Safe Harbor Statement
This transcript of the earnings call that occurred on February 6, 2019, contains certain statements that are, or may be deemed to be, “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or “Exchange Act,” and are made in reliance upon the protections provided by such acts for forward-looking statements. Such statements are not based on historical fact, but are based upon numerous assumptions about future conditions that may not occur. Forward-looking statements are generally identifiable by use of forward-looking words such as “may,” “should,” “intend,” “estimate,” “will,” “potential,” “could,” “believe,” “expect,” “anticipate,” “project,” and similar expressions. Readers are cautioned not to place undue reliance on any forward-looking statements made by us or on our behalf. Forward-looking statements are made based upon information that is currently available or management’s current expectations and beliefs concerning future developments and their potential effects upon us, speak only as of the date of the earnings call, and are subject to certain risks and uncertainties. We do not undertake any obligation to publicly update or correct any forward-looking statements to reflect events or circumstances that subsequently occur, or of which we hereafter become aware. Actual events, transactions and results may materially differ from the anticipated events, transactions or results described in such statements. Our ability to consummate such transactions and achieve such events or results is subject to certain risks and uncertainties. Such risks and uncertainties include, but are not limited to, the matters set forth below:
We cannot be certain that our business strategy will be successful or that we will successfully address these and other challenges, risks and uncertainties. For a further list and description of various risks, relevant factors and uncertainties that could cause future results or events to differ materially from those expressed or implied in our forward-looking statements, see the Item 1A, “Risk Factors” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections in the Form 10-K for the year ended March 31, 2018, as well as other reports that we file with the SEC.
This document may also contain non-GAAP financial information. Management uses this information in its internal analysis of results and believes that this information may be informative to investors in gauging the quality of our financial performance, identifying trends in our results and providing meaningful period-to-period comparisons. For a reconciliation of non-GAAP measures presented in this document, see our earnings press release issued February 6, 2019, a copy of which is posted on our website at www.eplus.com/investors.
February 6, 2019 – FY19Q3
Good day, ladies and gentlemen. Welcome to the ePlus earnings results conference call. As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference, Mr. Kley Parkhurst, Senior Vice President. Sir, you may begin.
Kleyton L. Parkhurst, SVP
Thank you for joining us today. On the call is Mark Marron, CEO & 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 & Exchange Commission including our form 10-K for the year ended March 31, 2018, and our form 10-Q for the quarter ended December 31, 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 have included a GAAP financial reconciliation in 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, CEO & President
Thanks Kley and thank you all for participating in today’s call to discuss our third quarter fiscal 2019 results.
This was a strong quarter for ePlus in a number of key areas. We reported substantial increases in gross profit and gross margin, two metrics that we believe reflect the success of our business model. Adjusted gross billings increased nearly 3% year-over-year. We continue to see positive operating leverage, due in part to our continuing efforts to hold the line on costs, and focusing on solutions which have strong customer demand. I am also pleased to announce that, just after quarter end, we acquired SLAIT Consulting. We are very excited about this acquisition, as it broadens our security solutions and services offerings, and strengthens our geographic presence in the mid-Atlantic.
Our 8.1% increase in gross profit is due, in part, to a favorable business mix of increased product margins and services revenue. We also experienced higher margins in many of our product lines. For the quarter, our consolidated gross margin expanded 170 basis points to 24%, amongst the highest in our industry.
These drove significant positive operating leverage results in the third quarter. Our gross profit grew 8.1% while our operating expenses grew only 4.3%. We will continue to focus on cost optimization, while still ensuring that we have the optimal number and properly experienced customer-facing professionals to support our consistent migration to a services-led approach to customer engagements.
ePlus has a good track record of striking a balance between controlling costs and investing in our business. An example of this is that our headcount declined 1.5% on a year-over-year basis but increased modestly on a sequential basis, as we added more client-facing professionals and highly-skilled engineers in areas of current and emerging customer demand.
