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Conference Call Discussing Earnings for the Three Months Ending 9-30-09

November 9, 2009

Prepared Remarks

Operator: Good day, everyone and welcome to today’s Fiscal Second Quarter 2010 Earnings Conference Call for ePlus. Today’s conference is being recorded. And now for opening remarks and introductions I would like to turn today’s conference over to Mr. Kleyton Parkhurst with ePlus. Please go ahead, sir.
 
Kleyton L. Parkhurst, Senior Vice President
Thank you, Lisa, and thank you, everyone, for joining us on today's call. With me today are Phillip Norton,ePlus Chairman, President, and Chief Executive Officer, and Elaine Marion, Chief Financial Officer.
 
I want to take a moment to remind you that the statements we make this morning 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, including, without limitation:
  • Possible adverse effects resulting from the recent financial crisis in the credit markets and general slowdown in the US economy, such as our current and potential customers delaying or reducing technology purchases;
  • Increasing credit risk associated with our customers and vendors;
  • Reduction of vendor incentive programs;
  • The possibility of additional goodwill impairment charges and restrictions on our access to capital necessary to fund our operations;
  • The demand for and acceptance of our products and services;
  • Our ability to adapt our services to meet changes in market developments;
  • The possibility of defects in our products or catalog content data;
  • Our ability to protect our intellectual property;
  • Our ability to reserve adequately for credit losses, and
  • Other risks and uncertainties detailed in the earnings release we issued last week and our periodic filings with the Securities and Exchange Commission.
The Company undertakes no responsibility to update any of these forward-looking statements in light of new information or future events.
 

With that, I'll turn the call over to our Chairman, President, and Chief Executive Officer, Phillip Norton.
 
Phillip G. Norton, Chairman, Chief Executive Officer and President

Thank you, Kley.

Good morning, everyone, and thank you for joining us.
ePlus’ financial performance, in the second quarter of fiscal year 2010 which ended September 30, 2009, showed sequential improvement in top-line revenues, net earnings and earnings per share. While it is still too early in this economic cycle to predict when IT purchasing may return to prior levels and we continue to show a year over year decline in both revenues and earnings, we believe that last quarter’s sequential improvement indicates that customers are purchasing again. The motivations for resumed purchasing are varied, but seem to be driven by either the necessity to replace aging equipment, or take advantage of the operating cost savings by investing in new technologies, such as virtualization. Later in this presentation, Elaine will go over our specific financial results, but for now I will discuss some of the broader trends that are driving ePlus’ performance.
As I indicated last quarter, gross profit dollars and gross margin percentages are important indicators for us as we manage the overall mix of products and services revenue throughout the quarter. In the second quarter, gross profit from products and services totaled $22.9 million, and our gross margin percentage on products and services was 14.6%. This was the second consecutive quarter with sequential improvement for both metrics, and the gross margin percentage is higher than it was a year ago. Our ability to increase the gross margin in today’s economy is very important, and is attributable to a few key strategies that we’ve had in place for several quarters. First, we are continuing to get better at participating in vendor incentive programs to maximize rebates, marketing funds, and other programs that vendors use to drive sales. Our investment in our vendor partnerships and the internal engineering talent is continuing to enhance margins. Second, our focus on advanced technology solutions, and the higher value-add we provide to customers, allows us to sell higher margin products and services. And lastly, we are focused on using data analytics to review current and historical purchasing patterns of our customers, to capture more customer spend and add-on sales using our internal sales resources and telemarketing representatives. Put together, ePlus continues to optimize its sales of products and services to maximize gross margin dollars and gross margin percentages.
Speaking of advanced technologies, over the course of the quarter, we announced several awards that go to the heart of our ability to deliver the right solutions to our customers. We received a Sales Excellence Award for the first HP BladeSystem Matrix sale through the U.S. reseller channel. In addition, we achieved a Customer Satisfaction Excellence Gold Star from Cisco for the fourth straight quarter. This is the highest customer satisfaction distinction and measures pre-sales and post-sales support over a rolling 12-month period.
I’d like to turn now to our patent portfolio. During the quarter, we recorded $3.4 million in revenue attributed to settlement and license agreements with 3 different companies. These actions were taken on the same patents that we successfully prosecuted a few years ago, and there is an ongoing suit against a fourth company. We continue to invest in our intellectual property and broaden our portfolio. During the quarter, we received a patent titled "System and Method for User Creation and Direction of a Rich-Content Life-Cycle", which assists in the development of rich-content. We market this capability under our Content+ trademark. Our intellectual property represents an important differentiator for ePlus.
Financial performance in the leasing segment is down year over year, primarily because we have a smaller lease portfolio which is the result of a strategic decision a few years ago to build cash. With the turmoil in the financial services market, especially in the commercial finance sector as a number of market participants have been under stress, we believe we have an opportunity to gain market share, especially in the middle market.
We remain focused on improving operating performance by reducing costs, improving purchasing practices, and optimizing our participation in vendor incentive programs. Discretionary cost items, such as travel, recruiting fees and outside services have been -- and will continue to be -- heavily scrutinized.
We continue to be an active participant in the M&A marketplace, are engaged in reviewing many transactions, and are proactively seeking strategic opportunities. We believe there will be opportunities that fit our strategy and valuation parameters, however, we will continue to be very disciplined in our approach.
In summary, despite the continued difficult economic conditions, ePlus has a strong balance sheet which allows us to focus our efforts to expand our business with existing clients and win new clients. We believe we are well positioned to deliver what customers want today on two fronts. First, customers want to reduce the cost of doing business with their vendors, and we believe our electronic procurement software, OneSource IT, in combination with our leasing and outsourced business process services, offers a better solution than our competitors. Second, customers seek to reduce their internal operating costs by optimizing their IT infrastructure through virtualization and intelligent investments in newer technology. Our focus on advanced technologies and the delivery of top-flight engineering services provides the best solutions for our customers. We will continue to focus on customer acquisition to further our market share gains and position the Company for long-term growth.
That completes my prepared remarks. I will now ask Elaine to walk you through the financial statements. Elaine?
Elaine D. Marion, Chief Financial Officer
Thanks, Phil.

