Earnings Conference Call Transcripts

Conference Call Discussing Earnings for Fiscal 2018 Third Quarter Results

Safe Harbor Statement

This transcript of the earnings call that occurred on February 7, 2018, 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:

  • national and international political instability fostering uncertainty and volatility in the global economy including fluctuations in foreign currency rates and downward pressure on prices;
  • exposure to changes in, interpretation of, or enforcement trends in legislation and regulatory matters;
  • we offer a comprehensive set of solutions— integrating information technology (IT) product sales, third-party software assurance and maintenance, our advanced professional and managed services, our proprietary software, and financing, and encounter the following challenges, risks, difficulties and uncertainties:
    • managing a diverse product set of solutions in highly competitive markets with a small number of key vendors;
    • increasing the total number of customers integrated bundled solutions by up-selling within our customer base and gaining new customers;
    • adapting to meet changes in markets and competitive developments
    • maintaining and increasing advanced professional services by retaining highly skilled, competent personnel and vendor certifications;
    • increasing the total number of customers who utilize our managed services and professional services and continuing to enhance our managed services offerings to remain competitive in the marketplace;
    • performing professional and managed services competently;
    • maintaining our proprietary software and updating our technology infrastructure to remain competitive in the marketplace; and
    • reliance on third parties to perform some of our service obligations to our customers.
  • our dependence on key personnel to maintain certain customer relationships, and our ability to hire, train and retain sufficient qualified personnel;
  • our ability to implement comprehensive plans for the integration of sales forces, cost containment, asset rationalization, systems integration and other key strategies;
  • a possible decrease in the capital spending budgets of our customers or a decrease in purchases from us;
  • our ability to protect our intellectual property rights and successfully defend any challenges to the validity of our patents, or allegations that we are infringing upon any third party patents, and the costs associated with those actions, and, when appropriate, license required technology;
  • the creditworthiness of our customers and our ability to reserve adequately for credit losses;
  • the possibility of goodwill impairment charges in the future;
  • changes in the IT industry and/or rapid changes in product offerings, including the proliferation of the cloud, infrastructure as a service and software as a service, and our dependency on continued innovations in hardware, software and services offerings by our vendors and our ability to partner with them;
  • our contracts may not be adequate to protect us, and we are subject to audit in which we may not pass, and our professional and liability insurance policies coverage may be insufficient to cover a claim;
  • future growth rates in our core businesses;
  • significant adverse changes in, reductions in, or loss of our largest volume customer or one or more of our large customers or vendors;
  • reduction of vendor incentives provided to us;
  • failure to comply with public sector contracts or applicable laws;
  • our ability to secure our customers’ electronic and other confidential information, and remain secure during a cyber-security attack;
  • our ability to raise capital, maintain or increase as needed our lines of credit with vendors or floor planning facility, or obtain debt for our financing transactions or the effect of those changes on our common stock or its holders;
  • changes to or loss of members of our senior management team and/or failure to successfully implement succession plans;
  • disruptions or a security breach in our IT systems and data and audio communications networks;
  • our ability to realize our investment in leased equipment;
  • our ability to successfully perform due diligence and integrate acquired businesses; and
  • significant changes in accounting standards including changes to the financial reporting of leases which could impact the demand for our leasing services, or misclassification of products and services we sell resulting in the misapplication of revenue recognition policies or inaccurate costs and completion dates for our services which could effect our estimates.

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, 2017, 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 7, 2018, a copy of which is posted on our website at www.eplus.com/investors.

February 7, 2018 – FY18Q3

Prepared Remarks

Operator

Good day, ladies and gentlemen, and 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, SVP. 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, 2017 and our form 10-Q for the quarter ended December 31, 2017, 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 posted a GAAP financial reconciliation on the Shareholder Information section of our website at www.eplus.com.

Reclassifications of prior period amounts related to numbers of shares and per share amounts have been made to conform to the current period presentation due to the March 31, 2017 stock split. The effect of the stock split was recognized retroactively in the stockholders’ equity and in all share data. The financial statements include the effect of the stock split on per share amounts and weighted average common shares outstanding for each of the three-month periods ended December 31, 2017 and 2016.