In addition, security is an important business driver for ePlus, and we continue to deepen our expertise in supporting and developing security solutions for our enterprise and mid-market customers. Adjusted gross billings of security products and services in the third quarter increased by 23.6% year to year, and on a trailing 12-month basis, security products and services comprised 19.9% of our trailing twelve month adjusted gross billings, up from 16.7% just one year ago. Security now represents one fifth of our business. Given customer demand dynamics, this is an area that we expect will continue to increase in importance.
In fact, many of the key wins we had in the third quarter had important security-solution components. For example, we helped a large global manufacturing client in multiple countries looking for a solution to secure their multi-cloud workloads in their environment. This customer was heavily invested in cloud-based office productivity tools that required them to extend security outside of their internal infrastructure and applications. Protection and data loss were their key concerns. ePlus delivered a cloud usage and risk workshop to help the customer understand the challenges they would face from a business, technical and compliance standpoint in these SaaS environments. ePlus helped the customer evaluate the top Cloud Security solutions in the market, and facilitated the selection of the best tools and processes to gain and maintain compliance with multiple internal and external rules while securing their data.
Finally, in the third quarter we successfully negotiated the SLAIT acquisition, which was completed in mid-January. SLAIT satisfies many elements of our acquisition strategy. Based in Virginia Beach, it strengthens our geographic presence in key markets, including the Tidewater and Richmond regions. With annual revenues of over $100 million, this acquisition brings us a large customer base with concentration in the higher education and state and local government space and in healthcare verticals. Importantly, SLAIT complements our existing expertise and national practices focused on IT security and hybrid cloud, and brings ePlus additional consultative services in the areas of Governance, Risk and Compliance or GRC, and adds bespoke help desk and managed services solutions, as well as a strong staffing practice. Over time, we will bring these new capabilities to our existing clients and bring core ePlus services and offerings to SLAIT’s customer base. SLAIT’s focus on providing consultative solutions, along with security advisory and managed services is fully aligned with the offerings that ePlus has been building out over the last several years, which tend to be higher margin and represent recurring demand. From a strategic standpoint, we are very enthusiastic about this combination, and we are pleased to welcome SLAIT’s 300 associates to the ePlus team.
In closing, we are very pleased with the progress we have made in building our footprint and geographic reach, expanding and enhancing our solutions and services offerings, and growing our annuity services and revenues. The expansion of ePlus’ services business has been a positive contributor to our gross profit performance, and we have acquired a complimentary services portfolio through the SLAIT transaction.
With that, I will turn the call over to Elaine Marion, our CFO, to review our third quarter and nine month results. Elaine?
Elaine Marion, CFO
Thank you, Mark, and thanks to everyone for joining our call.
Our net sales in the third quarter of fiscal 2019 increased 0.4% year-over-year to $345.7 million, and gross profit increased 8.1% to $82.9 million. Our consolidated gross margin expanded 170 basis points to 24.0%, driven by 160 basis points of margin improvement in the Technology segment, which I’ll discuss further in a moment, with the remaining contribution from the Financing segment.
Operating income increased 22.2% to $20.0 million year-over-year, more than compensating for a 4.3% increase in operating expenses. Higher operating expenses reflected a 4.7% increase in salaries and benefits resulting from higher variable compensation that was directly tied to higher gross profit. Our headcount was down by 19 employees year over year, however, our headcount increased modestly from 1,255 at the end of the second quarter to 1,265 at the end of the third quarter.
Adjusted EBITDA was up 17.7% year-over-year and amounted to $25.6 million, while our adjusted EBITDA margin expanded 90 basis points to 7.4%.
In last year’s third quarter, we had a 4.2% tax rate due to the provisional adjustment of our deferred tax balance as well as an adjustment of our tax provision for the new corporate tax rate which resulted in a tax benefit of $5.7 million. This year, our third quarter tax rate was 28.3% resulting in net earnings of $14.9 million, a decrease of 4.6%. Note that sequentially, our tax rate went up from 27.7% to 28.3%, and as we have said on our previous calls, we expect our tax rate to range from 28% to 29% for fiscal 2019. Fully diluted earnings per share were $1.10, down slightly from last year's $1.11. Conversely, non-GAAP diluted EPS amounted to $1.29, representing a 17.3% year-over-year increase. Our weighted average diluted share count totaled 13.5 million, compared to 14.0 million in the year ago quarter.
