ePlus inc

NASDAQ:PLUS

Earnings Call Transcript 2019-Q1

[Operator]

Good day, ladies and gentlemen. Welcome to the ePlus Earnings Results Conference Call. As a reminder, this conference call is being recorded. I would like to introduce your host for today's conference, Mr. Kley Parkhurst, SVP. Sir, you may begin.

[Kley Parkhurst, executive]

Thank you, and thank you for joining us today. On the call is Mark Marron, CEO and President; Elaine Marion, Chief Financial Officer; and Erica Stoecker, General Counsel.

I want to take a moment to remind you that the statements we make this afternoon that are not historical facts may be deemed to be forward-looking statements and are based on management's current plans, estimates and projections. Actual and anticipated future results may vary materially due to certain risks and uncertainties detailed in the earnings release we issued this afternoon and our periodic filings with the Securities and Exchange Commission, including our Form 10-K for the year ended March 31, 2018, and our Form 10-Q for the quarter ended June 30, 2018, when filed. The company undertakes no responsibility to update any of these forward-looking statements in light of new information or future events.

In addition, during the call, we may make reference to non-GAAP financial measures and we've included a GAAP financial reconciliation on our earnings release, which is posted on the investor information section of our website at www.eplus.com.

I'd now like to turn the call over to Mark Marron. Mark?

[Mark Marron, executive]

Thanks, Kley, and thank you all for participating in today's call to discuss our first quarter 2019 results and our business outlook.



Our first quarter results represented a solid start to the fiscal year on key metrics. We reported a 4% year-on-year increase in gross profit and a significant improvement in our gross margin, which increased 180 basis points to 22.6%. Our gross margin remains at or near the top of our peer group, and was supported this quarter by a favorable product mix and continued expansion of our consultative, professional and managed services within our customer base.

We believe that our continued focus on cloud, security and digital infrastructure solutions for our middle market and enterprise customer base positions ePlus very well in the broader IT market to capture share and allows us to nurture and maintain highly relevant and valuable relationships with our customers.

On a very tough year-over-year compare due to an outsized customer project that we delivered in last year's first and second quarter, net sales for the quarter declined 4.5%. On a sequential basis, net sales increased approximately 8%. We are starting to see the gradual effect of ratably recognized revenues and subscription sales that are increasingly becoming a factor in our business model.

These new types of revenue streams provide a few notable financial and operational benefits to ePlus, recurring revenue and better revenue visibility and higher gross margins over time. They also allow us to provide an ongoing solution or service to our customers and engage with them consistently on a consultative basis, giving us opportunities to cross-sell and up-sell additional services and solutions. Customers prefer this paradigm for consuming IT as well, as it is more closely aligned with how they consume and utilize cloud, telecom and IT applications over time.

Our middle market customer base has demonstrated consistent growth across all of our key offerings, including enhanced maintenance, professional and managed services. We are investing in the right solution areas and remain focused on improving the value proposition we offer our customers while earning their confidence in our abilities. Of particular note is the continuing success of our security offerings.

Sales of security products and services accounted for 18.4% of trailing 12-month adjusted gross billings, up 160 basis points year-on-year. We've also seen notable growth in our health care vertical.

We recently had a regional health care customer acquire 5 new hospitals. Working with them from a consultative basis, first, performing an assessment of their IT estate and building a plan to deliver desired outcomes, we engaged in a multiphase project to build a plan to standardize IT equipment and processes across all hospitals, upgrade and then optimize their outdated IT infrastructure with new, robust and secure modern technology, maximize its network performance to handle the increased digitalization of its medical practices, help to measure balance and monitor data motion across the network and built a security plan and implemented projects to improve the customer security posture.

In addition, we are harnessing emerging technologies to provide virtual reality solutions for the medical community. This technology creates 3D anatomical images of an individual patient, which surgeons can use to virtually plan, practice and test treatments to achieve the best patient outcome.

We continue to make progress on the realignment of our resources to most effectively serve our customers. While headcount increased 2.1% year-over-year, much of this reflects customer-facing personnel added as a result of a recent acquisition.