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

Mark Marron, CEO & President

Thanks Kley and thank you everyone for joining us today.

Our third fiscal quarter net sales increased 4.9% year-on-year and adjusted gross billings of products and services were up 7.3%. Year to date, our net sales increased 8.4% and our adjusted gross billings of products and services increased 10%.

We have continued to execute well on our strategic plan to position ePlus in high growth segments of the IT market, significantly expanding our Cloud, Security and Digital Infrastructure solutions. This strategy has enabled us to grow our revenues at a faster pace than overall IT spending, expand our customer base, and drive a favorable mix of products and services. Going hand-in-hand with our broadened Cloud capabilities and increased security offerings, is the expansion of our consultative and annuity services capabilities, which enable us to build out long-term recurring or annuity revenue streams.

Revenues from security products and services grew at a double-digit rate year to date and reached 17.6% of our adjusted gross billings on a year to date basis, up from 16.7% in the same period last year. We expect security to remain an important growth driver for our business as it touches almost every solution offering we sell.

Our acquisitions of OneCloud and IDS have not only expanded our Cloud enablement capabilities but also broadened our geographic presence in the Midwest.

ePlus has supported our customers’ data center needs for years. As cloud services drive innovation and transformation in the data center to support continuous innovation, we have invested in these acquisitions along with organic hires and training.

ePlus’ recent acquisitions solidify our cloud strategy and strengthen our ability to engage with customers in all stages of their journey to the cloud as a business model for agility and innovation. The OneCloud acquisition allowed us to quickly differentiate ourselves with our customers and strategic partners, providing technical expertise to guide customers through the adoption of hybrid cloud solutions through automation, analytics, and customized software integration. In addition, our recent acquisition of IDS further extends our cloud capabilities and solution offerings, including Backup as a Service (BUaaS) and Disaster Recovery as a Service (DraaS). We expect continued investments in our cloud practice to address our customers’ productivity, security and cost challenges – empowering them to reduce IT cost and complexity, manage the explosion of data, protect that data, and gain better value from their IT investments.

Despite increases in revenue and EPS, there are areas for improvement that we identified in the quarter. Our revenue performance reflected some softness in the SLED market. Also affecting results this quarter on the cost side were the acquisitions we made earlier this fiscal year. While we absorb the full expense burden of these transactions upon closing, it takes time for us to see the full revenue benefit from their integration onto the ePlus platform. Further, it can take up to a year before we get the full benefit of the upsell and cross-sell opportunities along with overall optimization of cost structures.

So far this year, we have increased our investment in headcount significantly over the past year via both organic and acquisition-related additions. Our headcount was up 10.3% year over year; we added 120 employees but importantly, the bulk of the new additions are client-facing, supporting our cross-selling capabilities and enhancing our account coverage. Our growth strategy has been balanced between making investments in organic initiatives and acquisitions to drive future revenue and margin expansion and at the same time generate operating leverage. We will continue to rationalize our cost structure and we expect to return to more normalized operating leverage.

It is also important to note that some of our headcount additions in the third quarter were made to support our Managed Services and Enhanced Maintenance Services programs, and these actions led to our best recurring-revenue, annuity services quarter to date. We just announced the launch of our new enhanced maintenance support customer portal which provides our customers a consolidated view of all assets under maintenance management. This portal, along with our EMS programs, have enabled our customers to outsource support to us, and we will continue to make enhancements to the platform to offer greater functionality and a broader array of managed technologies for our customers.

Our Enhanced Maintenance service offerings deepen our relationships with our customers and provide us with longer-term visibility, as they extend over multiple years and are recognized ratably.

Also, we are pleased to report that as part of our overall expansion plans, we have become Cisco Gold certified in the UK. This enhances our ability to support and service our customers in this region and our global customers overall.

As a high rate taxpayer, we are pleased about the significant benefits we gained from tax reform, including a lower tax rate. We see a dual benefit – additional cash flow for us and additional funds for customers to invest in our product and service offerings. Our financial wherewithal and the increased savings from the reduced tax rate allow for a continued focus on M&A to add technical and services offerings and extend our geographic coverage. At the same time, we will continue to invest in our organic growth and our infrastructure to increase our efficiency in supporting and selling to our customers. Share repurchases remain a consideration as well.