Now, let me give you more color on our Technology segment performance. Net sales amounted to $334.7 million, 0.8% ahead of last year's third quarter mainly reflecting higher demand for our products and services that more than offset the last portion of the large competitively bid project we completed in last year’s third quarter. Technology and SLED continue to be our largest end markets on a trailing 12-month basis accounting for 22% and 17% of the Technology segment net sales, respectively. Telecom, Media and Entertainment represented approximately 14% of net sales, and Healthcare, 14%. The balance includes Financial Services at 15% and 18% from several other client types.
Adjusted gross billings amounted to $478.4 million, compared to $465.2 million in the same period a year ago, reflecting a 2.8% increase. The adjustment from adjusted gross billings to net sales was $143.7 million, representing 30.0% compared, to $133.2 million or 28.6% in the year ago quarter, as a greater proportion of sales derived from third party maintenance, subscriptions, and services.
Our gross profit grew 8.6% to $74.0 million, while our gross margin expanded by 160 basis points year-over-year to 22.1%, reflecting the benefit of a more profitable product mix and higher sales of third party maintenance and subscriptions. As we previously mentioned, in last year’s third quarter, we completed the remainder of a large competitively priced project which partially contributed to the year-over-year increase in our gross margin.
Our Technology segment operating income amounted to $14.7 million, up 28.4% compared to $11.4 million in the year ago quarter, reflecting our higher gross profit year-to-year and operating leverage. Adjusted EBITDA increased 20.7% to $20.1 million.
Now, let me share more details about the Financing segment performance. As a reminder, the results in the financing segment have historically fluctuated due to the timing and nature of originations, transaction gains, and post contract transactions. We reported net sales of $11.0 million, representing a 10.0% decline from $12.2 million in the year ago quarter as a result of lower proceeds from a large sale of off lease equipment, which was partially offset by higher portfolio earnings and transaction gains. Despite lower net sales, our Financing segment gross profit in the third quarter of fiscal 2019 was up 4.6% year-over-year to $8.9 million. Operating expenses were flat at $3.6 million. Operating income amounted to $5.4 million, up 8.0%.
I will now turn to our consolidated year-to-date results. Net sales for the first nine months of fiscal 2019 decreased 3.8% to $1.05 billion. Net sales in our Technology segment decreased 3.5% to $1.02 billion. Adjusted gross billings of product and services decreased by 0.7% to $1.45 billion, while consolidated gross profit increased 3.0% to $249.1 million. Our consolidated gross margin expanded by 160 basis points to 23.8% and this was supported by gross margin in the Technology segment, which increased by 160 basis points to 22.0%.
Adjusted EBITDA increased 1.7% to $80.8 million, while net earnings grew 4.1% to $48.1 million and EPS grew 7.3% to $3.54 per diluted share. Non-GAAP diluted earnings per share were $4.10, representing a 3.0% year-over-year increase.
Moving to the balance sheet, we ended the quarter with cash and cash equivalents of $84.3 million as compared to $118.2 million at March 31, 2018 mainly due to an increase in working capital for the technology segment, investment in our financing portfolio, and approximately 160,000 shares repurchased for $12.0 million. Inventory levels increased $11.5 million to $51.4 million from the fiscal yearend. As we have previously mentioned, our inventory levels vary and are dependent upon customer-specific projects. Our cash conversion cycle increased to 26 days, up from 25 days in the second quarter of fiscal 2019 and up from 24 days a year ago. Overall, our balance sheet provides us with significant financial flexibility.