As Phil noted, this was a good quarter for ePlus sequentially, and there was also some improvement in year over year comparisons which are worth noting.
Sequentially, net earnings for the fiscal second quarter ended September 30, 2009, increased $3.1 million or 163%, as compared to $1.9 million in the first quarter ended June 30, 2009, and earnings per diluted share increased $0.35 or 152%, as compared to $0.23 in the first quarter. Also on a sequential basis, revenues increased $20.3 million or 13.3%, as compared to $152.4 million in the fiscal first quarter.
Net earnings totaled $5.0 million, or $0.58 per diluted share, as compared to $6.4 million [corrected], or $0.74 per diluted share in the second quarter of the prior fiscal year. For the six months ended September 30, 2009, net earnings totaled $6.9 million, or $0.81 per diluted share, as compared to $10.1 million, or $1.18 per diluted share, for the first six months of the prior fiscal year.
The technology sales business segment generated $162.6 million of total revenues, up 14% sequentially. Results benefitted from the $3.4 million in patent licensing and settlement revenue that Phil mentioned in his remarks. We had a good mix of products and services, with Cisco, Hewlett Packard and Sun Microsystems products representing approximately 40%, 18% and 5%, respectively, of total products and services revenues. On a year-over-year basis, total revenues in the technology sales business segment were down slightly more than 10%. This is an improvement compared to the year-over-year decline in the fiscal first quarter. The gross margin for product sales and services for the quarter was 14.6%, a 40basis point improvement sequentially and a 60 basis point improvement year-over-year.
Revenues generated in the financing business segment, which include primarily sales of leased equipment, lease revenues, and fee and other income, declined 34.3% [corrected] to $10.1 million for the quarter ended September 30, 2009 as compared to the quarter ended September 30, 2008 and were largely unchanged sequentially. The decline in revenues in the financing business segment, compared to the prior year’s second quarter, is attributable to a smaller balance of investment in leases and leased equipment which generates less lease revenue, and a decline in sales of leased equipment which can vary from quarter to quarter based on the Company’s risk mitigation strategy. We continue to feel that lease financing is an important part of our overall value proposition and a competitive differentiator for us in the marketplace.

For the quarter, salaries and benefits were down about 2% on a year-over-year basis and slightly more than 5% for the first six months. We made a gradual reduction in headcount to 657 employees as of September 30, 2009, compared to 674 employees a year ago. In addition, commissions expense was reduced due to lower year-over-year sales in the quarter and for the 6-months ended September 30, 2009.
Partially offsetting these cost savings were increased legal fees incurred in relation to the patent infringement lawsuit, which resulted in increased professional and other fees for the quarter and for the 6-months ended September 30, 2009.
Based on our reduced non-recourse debt level and a general decline in interest rates compared to a year ago, interest expenses were reduced more than 25% on a year-over-year basis.