In summary, we believe we will continue to outpace overall industry market growth based on our expansion in our key focus areas of cloud, security and digital infrastructure. We will continue to aggressively manage and optimize expenses, with a view toward increasing productivity and enhancing operating leverage.

I will now turn over the call to Elaine to review our financial results.

Elaine Marion, CFO

Thank you, Mark, and thank you everyone for joining our call.

Our top line, adjusted gross billings and gross profit showed positive year-over-year comparisons in the third quarter of fiscal 2018 and year-to-date. In light of the recently enacted reduction in U.S. Federal tax, we recognized a one-time tax benefit of $5.7 million from the provisional adjustment of our deferred tax balance for the new corporate tax rate as well as the adjustment of our tax provision from the beginning of our fiscal year to the new blended rate. These adjustments had a positive impact on our net earnings that I’ll discuss in more detail in a moment.

In the third quarter of fiscal 2018, our consolidated net sales of $342.6 million increased 4.9% from last year’s third quarter. Our gross profit increased by 3.9% to $76.7 million. The consolidated gross margin decreased by 20 basis points year-over-year to 22.4%. This resulted from several factors including our land and expand strategy which led to lower margin on some large competitively bid projects, partially offset by increases in higher margin sales of services and a higher proportion of sales of third party software assurance, maintenance and services, which we record on a net basis.

Our operating expenses increased 14.9% to $60.3 million, reflecting higher salaries and benefits due to personnel additions. The increase in salaries and benefits was also attributable to higher variable compensation as a result of higher gross profit. Our total headcount grew by 10.3% to 1,284 from 1,164 a year ago, as we added 120 total positions, the majority of which are from the acquisition of IDS in September and OneCloud in May 2017.

General and administrative expenses increased 28.3% due to higher expenses for travel, advertising and marketing, as well as the incremental expenses from recent acquisitions, including adjustments to the fair value of contingent consideration which added approximately $720,000 to G&A. Also worth noting, amortization expense relating to the acquisitions increased approximately $1 million year to year. As a result of higher operating expenses, our operating income of $16.4 million decreased 23.1% year-over-year. Adjusted EBITDA declined 16.9% to $19.3 million, and our adjusted EBITDA margin was 5.6%.

Net earnings increased 23.5% to $15.6 million. Diluted earnings per share for the quarter were $1.11, up 22% from $0.91 in the comparable quarter of fiscal 2017. The one-time tax benefit of $5.7 million that I mentioned earlier added $0.41 to earnings per diluted share, as a result of the change in the U.S. Federal tax rate in late December and the related adjustment in our deferred taxes plus an adjustment for the first half of the fiscal year.

Non-GAAP diluted earnings per share decreased 13.4% to $0.97 for the third quarter of fiscal 2018. Non-GAAP diluted earnings per share is based on net earnings calculated in accordance with GAAP, adjusted to exclude other income and acquisition related amortization expense, net of taxes, the tax benefit recognized due to the vesting of share based compensation, and the provisional tax benefit associated with the re-measurement of our deferred tax assets and liabilities at the new tax rate.

Our diluted shares outstanding totaled 14 million for the quarter compared with 14.2 million at the end of fiscal 2017, when we completed a 2 for 1 stock split. During the quarter, we purchased 125,605 shares of our outstanding common stock at an average cost of $77.88 per share for a total purchase price of $9.8 million under the share repurchase plan.

I'd now like to discuss the quarterly results from our Technology segment. Net sales grew 4.5% to $332.6 million and accounted for approximately 97% of consolidated net sales. Adjusted gross billings of product and services grew 7.3% to $464.1 million. This improvement derived from demand for our product and services from our healthcare customers, as well as the revenue contribution from CCI, acquired in December 2016, OneCloud, acquired in May 2017, and IDS, acquired in September 2017. This quarter the adjustment from adjusted gross billings to net sales of product and services was 28.7% as compared to the prior year of 26.6%, reflecting a higher proportion of sales of third party maintenance contracts. As a reminder, adjusted gross billings include the gross sales price for transactions that we present within net sales, however, only the gross profit of the sales of applicable third party software assurance, maintenance and services is included in net sales.

