ePlus inc. (PLUS) Q4 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to ePlus Fourth Quarter and Fiscal Year 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. And now I would like to hand the conference over to your host, Mr. Kley Parkhurst, Senior Vice President. Sir, you may begin.

Thank you, Saeed, and thank you, everyone, for joining us today. With me today are Phil Norton, Chairman, President and CEO of ePlus; Mark Marron, Chief Operating Officer and President of ePlus Technology; 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, 2013, and subsequent Forms 10-Q and our 10-K for the year ended March 31, 2014, when filed. The company undertakes no responsibility to update any of these forward-looking statements in light of new information or future events. I'd now like to turn the call over to Phil Norton. Phil?

Thank you, Kley, and thank you, all, for joining us to review our fourth quarter and full year fiscal 2014 results and discuss our business outlook. Our final results for the fourth quarter were in line with the estimates provided in our pre-release of April 21 and demonstrated the re-acceleration in product and service sales that began in this year's third quarter. Despite weather-related closures in the fourth quarter, we succeeded in posting total revenue growth of 10% led by our technology segment, which was up 11.6% and produced a 20.4% increase in segment earnings. Supporting the strong segment performance was the growth of our services and security business, which has been a key element of our strategy over the past several years and continues to be a major priority for our sales force. We produced strong results for our 2014 fiscal year. Total revenue growth of 7.6% driven by an 8.3% increase in technology segment revenues where gross margins on sales of products and services expanded by 30 basis points and segment earnings increased 10.3%, again thanks to our focus on building the higher-margin services part of this business. Our financing operation faced difficult year-over-year comparisons, which our CFO, Elaine Marion, will address a little later on this call. However, we are seeing solid demand for our financing services from both new and existing customers and have further strengthened our cross-sell programs. We consider our ability to help our customers make buy or lease decisions to be a competitive differentiator for ePlus, and we look to continue the growth of this part of our business in the periods ahead. Technology segment revenues represented 97% of total revenues in fiscal 2014 and will continue to be our key driver. Here, we are addressing the increasingly complex needs of our customers by offering end-to-end customized solutions across the entire IT life cycle. Through significant investments to build our engineering capabilities, ePlus is now well positioned in emerging technologies such as mobility, cloud, security and virtualization, all of which are expected to grow much faster than IT spending as a whole. And this has led to our wanting an increasing number of higher-margin, longer-term managed services centers [ph], which will benefit profitability and enhance our customer relationships across our diversified end markets. In a moment, our Chief Operating Officer, Mark Marron, will provide more detail on our expanded engineering and sales and marketing headcount, our vendor relationships and how we leverage all of this to meet the needs of more than 2,800 customers. Suffice it to say that we gained market share again in fiscal year 2014, and we believe we have significant organic growth opportunities ahead. At the same time, we have financial and human resources to support internal investments and to make acquisitions that will expand our capabilities and our geographical reach. At this point, I'd like to turn over the call to Mark.