We continue to maintain liquidity on the balance sheet. As the business has expanded sequentially, some cash was converted to other assets in the normal course of business. As of September 30, 2009, cash and cash equivalents totaled $88.3 million, as compared to $107.8 million on March 31, 2009. The reduction in cash is attributable, in part, to increases in accounts receivable from $82.7 million to $93.3 million which was due to a sequential increase in sales and an increase in investment in leases and leased equipment from $119.3 million to $124.2 million, from March 31, 2009 to September 30, 2009, and share repurchases. During the quarter, we repurchased 14,858 shares, at an average cost of $15.37 per share. Our total investment was approximately $228,000. Since the inception of our initial repurchase program on September 20, 2001, as of September 30, 2009, we have repurchased about 3.4 million shares of our outstanding common stock at an average cost of $10.92 per share for a total purchase price of $37.5 million.
Furthermore, while our lease portfolio has expanded slightly, we reduced the amount of non-recourse notes payable from $85.0 million to $64.6 million from March 31, 2009 to September 30, 2009. As Phil mentioned earlier, this will allow us to generate higher net earnings in the leasing segment by using our cash to retain higher yielding assets.

As I mentioned on the last call, we have been and continue to be highly focused on credit and collections for new and existing customers to ensure that our accounts receivable are solid, to minimize credit losses, and to enhance working capital. We continue to perform very well in these areas.
In summary, we continue to focus on containing costs, maintaining and enhancing gross margins, retaining and adding customers, and exploring M&A opportunities. While the next few quarters could prove to be challenging in terms of revenue and earnings because of uncertain economic conditions through our fiscal year end, we believe ePlus is well positioned with a solid balance sheet and the right business mix to execute on future opportunities.
That concludes my remarks.

Questions and Answers

 

Operator: Are you ready for questions? Mr. Parkhurst are you ready for questions? [Operator Instructions] Thank you. Mr. Parkhurst are you ready for questions?
 
<A – Kleyton Parkhurst>: Yes, we are, thank you.
Operator: Thank you. [Operator Instructions] And we’ll take our first question from Mark Argento with Craig-Hallum Capital.
 
<Q – Mark Argento>: Hey, good morning, guys.
 
<A – Phillip Norton>: Morning.
 
<Q – Mark Argento>: Question, can you give us a little bit more color around your hardware and services revenue? Can you break out, if you have it, what percentage was more kind of pass through hardware revenue versus actual value-added services revenue?
 
<A – Phillip Norton>: I’ll let Elaine take that.
 
<A – Elaine Marion>: We don’t currently break that out in our filing.
 
<Q – Mark Argento>: Could you help us think about, I know it’s been a focus for the company to increase the value proposition to customers. Have you made any progress to that point in terms of the mix of revenue?
 
<A – Phillip Norton>: We wouldn’t really be able to comment on the mix of revenue, but what I would say is that we have a continuing effort to hire and to train higher-level engineers to enhance the engineering services, and a good portion of our product sales are in complex solutions such as IP telephony and security and storage and virtualization of which without the higher-level engineering services we wouldn’t be competitive, and I believe it’s one of the reasons that we have been able to increase our margins and enhance the capabilities of the company. I think over time that will turn into services revenue separate from the hardware.
 
<Q – Mark Argento>: And when you guys go into an engagement do you typically, is it all bundled price or do you typically bundle or breakout the services, consulting services portion relative to that, say that sale of equipment Voice over IP bid in particular, the equipment versus the integration. Are those typically all bundled or are the separate?
 
<Q – Phillip Norton>: I think it can work both ways, but in most cases we have a focus on being project management oriented, and presenting a project management plan that breaks out the services in some cases for the larger transactions. And we are continuing to drive that methodology through our whole business model to enhance our ability to become a service organization as well as a product organization. We’ve made some significant changes structurally in the company in the last year where we have or the last six months where we’ve broken the engagement teams from being direct quarterly reporting to regional manager sales to reporting into the head of the technology group so that we will have a strong differentiation between service and sales going forward.
 
<Q – Mark Argento>: Okay. Then could you talk a little bit the patents I know you said you had settlement in this quarter particular but a little bit more about the patents and really what the technology is behind that.
 