Sequentially, however, our headcount was down 1%. We will continue to add professionals in areas of strong customer demand while we optimize our cost structure. And we have the financial resources to continue to make acquisitions that will expand our service offerings and our geographic footprint.

Additionally, we expanded our executive management team to help support our future strategic and operational initiatives. In the first quarter, Darren Raiguel was promoted to Chief Operating Officer and Douglas King joined ePlus as Chief Information Officer, bringing over 18 years of experience as a C-level executive. ePlus is fortunate to have a deep talent bench who will help support our strategic and operational initiatives as we scale the business.

With that, I will turn the call over to Elaine Marion, our CFO, to review our first quarter results. Elaine?

[Elaine Marion, executive]

Thank you, Mark, and thank you, everyone, for joining us today. Before I discuss our financial results, I want to remind you that we adopted ASU 606 April 1, 2018. The 2 primary changes in our accounting for revenue are sales of off-lease equipment, which we recognize on a growth basis, and the timing of recognition of certain transactions known as bill-and-hold arrangements.

The impact from the adoption on our consolidated statement of operations for the 3 months ended June 30, 2017, was an increase in net sales and cost of sales of $6.2 million. We adopted the standard on a retrospective basis and as such, have shown our prior periods on an adjusted basis.

I am pleased to report on our first quarter financial results, which represented a solid start to fiscal 2019. Our net sales amounted to $356.5 million, representing a 4.5% decline year-over-year due to a tough comp. And some of the decline attributed to a greater proportion of sales of third-party maintenance and assurance presented on a net basis.

It is worth noting that excluding a large project in the first quarter of fiscal 2018, our net sales would have increased. Despite the revenue decrease, we reported a 4% year-over-year gross profit growth to $80.7 million while our gross margin expanded 180 basis points to 22.6%. This positive performance is a result of our success selling value-add services and a shift in mix of products and services.

Operating expenses increased 5.5% to $60.2 million principally due to higher salaries and benefits, reflecting the year-over-year headcount increase of 2.1% to 1,249 employees. The higher headcount was largely due to the acquisition of IDS in September 2017. However, as we continue to realign talent, our headcount declined sequentially by 1% from 1,260 at the end of fiscal 2018.

As a result of higher operating expenses offsetting the gross profit increase, our operating income of $20.5 million was flat year-over-year. Adjusted EBITDA was up 3.9% year-over-year and amounted to $25.4 million, while our adjusted EBITDA margin expanded 60 basis points to 7.1%.

In the first quarter of fiscal 2019, we had a lower effective tax rate of 25.7%, as a result of the federal tax rate decrease and a benefit from share-based compensation in the quarter, compared to 35.4% tax rate in the year ago quarter. As a result, net earnings increased by 13.8% to $15.3 million. Fully diluted earnings per share were $1.12, up 16.7% from last year's $0.96.

Excluding acquisition-related amortization expense and other income on a tax-adjusted basis as well as the tax benefit recognized for the vesting of share-based compensation during the quarter, non-GAAP diluted EPS were $1.28, up 6.7% year-to-year. Our weighted average diluted share count declined 3% to 13.6 million for the June quarter from the prior year's first quarter share count of 14 million due to share repurchases.

Now let me give you a more detailed overview of our technology business, which is our largest segment accounting for 97.3% of revenue this quarter. The technology's segment net sales of $346.9 million declined 4.4% over last year's first quarter due to a difficult year-on-year comparison and a larger proportion of sales of third-party maintenance and assurance in the current quarter as compared to the prior year's quarter.

Technology and SLED continue to be our largest customer end markets on a trailing 12-month basis, accounting for 24% and 17% of the technology segment net sales, respectively. Telecom, media and entertainment represent approximately 14% of net sales and health care, 14%. The remainder includes financial services at 15% and 16% from several other client types.

Adjusted gross billings amounted to $482.3 million compared to $487.5 million in the same period a year ago. The adjustment from adjusted gross billings to net sales was $135.4 million, representing 28.1% compared to $124.6 million or 25.6% in the year ago quarter, reflecting a higher proportion of third-party software assurance, maintenance, subscription, SaaS licenses and services.

