholder value.
At this time, I'd like to turn the call over to our President, Jay Miley for some more specific details on the quarter. Jay?
Robert J. Miley -- President
Thanks, Frank. As indicated in Frank's remarks and as demonstrated in the financial results just released, we remain extremely focused on optimizing our cost structure. In Q1, on a relatively stable sales level our operating expenses or SG&A declined by $2.7 million, or 3% and was down 26 basis points year-on-year to 14% of net sales. In addition to our cost structure optimization efforts, we continue to expand our gross margins. In the quarter just reported margin improved by 20 basis points year-on-year to 15.6%. We remain committed to further gross margin expansion by continued investments in cloud, managed En Pointe, field services and advanced solutions. We saw significant gross profit and gross margin expansion in our digital signage and Microsoft practices. Also our strong commercial mix coupled with nice gross margin expansion in UK and Canada contributed to the year-on-year gross margin improvement.
From a category perspective, as measured based on gross book revenues net of returns, we saw strength in our notebook and tablets category and in our desktop category, as we began to see improvement in the processor supply from a major player in the semiconductor space. We continue to be impacted by walking away from several non-strategic customer transactions and we expect this to continue to impact us in the second quarter and then to normalize for comparison purposes throughout the second half of the year. Despite this impact in Q1, the notebook and tablets category and the desktop category grew 9% and 3% respectively and now represents 20% and 9% of gross billings.
The display category which plays a role in all digital signage solutions grew 8% and now represents 5% of gross bill revenues. Two large South Korean-based OEM vendor partners both of whom supply large panel displays for digital signage solutions have benefited from our recently launched digital signage practice and grew a combined 43% year-on-year with us. The storage category, an area where we believe has untapped opportunity for us and as such are making incremental investments with several key OEMs this year, grew 19% year-on-year and now represents 4% of gross billings. We are spending a significant amount of time, effort and resources training our sales force on how to be more effective in this category and expect momentum to increase in the future.
And our accessories category which represents 4% of gross billings grew 9% year-on-year, as we get a better job in attaching accessories to our notebook and desktop business.
Our networking and server categories which represents 8% and 2% of gross billings respectively were down year-on-year, as we had several large deals in both Federal and Commercial segments last year that did not repeat and we were unable to replace in the current year.
Our software category which represents 25% of gross billings, increased 5%. In this quarter, this category was largely impacted by the Public Sector segment and particularly slide, where software gross margin is skinnier. Within the software category, our cloud solutions practice nearly quadrupled year-on-year and as an area of strategic focus for us going forward and comes with higher selling margins and software licensing.
Our delivered services category, a category that grew quite nicely for us throughout all of fiscal 2018 was down 2% year-on-year on aggregate. That said, we continue to see growth in our US-based managed and advanced technology services businesses and in our Canadian services business and are bullish on our overall services business as we have significant momentum and pipeline.
I'd like to end by saying that, I'm proud of the results and the hard work the team put in around the world. In particular, I'd like to congratulate our US commercial field sales and US commercial inside sales teams for a great start to the year. I'd be remiss, if I didn't take this opportunity to thank all of our teammates around the world who are making our ERP transition a seamless one, because of your hard work, we exited March with over 47% of the company wide gross billings and 60% of company wide invoice lines being transacted on our new ERP platform. The light at the end of the tunnel is fast approaching and as previously indicated we should be done with the vast majority of this foundational transformation by the end of this quarter -- excuse me, by the end of our Q3 quarter.
I'd now like to turn the call over to Brandon LaVerne, our Chief Financial Officer, who will discuss our Q1 results in more detail. Brandon?
Brandon H. LaVerne -- Chief Financial Officer, Treasurer and Assistant Secretary
Thanks, Jay. Detailed information about non-GAAP financial measures and a reconciliation of those non-GAAP financial measures are provided in our current report on Form 8-K. filed with the SEC earlier this morning and also available on our website.
As I review the results for the quarter, all comparisons will be relative to the first quarter of 2018, unless otherwise noted. Note that we had one less selling day in Q1 2019, as compared to Q1 2018.
Consolidated net sales were $534 million and declined 2% from the first quarter last year, almost flat if measures on an average daily sales basis. We saw return to growth in our Commercial segment, which grew 3%, despite walking away from certain lower margin non-strategic customer transactions and the impact of the one less day.
The growth in our Commercial segment was offset by a 29% decline in our public sector business, which were primarily impacted by the federal government shutdown in January. We ultimately believe that we'll have the opportunity to make up any negative impact related to the shutdown over the remainder of 2019.
Our Canadian segment also declined by 13%, primarily due to a reduction of revenues from the single large customer on a low margin contract. Consolidated sales and services decreased $1 million to $44 million and represented 8% of consolidated net sales. Our top partners by build revenues in the first quarter of 2019 were HP Inc., Microsoft, Dell, Cisco, Apple, Lenovo and Hewlett Packard Enterprise. Collectively these top seven partners represented approximately 56% of gross billed revenues.