<A – Phillip Norton>: Well the patents that we are presently under litigation, we have to try to restrain from anything that would potentially hurt us but what they’re basically procurement patents in which there are several different things that you have to go through in each case to make sure that someone would be infringing. And this last case we had four different people that we were prosecuting the patents against and three of them decided that it was in the best interest of them to settle. Another one is, we’re presently in litigation and I can’t really discuss that.
 
<Q – Mark Argento>: Do you believe that the patents are applicable? Is it just four targets or four people that could be infringing or is there opportunity to assert those patents in a broader venue?
 
<A – Phillip Norton>: I think that’s something that we have our technology people and our attorneys looking at, but we try to focus on what we believe that are the ones that presently come across and I think our attorneys will advise us that there are other people at different points in time that would be able to pursue patent cases or licenses.
 
<Q – Mark Argento>: And then I think in your prepared comments you also mentioned looking at M&A could you give us an idea of what you’re seeking at in a potential M&A target. What things would you like to, what types of business or size or frame that up for us if you could.
 
<A – Phillip Norton>: Well.
Operator: Mr. Parkhurst, this is the operator. Mr. Parkhurst, this is the operator, we are unable to hear you. [Operator Instructions] Hi, Mr. Parkhurst?
 
<A – Kleyton Parkhurst>: Yes, ma’am.
Operator: This is the operator, we’ll take our next question from Brian Kinstlinger with Sidoti and Company.
 
<Q – Brian Kinstlinger>: Hi. Good morning. I was curious if you could characterize the seasonality of your business? Is the fourth quarter generally seasonally strong time? And would you envision given the recession or just coming out of it would be more or less pronounced than usual?
 
<A – Phillip Norton>: Last year I think we saw still I think a reasonable level of spend and it didn’t go into a total tailspin until the first quarter of the calendar year, our fourth quarter. And I think that we’ll probably see the same thing we saw last year but you know it’s all you know based on what happens in Congress and other places. But last year we started to see a lot more sales at the end of the year because of people having budgeted money that they hadn’t spent earlier in the year and we saw an up tick. So you know I think you’re, based on the economy there, you know I don’t think we see a tailspin this quarter. I think first quarter is going to all depend on what happens with retail sales and the economy.
 
<Q – Brian Kinstlinger>: Now, I mean outside of a recession, in most years, do you see seasonal strength in the fourth quarter? Or the December quarter? And then my other question is, was – did October suggest that you continue to see a modest pick up?
 
<A – Phillip Norton>: I think – our fourth quarter sales are normally, you know what would you say, Elaine?
 
<A – Elaine Marion>: A little softer probably than third quarter.
 
<A – Phillip Norton>: Yes. And third quarter is where we have a lot of sled business, or state and local government, so that usually is a little bit higher. But I think we’ll, based on where we are now, I still think the economy is still soft and it’s pretty hard to figure out where it is, although I think based on Cisco’s projections and other people, it appears like there will be some pick up.
 
<Q – Brian Kinstlinger>: And what percentage of revenue is state and local? And so the budgets’ having an impact, hurting that business right now?
 
<A – Phillip Norton>: We don’t really break out the percentage but it’s had an intermittent impact. What – the impact that it’s had is people will be planning on projects but wait until the budgets get approved. For example in Pennsylvania, they had to wait for a long period of time, which is where one of our big state and local markets are. Also in New Jersey they hadn’t signed new contracts, and there was a time waiting for that, so you have to use other avenues, so I think indirectly, the budgets have affected some of that business.
 
<Q – Brian Kinstlinger>: Now you say that you don’t break out revenue, but I mean is it meaningful that the budgets are such a problem right now? Are we talking about half your business is state and local, is it less than a quarter?
 
<A – Phillip Norton>: Well it’s this way, it’s not as meaningful because it’s – it has reasonable percentage, I can’t give the exact number, but it’s – I think it’s been in line with what our reduction in overall sales are.
 
<Q – Brian Kinstlinger>: The Sun-Oracle deal obviously has taken a while to close and Oracle really hasn’t talked too much until recently about the plans for Sun. Has it at all impacted your Sun business, which I think you said is five, 10% of revenue I think, I can’t remember?
 
<A – Phillip Norton>: So far I think our Sun business has been at the same or similar levels as it has been in the past for overall percentage, but from the Oracle standpoint, I think that is still going to take a while to put in place. I don’t see a dramatic increase in Sun sales because Oracle bought them. I think it will take a period of time for them to start driving more of the database sales and the ERP sales on, and give Sun a big advantage over other manufacturers when implementing ERP systems. But I think long-term it will have a positive effect on Sun sales.
 