Lastly, we are very pleased with our recent acquisition of SLAIT. Let me give you some color on the key financial aspects of this transaction. We paid $50.7 million in cash at closing. SLAIT’s annual revenues were approximately $100 million. Our headcount will increase by approximately 300 employees, some of whom are assigned to SLAIT’s staffing business. We are completing our purchase accounting, however, as with all our acquisitions, we expect amortization expenses to increase and, in this case, may be a little higher as a percentage of the purchase price than our historical acquisitions. Therefore, we do not expect the acquisition to be accretive for the next several quarters on a GAAP basis.
Worthy of note, in the fourth quarter, we received a $5.4 million distribution from a bankruptcy claim. While this gain will be recognized below the operating income line in the fourth quarter, we are pleased this matter has come to a conclusion.
Going forward, our capital allocation strategy will be focused on pursuing growth opportunities both organically and through acquisitions. We will continue to focus on adding capabilities in the faster growing segments of the market.
Thank you for your time today. I will now turn the call back to Mark for closing remarks.
Mark Marron, CEO & President
The shift in business mix resulted in strong third quarter performance and drove continued growth in gross profit and gross margin for the first nine months of this year. Our emphasis remains on higher growth markets, including digital transformation, cloud and security solutions, and the related consultative and annuity services. And, we have found an excellent acquisition in SLAIT, which will expand our reach, customer base, and capabilities.
We consider acquisitions to be a key element of our capital allocation strategy and are staying active in the marketplace, where we believe that ePlus is distinguished by the benefits of our platform and culture
We continue to be the provider of choice for an expanding roster of mid-market and enterprise clients and remain well-positioned to help with the solutions they require in today’s dynamic marketplace.
Operator, I would now like to open the call for questions.
QUESTION AND ANSWER
Our first question comes from Maggie Nolan with William Blair.
Good strong gross margins this quarter. I wanted to dig into that in a little bit more detail. I know you said benefit from a more profitable product mix, was there any particular product or service that was getting traction this quarter or is there anything underlying may be a trend there for coming quarters?
Hey Maggie, it's Mark. Thanks for the question. So, couple of different things. Yes, we started across multiple product lines both in the security as well as infrastructure space. Our services margins continue with both our, what I'd call, consult ative services and annuity services continue to add to our margins and then we also had a strong gross to net quarter as well that affected gross margins.
Okay understood. And then I wanted to check in on some of your large customer relationships. Are you seeing any opportunities develop with some of these clients, some that you may have previously bid competitively on or pursuit that kind of land and expand approach that we've talked about in the past? How are those relationships going? And is there any opportunity developing there?
Thanks. Yes, Maggie, we're definitely seeing opportunity there. So, for everyone's benefit on the land and expand it’s where we'll go in whether it's a competitively bid project or just a nice large opportunity, we'll be aggressive in terms of winning that opportunity and then over time, we'll try to show the value-added services and solutions that we can provide to those customers.
And yes we are seeing with a lot of the higher and mid-market as well as enterprise customers that once we're in we're able to work with them on new projects, not only in the U.S., but also as we start to expand our footprint a little. We're starting to see some progress with some of the bigger customers that go across the Atlantic and so forth.
Okay, great. Thanks Mark. And if I could just add one more in there. Just some help on the relationship with Cisco the efforts there to build out some new relationships, there's leadership changes over there. And then I don't know if you said it, I might have missed it, just percentage related to Cisco in the quarter? Thanks.
Okay, well Cisco percentages for the quarter was approximately 40%. I don't have it in front of me Maggie, but its right in that range 40%, 41%. And what we've seen Cisco has been very open, it continues to work with us as they've made the changes on their end.
Based on the relationships we've had prior where there's still a lot of folks there at Cisco that we're able to continue to leverage those relationships. And based on the amount of revenue we do across all of their product lines, it's been fairly easy to get together with their new management teams, both in general settings, but also in individual settings with our ePlus management team and the Cisco management team. So, no issues there.
Very good. Thanks guys.
All right Maggie. See you soon.
Thank you. Our next question comes from the line of Greg Burns of Sidoti & Company. Actually it looks like we've lost that line.