Consolidated gross profit declined slightly by $500,000 to $83.1 million as compared to the record gross profit in the first quarter of last year. On an average daily basis gross profit increased 1%. Gross margin improved to Q1 record 15.6%, up 20 basis points from last year's Q1 record 15.4%, as a result of the increase in sales from our higher Commercial segment and a shift toward higher margin solution sales partially offset by the decrease in sales reported on a net basis.
Consolidated SG&A expenses decreased by $2.7 million, or 3% primarily due to a $1.2 million decrease in personnel costs, a $600,000 decrease in telecom costs and a $500,000 decrease in outside service costs. Further, our SG&A benefited from a $500,000 gain related to the Canadian LCD class action settlement. For clarity this gain was excluded from our non-GAAP adjusted EPS.
Interest expense decreased by $200,000 to $2.3 million due to lower average borrowings during the first quarter of 2019 versus the first quarter of 2018, partially offset by increased variable interest rates during the period.
Income tax expense was $1.7 million, or an effective tax rate of 27.1% and reflected increased excess tax benefits associated with stock-based compensation. This compares to an effective tax rate of 28.9% in the first quarter of last year. We now expect our annual effective tax rate to be in the 28% range for the 2019 year. GAAP diluted EPS increased 52% to a first quarter record $0.35, while non-GAAP adjusted EPS increased 35% to $0.46 per share.
Turning to the balance sheet and cash flow. In the first quarter, we generated $17.6 million of operating cash flow driven primarily by our quarterly income. Accounts receivable decreased $100,000 to $463.4 million from the end of the year and inventory was flat at $61.6 million. Accounts payable declined $6.4 million to $350.8 million. Cash used in investing activities totaled $1.7 million, as compared to $1.5 million in the same period last year. These investing activities were primarily related to investments in our IT, infrastructure.
Outstanding borrowings under our line of credit decreased by $16.8 million to $71.6 million at the end of the quarter. As a result of the cash generated from operations and $10 million received from refinancing one of our real estate properties. Net debt at the end of Q1 declined by $8.8 million to $106.4 million from $115.2 million at the end of the year. We continue to expect, we'll reduce net debt by approximately $50 million by the end of 2019 as compared to the end of 2018.
Lastly I'd like to address the adoption of the new lease accounting standard during the quarter. As a result of the new standard, we recorded right-of-use assets in related short and long-term lease obligations on the balance sheet during the first quarter. As of March 31, 2019, the right-of-use assets which are recorded net of deferred rent obligations that were already on the books, totaled $32.5 million. Short-term lease obligations were $4.6 million and long-term lease obligations were $31.4 million. The new lease standard did not materially affect the amount of lease expense that is or has been recorded in our SG&A on our income statement.
At this point, I'll turn the call back over to Frank to discuss our outlook.
Frank F. Khulusi -- Chairman and Chief Executive Officer
Thanks, Brandon. We believe we are well on our way toward a record 2019. Our Q1 results strongly support our full year guidance for adjusted EPS in the range of $2.55 per share to $2.75 per share with full year gross profit growth in the mid single digit range on low single digit net revenue growth.
Operator, we can now open the call for Q&A.
Questions and Answers:
Operator
(Operator Instructions) Our first question comes from the line of line William Gibson from ROTH Capital. Your line is open.
William Gibson -- ROTH Capital -- Analyst
Good. You know, you went through your presentation pretty quickly, Jay. Could you highlight little more slowly for me the areas where you're investing in the advanced technologies?
Robert J. Miley -- President
Yeah. So look, I mean we're investing in a variety of areas in the advanced technology space. You know, our Microsoft practice is very key to us in that space. We're investing in our Microsoft CSP practice and the cloud arena in general. So that's one area. We're investing in security solutions, it's another area. We're investing in our collaboration practice, that's another area. We're investing in our digital signage practice, that's another area of focus for us. I say, those are at this stage the areas we're deploying the most effort and resources against.
William Gibson -- ROTH Capital -- Analyst
Good. Thank you. And then a follow up question. I know you're focused on your operations and improving basically the numbers, but could you share with us what the acquisition backdrop looks like?
Frank F. Khulusi -- Chairman and Chief Executive Officer
The acquisition backdrop is something that we don't really discuss continue to be opportunistic and the marketplace and always look for opportunistic acquisitions. And there is you know availability in the marketplace, but we don't. As I mentioned on previous calls, we don't do acquisitions for acquisitions sake, has to be something that is meaningful to our business that will move the needle for us and areas of focus or increases our footprint from market perspective or increases our relevance materially in some way or another.
William Gibson -- ROTH Capital -- Analyst
Thanks, Frank.
Frank F. Khulusi -- Chairman and Chief Executive Officer
Thank you.
Operator
Our next question comes from the line of Marc Wiesenberger from B Riley. Your line is open.
Marc Wiesenberger -- B Riley -- Analyst
Yeah, thank you. Good morning.
Robert J. Miley -- President
Good morning.
Marc Wiesenberger -- B Riley -- Analyst
With regards to the strength in -- good morning. With regards to the strength in the commercial sales were there any specific areas that were notable or maybe some kind of budding emerging trends that you could share?