On a trailing 12-month basis, the Technology and SLED markets were our largest, accounting for 25% and 17% of Technology net sales, respectively. Next was Financial Services, which accounted for approximately 16% of net sales, followed by Telecom, Media and Entertainment at 14% and Healthcare at 13%. The remaining 15% was from several other customer types. We continue to have a diversified customer base by industry, size, and geography.

Our gross margin on sales of product and services decreased by 60 basis points to 20.1%, compared to 20.7% in the third quarter of fiscal 2017. The decline is for the same reasons I mentioned on our consolidated margin decline: land and expand and some large competitively priced sales that weighed on margin offset somewhat by increases in sales of services and a higher proportion of the sales of third party software assurance, maintenance and services.

Operating expenses in the Technology segment increased 14.2% to $56.7 million compared to $49.7 million last year which related to an increase of $4.3 million in salaries and benefits as we hired 123 professionals, adding 11.1% year-over-year. Importantly, the bulk of the new personnel are client-facing. The increase in salaries and benefits was also attributable to higher variable compensation as a result of our higher gross profit. General and administrative expenses increased $1.5 million, of which $720,000 relates to an adjustment to contingent consideration associated with prior acquisitions. The remaining increase of $800,000 related to higher travel expenses, as well as incremental G&A associated with the recent acquisitions.

Our operating income in the Technology segment decreased 32.4% to $11.4 million. Adjusted EBITDA was down 23.9% year-over-year totaling $14.3 million. The decline was largely attributed to higher operating expenses with the increased headcount a large component of the additional cost.

Moving to our Financing segment, net sales were $9.9 million, up $1.6 million, or 19%. This top line growth was mainly attributable to higher post-contract earnings of $1.4 million due to the sale of equipment related to several terminated leases. As a reminder, post contract earnings can vary significantly quarter by quarter. Direct lease costs increased $300,000 or 22.1% over the previous year period due to higher depreciation expense from operating leases. Financing gross profit increased 18.5% to $8.5 million. Operating expenses increased by $800,000, or 27.9%, due to an increase in variable compensation as a result of the higher gross profit, as well as the changes in the reserve for credit losses. Operating income and Adjusted EBITDA amounted to $5.0 million, up 12.6% from the year ago quarter.

I will now turn to our consolidated year-to-date results. Net sales for the first nine months of fiscal 2018 increased 8.4% totaling $1.08 billion. This strong top line growth was driven by robust performance in our technology segment where net sales increased 7.9% to $1.05 billion. Adjusted gross billings of product and services increased by 10% to $1.45 billion, while consolidated gross profit increased 8.3% to $241.9 million. Our consolidated gross margin was stable at 22.4% when compared to the same period in fiscal 2017, while gross margin on product and services decreased by 30 basis points to 20.2%. Adjusted EBITDA was up 0.6% and amounted to $72.8 million. Net earnings grew 15.4% to $46.2 million. Our first nine months of fiscal 2018 earnings per diluted share increased 15.4% to $3.30. Our non-GAAP diluted earnings per share increased 0.6% to $3.14.

Turning now to our balance sheet, we ended the quarter and first nine months of fiscal 2018 with cash and cash equivalents of $76.1 million compared with $109.8 million as of March 31, 2017. The decrease was primarily due to cash used to acquire OneCloud Consulting and IDS. Our inventory and deferred revenue decreased from March 31st primarily due to the shipment of large projects within the first nine months of the fiscal year. Our cash conversion cycle for the quarter was 24 days, up slightly from 23 days for the second quarter of fiscal 2018, and down from 27 days a year ago.