<Q – Brian Kinstlinger>: Okay. Thank you.
Operator: [Operator Instructions] We’ll take our next question from Patrick Retzer with Retzer Capital. Please go ahead.
 
<Q – Patrick Retzer>: Hi, guys. Congratulations on a good quarter.
 
<A – Elaine Marion>: Thank you.
 
<Q – Patrick Retzer>: I think the gentlemen from Craig-Hallum asked a question regarding your comments on looking at potential acquisitions. He asked something along the lines of, what size company or in what business, or part of the business do you think an acquisition is more likely to occur? And I believe the line got cut off before you could respond.
 
<A – Phillip Norton>: Oh. I’m sorry. Well to, we believe there’s a starting, I don’t know if this going over that, the pricing on acquisitions still has not, equaled reality yet. People are still trying to sell past performance versus future projections, and so therefore pricing is still a little high. We’ve reviewed several transactions and pricing is still out of whack a little bit. However we are looking in general transactions where there’s revenue less than 100 million and that they are geographically in places where we are not, that they are have significant cost savings that we’d be able to enact and they have similar product sales that and services that we provide today. And also we’re also looking at smaller companies that may have specific capabilities in both engineering and in product sales and areas in the country where we’re already established to help build up additional capability and drive sales and revenue in different specific technologies.
 
<Q – Patrick Retzer>: Okay. Would you say that prices are approaching reality or with the run up in the stock market over the last six months are they moving further away?
 
<A – Phillip Norton>: Well I think they’re starting to approach reality for the most part the companies we’d be looking at are not driven by stock prices since they’re not public and if you look at the state of the finance market when it comes to CIT and GE and other distributors, Tech Data, Ingram, Arrow, they’re all being I think very cautious on credit and accounts receivables and therefore that’s the biggest driver for the most of the people that we’re looking to acquire that they would be challenged from a credit standpoint and that their ability to get liquidity or borrow is limited somewhat. And they tighter that becomes the more relevant it becomes to their ability to grow and in most cases because of the liquidity issues they are down sizing rather than growing. And so we believe they will be better targets and opportunities both from acquisitions and acquiring better people in the marketplace.
 
<Q – Patrick Retzer>: Okay. And you had some comments on the lease portfolio I see you’ve started to rebuild that. You had it about five million while paying off 20 million of non-recourse debt do you see that rebuilding process continuing and if so is that five million a quarter about the right rate we should look for? Or will that start to ramp up?
 
<A – Phillip Norton>: Well I think it has to do with credit quality number one. Two, the opportunity for us to enhance the yield without taking any large risk and making sure that we are, have good control over the future such as fair market value leases in general. But, and whether or not we are in a strong enough cash position to be able to hold more on our balance sheet as the market improves and this will give us significantly higher yield than earning a half a percent in treasuries with accounts that we know are strong and made it through the, you know, the down turn and have good earning cycles going forward and we have a long history with them. So I think we’ll see a build up of that to what degree I think it’ll be more opportunistic as we have better credits that we can finance and the need for cash for acquisitions or something of that nature is reduced and we will invest more because that can give us a much higher yield.
 
<Q – Patrick Retzer>: Okay. And should we assume you’ll continue to buy-back stock on an ongoing basis?
 
<A – Phillip Norton>: I think our program is how long, Elaine?
 
<A – Elaine Marion>: A year. Until September 15, 2010.
 
<A – Phillip Norton>: With, that program is in place until September of next year and we will, at the present time we intend to continue forward on that.
 
<Q – Patrick Retzer>: Okay. And then finally, over the course of the year you’ve it looks like made an effort to tell the story on the company a little bit with conference calls and maybe a couple of small road trips. Do you see that process continuing or advance in the foreseeable future?
 
<A – Phillip Norton>: We’re making every effort to do that.
 
<Q – Patrick Retzer>: Okay. Okay and thanks, guys.
 
<A – Phillip Norton>: Thanks, Pat. Have a good day.
 
<Q – Patrick Retzer>: You too.
 
Operator: [Operator Instructions] And there are no further questions. I’d like to turn the conference back over to Mr. Phil Norton for any additional or closing remarks.
 
Phillip G. Norton, Chairman, Chief Executive Officer and President
Thank you very much for attending the call. We’re sorry for the communication snafu however I hope we answered anyone’s questions and we look forward to discussing this with you further next quarter. Thank you very much.
 
Operator: And that concludes today’s teleconference. Thank you for your participation.



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