Robert J. Miley -- President
Yeah. Look, I mean, I would say that in the commercial space as you know we really target the entire breadth of the commercial space. We go after large enterprises. We go after the small, medium-sized mid-market as well. We saw strength in our field sales organization, which generally target the mid mark -- the higher end of the mid-market to the large enterprise. But we also saw quite a bit of strength in our commercial inside sales motion as well, which targets small medium-sized commercial enterprises.
Frank F. Khulusi -- Chairman and Chief Executive Officer
Actually we had great growth in both of those areas. Jay, why don't you share those growth numbers.
Robert J. Miley -- President
Yeah. On an average daily sales basis in the commercial field sales market, we grew on average daily sales basis 9%, north of 9%, and then in the inside sales motion our growth reached double digit for the first time in many quarters on a you know again on a average daily sales basis. So that was 9% average daily sales growth and field and 10% average daily sales growth in the insides of emotion.
Marc Wiesenberger -- B Riley -- Analyst
That's really helpful. Thank you. Can you talk about, or should we expect the cadence of kind of cleansing some of that less profitable revenue to continue or has that really worked through and now it's kind of focused on now filling up the part with some of that higher margin stuff. How should we think about that going forward?
Frank F. Khulusi -- Chairman and Chief Executive Officer
So as we indicated before that applies to the first half of the year and was done in the first half of the year in the second quarter. However you know we're still very confident that it's going to become very small numbers in the second half of the year starting in the third quarter and the impact will be a little less than the second quarter as it was in the first quarter.
Marc Wiesenberger -- B Riley -- Analyst
Understood. With regards to the decrease in the public sales or the government shutdown, I know you expect that, that will come back. But can you quantify really what effort all will be lost and and/or kind of the timing when you would expect some of the others to come back?
Frank F. Khulusi -- Chairman and Chief Executive Officer
Yeah, I -- comeback is an action not -- is not the expression that we used. We said we were going to make up for it. I don't want to project an image where these sales will just -- are sitting there waiting for us to be had. There's a combination of sales that are lost, as well as sales that are not lost and will come back, but the team has told us that they feel very confident about their ability to make up for those lost sales as the year progresses. Now keep in mind that segment overall is not as material for us as the Commercial segment has to start with. And then secondly with respect to the federal piece, it's a small piece of the overall, second. And then third on the public sector side, the revenues that we've been cycling through, if you may, are lower-margin, lower-calorie-type revenues. We do have a new management team that started with us last year focus on what we believe are the right activities on both federal and the state and local. On the federal side, we believe that they're going to make that piece of the business much more meaningful for us. And on the SLED side, we believe that they are focused on value added transactions that are consistent with the way that our Commercial segment has historically done it. And so we are very optimistic about that segment overall on a go forward basis.
Marc Wiesenberger -- B Riley -- Analyst
That's great. Thank you. And just one last from me. With your discussions with your UK customers, Brexit, how is that impacting their business and ultimately your interactions with them?
Frank F. Khulusi -- Chairman and Chief Executive Officer
We have started hearing a bit more noise, actually on our last quarterly business review call. The management team was talking about Brexit in more ways and more detail than they have. And we thought -- we quickly shut them down on that, as we're trying to hold them accountable for results that don't factor in that backdrop, if you may. And the premise for them is that there's been just too much uncertainty back and forth now it's happening, not happening delays et cetera, which are affecting the demand environment over there they say. And our counter point to them is, we are small and we want to grow and we can take a lot of share which they agree with. So we continue to believe that the share that we can take is very significant in the marketplace. We also believe that as the uncertainty itself subsides, it should help us in our growth in that market in a relatively large manner. And also, if you recall, one of the areas that we haven't been able to participate in yet, and that area tends to be more consistent from a demand perspective is the public sector side in that market. And we have not been able to participate because we're not on the frameworks over there. We're very busy hiding ourselves slowly, but surely to the frameworks because we have to wait when the -- until the frameworks are up to date. And that activity is Fast and Furious going on as we speak. So as that happens, it should have some growth component part of this stuff not there, right now. We continue to be very optimistic about that business. We did that a few more sales resources toward the end of last year, at the beginning of this year, which we believe will contribute to the growth. We don't think that the Brexit backdrop is going to continue forever and we have the public sector play, so with all these components taken together, I think we're going to have a nice story with the UK business in the second half.
Marc Wiesenberger -- B Riley -- Analyst
Excellent. Thank you very much.
Frank F. Khulusi -- Chairman and Chief Executive Officer
Thank you, Marc.
Operator
I would now like to turn the call back to Frank Khulusi for his final closing remarks.
Frank F. Khulusi -- Chairman and Chief Executive Officer
Thank you all for joining us this morning. And we look forward to updating you on our progress in the coming quarters. Until then, goodbye.
Operator
This concludes today's conference call. Thank you for joining. Have a wonderful day. You may all disconnect.
Duration: 23 minutes
Call participants:
Kim Rogers -- Investor Relations
Frank F. Khulusi -- Chairman and Chief Executive Officer
Robert J. Miley -- President
Brandon H. LaVerne -- Chief Financial Officer, Treasurer and Assistant Secretary
William Gibson -- ROTH Capital -- Analyst
Marc Wiesenberger -- B Riley -- Analyst
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