In light of the recent tax law, our US Federal tax rate was reduced from 35% to 21% effective January 1, 2018, which brings our blended US federal tax rate for fiscal 2018 to approximately 31.5% and our total estimated effective tax rate for Fiscal year 2018 to 37%. For Fiscal 2019, when we will receive the benefit for the full year, we estimate that our effective tax rate will be approximately 29%. Given this change and our strong cash position, we will maintain our capital allocation strategy to invest in acquisitions, share repurchases, and continue to invest in internal projects to increase our operating leverage and support our growth.

I'll now turn the call back over to Mark for closing remarks. Thank you, everyone. Mark?

Mark Marron, CEO & President

Thanks Elaine.

We are pleased with year-to-date net sales growth of 10.2% and gross margin of 22.4%. We believe that as we continue to move toward being a higher-end IT provider, focusing on products and the consultative and annuity services our customers need around security, cloud and digital infrastructure positions us well to profitably capture market share in the faster growing segments of the IT market. We have an established and growing base of over 3,200 enterprise and mid-market customers across multiple industries, who rely on us to deliver the outcomes they need to achieve their business goals.

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

QUESTION AND ANSWER

Operator

Our first question comes from the line of Maggie Nolan from William Blair.

Arjun Bhatia, William Blair

It's actually Arjun Bhatia in for Maggie. As we were looking at the SG&A line, can you give us a sense of how much of the increase there is due to sales force expansion versus the acquisition costs this quarter? And what are your expectations on that over the next couple quarters?

Mark Marron - ePlus Inc. - President and CEO

Arjun, it's Mark here. So as it relates to the SG&A, our headcount was up 10.3% year-over-year, which was approximately -- or no, exactly 120 employees. I would say 90% of those are customer-facing. So as part of our long-term strategy of building out our solutions in cloud, security, digital infrastructure and services, we're adding headcount in those spaces to be able to go out and touch more accounts with our customers. Over the long-term, I think we'll start to see operating leverage from those investments, some being from the M&A side and some being from the organic side.

Arjun Bhatia, William Blair

Okay. And as we're just looking at your end markets, can you talk about how you're seeing the impact of the recently enacted tax cuts playing out? Is there any particular segment you're getting traction from or anything you've seen so far or expect to see going forward?

Mark Marron - ePlus Inc. - President and CEO

Well, a couple different things. One, I think it's a little early on the tax break to tie it to different verticals. So what I can tell you, one, we're excited as a company. With our net earnings being up 23.5%, it allows us to do certain things, whether it be M&A, organic hires, look to invest in some of our infrastructure to build out some of our efficiencies as we address folks internally as well as externally and then potentially continue forward with our stock buyback. As it relates to the market, there's a couple different things, one being too early to tell. But there are some indicators as it relates to some of the job increases out there in the market that I think are good indicators for potential spend as it as the market moves forward. I think the other things that you look at, some of the customers that I've visited with over the last month or so have talked about going from cost-cutting to making money for the business in different areas, whether it be in the digitization space or a couple different areas. So I think it's a little early to tell as it relates to the tax breaks, but we're optimistic on what it holds.

Arjun Bhatia, William Blair

Okay, that's fair. And then if we're looking at your just revenue mix top line, do you have a sense of how much of that mix is services-related versus on the product side or how much you would classify as recurring?

Mark Marron - ePlus Inc. - President and CEO

Well, here's a couple of different things, Arjun. We don't break that out. But what I can tell is you we had our strongest annuity services quarter to date. So from that end, we've talked about it on prior calls that part of our strategy going forward was building up both our consultative services as well as our annuity services, and I talked a little bit about our EMS portal and EMS offerings that we built for our customers. So we're starting to see more and more customers looking to offload certain tasks so they can focus on their core business, and we built up those capabilities, which have built up our annuity revenues. So from a long-term visibility and profitability, I think that's good news for us. But we don't break out the product and services piece.

Operator

And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Mark Marron, CEO.

Mark Marron - ePlus Inc. - President and CEO

All right. Thanks, Jonathan. Everyone, I'd just like to thank you for taking the time to join us today. We believe that we had a solid quarter, both in terms of revenue. We've continued to keep our margins stable. We've invested in our business and would hope to see operating leverage over time.

With that, have a nice day, and we'll speak to you soon.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.