We'll take the next question in queue from Brett Knoblauch of Berenberg. Your line is open.
Hi guys. Just got a question on the large project off, is there any expected impact going into Q4? Or is this the final I guess, really topline impact we should expect?
Yes that's the final as it relates to that large project that we've talked about Brett. So we were on the tail end in this quarter. Still provide a little bit of a tough compare if you will for Q3 for us, but won't see that in the subsequent quarters related to that deal or project.
Okay. And then just on the acquisition, I guess, how long was -- I guess, this like in the pipeline in terms of like finding the company? And then actually closing the deal? And then a follow-up to that based on, I guess like SLAIT's actual product mix.
Do you think they sell a greater amount of regularly recognized solutions compared to your business as a whole previously? And do you expect that to have a positive impact on your gross margins going forward? And you guys mentioned it would be a little bit of dilutive over the next couple quarters, but if you could provide some more detail that would be great.
Sure. So we've been aware we've competed against SLAIT for years. Very well-run company, believe they have a strong management team that's now part of the ePlus management team.
As it relates to the acquisition, this was something that was months in the making of which we've gone -- we went through the normal due-diligence with them, you build relationships, you make sure that there is a fit. I think there was a really nice cultural fit, at least that's what Casey, the former CEO and myself thought of both of our teams as we brought them together.
What they do for us? They really expand our reach and our footprint in the Tidewater and Richmond area. So from a size and scale what that does for us in the entire mid-Atlantic could be big over time.
They've got things that they've done in terms of -- from an upside that they provide with help desk services that we can leverage. They've got security services that we can leverage. They've got a strong staffing business. They have emerging vendors that -- some emerging vendors that they've got great relationships with that we can leverage at ePlus.
On the reverse side, I think they can leverage our Cisco capabilities over time in the appropriate customer base, our leasing capabilities. They also have some SLED contracts and customers that we think we can go wider and deeper in. And that would be it.
I think it just -- what it does, it just really expands our reaching capabilities in the mid-Atlantic, expands our customer base that we can upsell and cross-sell and we believe there is a really nice fit between the two organizations.
Do you guys expect I guess any -- I guess can you quantify synergies through it whether it's through rationalizations or what have you?
Well, are you talking about expense savings, or you're just talking about -- what are you?
I guess expense savings and also in terms of using your -- obviously, you're a much larger company, using your scale and your vendor relationships to achieve better pricing in terms of transferring that over to SLAIT?
Yes. That's a really good point. So, yes, what we do believe is, from a size and scale SLAIT will benefit from both our financial capabilities as well as the discounts and relationships that we have with vendors. So we do have multiple vendors that we've already identified where we have either bigger better relationships, bigger discounts that we can leverage and get some synergies there.
What I was talking about earlier is, we believe we can leverage some of the relationships and contracts that they have in the state local and higher-ed space and do more there. I think they can leverage our Cisco capabilities with the right customers and where it makes sense, they can leverage our financing and leasing capabilities.
So we believe there's many synergies, but the one thing I want to be careful is, like any acquisition in the beginning it's normally the first couple months are tough, as they get acclimated into ePlus get comfortable, understand all the different players on our side. So normally, what we want them to do is continue doing what they were doing at SLAIT and then over time we'll fully acclimate them into the ePlus fold.
All right. Great. Thanks, Mark
All right. Thanks. We'll see you soon.
Thank you. At this time, I'd like to turn the call back over to Mr. Marron for any closing remarks. Sir?
Okay. Thanks, Latif. Everyone, thanks for taking the time to listen to the call. We feel good about the quarter in terms of our gross profit growth or our gross margins, which are the highest in the industries. The continued growth we see in our security business where it's a-fifth of our business. And then adding the SLAIT acquisition to the ePlus fold, we think, is a real positive for us, both short term and long term. With that, thanks for your time and we'll speak to you soon. Take care.
Thank you, Mr. Marron, and thank you, ladies and gentlemen. This does conclude today's conference. Thank you for your participation and have a wonderful day. You may disconnect your lines at this time.
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