Gross profit for the technology segment increased 4.5% to $72.8 million, while gross margin expanded by 180 basis points to 21% due to the shift in mix towards third-party maintenance and subscription services as well as higher product margin and services revenue.

Technology segment operating expenses of $57.2 million increased 6.9% from $53.6 million in the prior year first quarter. This was primarily due to higher salaries and benefits, which were up $2.2 million or 5.2%. This increase includes $1.4 million of incremental variable compensation due to the increase in gross profit. The remaining increase was due to additional personnel.

As of June 30, 2018, we had 1,206 employees in our technology segment, a 2.6% increase compared with 1,175 employees at the quarter end last year. Sequentially, however, our headcount declined from 1,215 in the fourth quarter. The technology segment operating income amounted to $15.5 million compared to $16.1 million in the year ago quarter. Adjusted EBITDA, however, was up 2.3% to $20.3 million, primarily due to an increase in gross profit.

Now let me review the financing segment performance. We reported net sales of $9.7 million, representing a 7.5% decline from $10.5 million in the year ago quarter, as a result of lower transactional gains, post-contract revenues and fees earned from consumption-based financing arrangements. Operating expenses were down 15.2% to $3 million due to changes in the reserve for credit losses as well as lower salaries and benefits. This led to an 11.1% increase in operating income, which amounted to $4.9 million. Adjusted EBITDA of $5 million was up 11.2%.

Moving to the balance sheet. We ended the quarter with cash and cash equivalents of $57.5 million as compared to $118.2 million at March 31, 2018. The decrease was due to additional working capital needs from our technology segment.

Inventory levels increased $12 million sequentially to $52 million. Our inventory levels vary and are dependent upon customer-specific projects. Our cash conversion cycle improved to 22 days, down from 23 days in the fourth quarter of fiscal '18 and from 25 days a year ago.

Going forward, we plan to continue to execute on our strategy to focus on cloud, security and digital infrastructure and consider add-on acquisitions that build out our offerings and capabilities in these areas.

Thank you for your time today. I will now turn the call back to Mark.

[Mark Marron, executive]

Thanks, Elaine. First quarter 2019 sets the stage for another year of progress for ePlus. Market dynamics remain favorable, and we are positioned well to provide our customers with the solutions they need as we continue to build out our areas of focus in cloud, security and digital infrastructure. We continue to focus closely on growing gross profit, managing our core structure and evaluating strategic acquisitions.

Operator, I would now like to open the call for questions.

[Operator]

[Operator Instructions] And our first question comes from Maggie Nolan with William Blair.

[Margaret Nolan, analyst]

I wanted to get a feel for your internal expectations for revenue growth. I know it was a tough quarter for a year-over-year comparison. But how did the growth come in compared to what you all were expecting?

[Mark Marron, executive]

Maggie, it was in line with what we were expecting. Just a couple things to note or remind you of. One, it was a really tough compare. Last year, in this quarter, we were up 23%. The other thing that Elaine had talked about, in terms of our gross to net, our gross to net was actually a little bit higher, which affected our sales, but it was in line with what we were thinking. And if you go back to the last couple quarters, we've talked about gross profit and gross margins being better metrics to kind of manage us on as we move towards more of our service -- consultative services and as we move into the ratable subscription world a little bit more. Those are the things to kind of take a look at that'll show our growth as we go forward.

[Margaret Nolan, analyst]

Okay, great. Makes sense. And then, you have one acquisition that's about to anniversary, one that anniversary-ed a couple of months ago. Can you just give us an update on how those acquisitions are integrating into the business and whether or not they're performing in line with your expectations when you brought them on?

[Mark Marron, executive]

Okay. Yes, so 2 things. One, if you remember, the 2 acquisitions, one was OneCloud and the other one was IDS. The reasons that we acquired them was to help build out our cloud strategy and our cloud practice. And they were integrated on day 1, so we feel good about both acquisitions, that they're part of the ePlus team. They're building out the solutions that we provide to our customers, so that's everything from helping businesses align their business to be more cost-effective with their cloud strategy. That's helping them with health checks to ensure that the -- what they've deployed to the cloud has been deployed correctly. All the way down, that provide cost optimization to reduce costs as well as security solutions to kind of reduce risks. So we feel good what it's done to build out our cloud offerings and our cloud capabilities. And we're starting to see sales from both of those organizations, not only within the existing regions they were in, but across ePlus.

[Margaret Nolan, analyst]

Great. And then, Elaine, can you just give us your updated expectation for the normalized tax rate for the year? Or if you can't give a specific number, just kind of an idea of where this quarter falls compared to your expectation for the year?

[Elaine Marion, executive]

Sure. For the remainder of the 3 quarters, we expect each quarter to come in at about a 29% rate. This quarter, we saw an additional benefit from the vesting of stock compensation that occurred during the quarter, which is why the rate declined slightly from where we had said that there was -- we thought it was going to come in at about 29%.

[Operator]

[Operator Instructions] Our next question comes from Alvin Park with Stifel.

[Alvin Park, analyst]

This is Alvin Park on behalf of Matt Sheerin. Just for fiscal year 2019, especially considering the tough comps in Q1 and Q2 from the large customers, just wondering if you could provide any insight of how you guys are looking at the IT growth and market growth and where ePlus might be in terms of a spread on top of that growth. Any color on what top line growth might be, especially given tougher comps with the strong fiscal year '18.

[Mark Marron, executive]

So a couple different things. That was a lot of questions in there, Alvin. So a couple quick things. One, we still feel good with our strategy and what we're building. So we do believe we'll continue to outpace the IT market. We feel we're well positioned to do that. What we've talked about in prior calls is that as we're evolving the solutions that we sell to our customers, and a lot of those are either ratable or subscription related, we feel good that we're building the solutions that our customers are looking for, and that's showing up. If you look at our gross profit, on a net sales decrease, our gross profit was actually up 4%. If you had factored out that large deal, our sales would have been up as well as our adjusted gross billings. Also, the other thing I'd highlight is the services and solutions that we're selling are more valuated solutions in higher-end consultative and annuity services. So if you look at our gross margins, they were up 180 basis points over last year. So we feel good where we're positioned in the market. We feel good that we're positioned well not only with our customers and as well as with our vendors. And we feel good that we'll continue to grab market share as the market goes forward or as the year goes forward.

[Alvin Park, analyst]

Okay. And as well, if you could just give some color on share buybacks. I believe, for the last 2 quarters or so, you've been gradually decreasing the share count through buybacks. If you could just provide color on your general strategy on how you view it, if you can you remind us how much there is left in the coffer? And if there might be potential for further buybacks with the board approval?

[Mark Marron, executive]

Okay. So there's 2 things that we -- or 3 things that we normally look at in terms of how we allocate our cash. So we believe we're a growth company, Alvin. So first thing we normally try to do with our cash is either reinvest back in organic hires and/or look at acquisitions that could build out either our territory coverage or our technology portfolio that we can go back to our customers with. Over the years, we've had share repurchases for years and years and years, so -- and we have one open currently right now, but it's more opportunistic. But if I were going to look at a cash allocation, it would be more in investing in resources to build out our capabilities or potential acquisitions that are out there.

[Elaine Marion, executive]

And Alvin, the board did authorize a share repurchase program in April, which started May 27, and that was 500,000 shares.

[Operator]

Thank you. And I am not showing any further questions at this time. I would now like to turn the call back over to Mark Marron for any further remarks.

[Mark Marron, executive]

Okay. Thanks, Daniel. So if I could just close off with, we still feel very good about our strategy in terms of our long-term growth and the moves that we made both organically as well as through M&A. We've got a strong balance sheet. We've continued to build out both our footprint as well as our solutions and our services. And we will continue to manage our metrics closely as we go forward.

So with that, I want to thank you for joining us today on the call. Look forward to speaking with you on the next quarter's call, and have a good day. Thanks, Daniel.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone, have a wonderful day.