Thanks, Phil. With industry analysts calling for a 4% growth rate in the overall IT market, our track record of growing faster than the IT market consensus is a result of our ability to do a couple of different things: combine our expertise and relationships in existing technologies with cutting-edge providers and products. As we closely focus on the most sophisticated areas of IT, including services, we are leveraging the expertise of our highly skilled team of engineers and an experienced sales force. In fiscal year 2014, we continue to add to the staff in these areas, increasing our professional services headcount by 11% and sales and marketing personnel by 4%, while reducing our administrative headcount by 2%. We also made significant progress in further strengthening our customer offerings in fiscal 2014, particularly in the areas of services. For example, in the fourth quarter, we announced our newest managed services center built on the latest technology to handle growing demand for our managed services offerings. ePlus Managed Services provides customers with proactive control of their IT infrastructure, including network components, physical and virtual servers, private clouds, unified communications, storage, security and more all from its 24/7, 365-day managed services centers. The new managed service center, which is our third in the United States, is located near Raleigh, North Carolina, which is a vibrant market for a deep tool -- pool of technically talented personnel. By providing real-time support for our customers, we believe our managed services business is driving further customer loyalty, while at the same time positioning ePlus for future growth and improved profitability. Now we built this third managed service center to prepare for our enhanced managed services, or EMS, which is a vendor-certified Tier 1 first call program which we announced on February 13. It's designed to lower operating cost and improve customer services experiences. EMS is a manufacturer of certified alternative for customers' existing maintenance support programs. It delivers rapid problem resolution of critical network problems, access to expert U.S.-based technical support, flexible hardware coverage and personalized capabilities. Customer adoption of EMS will add to our recurring revenues, which is the key objective in building our services building business and provide a platform that up-sell additional managed services offerings. We have also introduced OneSource Asset Management, another unique, value-added solution from ePlus. OSM, as we call it, is a Software-as-a-Service offering designed to track assets, associated meta data and related maintenance contracts to deliver business intelligence including asset movement, warranty, end-of-life notifications, which can result in a lower total cost of ownership. Built on our long-term business and customer experience of providing robust e-procurement software, OSM is just another way we are building a platform of long-term recovering revenue streams to strengthen our customer engagement and differentiate ePlus from our peers. What differentiates us from many of our traditional competitors is that we offer a full suite of products and services. We serve traditional areas like data center servers, storage, networking, but we are keenly focused on emerging technologies in the area of cloud, mobility and security. Clients today are trying to determine how they can utilize cloud technology securely. ePlus has the expertise including a service methodology of what we call plan, build, support, optimize or PBSO, which helps customers identify the cloud solutions which makes the most sense for them. We continue to see strong demand for security product sales across all regions in ePlus, and we believe we are adding market share and growing well in excess of the industry analysts projected 8% annual growth rate. We're focused on providing security solutions that provide a secure perimeter and secured data for our customers while looking to complement these offerings with our strategic security services and managed security offerings. For example, we're also focused on emerging technologies such as next-generation firewalls, which provide security from the data center all the way to the mobile device. These solutions resonates with customers who understand the risk all too well. Industry analysts estimate that only 10% of the firewalls in place today meet the requirements to protect against sophisticated attacks and projects that only 35% will meet requirements by the end of this calendar year, giving us a lot of opportunity to address this growing customer concern. A number of ePlus recognitions and awards were -- in fiscal 2014 were noted in today's earnings release, but I would like to highlight the global Cloud Builder of the Year award that we received from Cisco on April 1 of this year. This recognition was awarded based on criteria including innovative practices, application successes, unique programs, problem solving and sales approaches. These attributes demonstrate our commitment to this high-impact technology and our success at implementing it for our customers including some of the world's largest service providers as well as enterprise and mid-market customers. We ended the year with more than 2,800 customers, up from 2,300 at the end of last fiscal year. Our customer base is comprised primarily of large and midsized companies across a broad spectrum of industries, many of which are household names like Verizon, Wells Fargo, Quest Diagnostics and NetApp. As you will see from today's earnings release, we have a balanced cross-section of end markets as well. Similar to last fiscal year, technology, SLED, which is State and Local Government and Education, and our telecom, media and entertainment each accounted for about 20% of fiscal 2014 revenues. Health care and financial services each represented about 11%, and the remaining customer categorized by us as other included diverse set of industries such as retail, energy, defense and business services. We believe there are significant opportunities to sell more products and services into our existing customer base and that our understanding of multiple vertical markets, along with the resources we have available and the expertise we have gained in providing complex IT solutions over the years gives us an advantage in competing for new customers. Turning now to our financing segment. We are continuing to find that customers and manufacturer partners are valuing our process automation, responsiveness and ability to offer customized financing solutions that are tailored to their unique requirements. We remain focused on increasing volumes to increase profitability through building our on [ph balance sheet portfolio for the long term to create recurring portfolio earnings while continually balancing risk in the portfolio by choosing to sell certain financing arrangements, which create a gain and increase earnings from post-contract transactions. In summary, we remain focused on our corporate objectives of expanding and enhancing the solutions, services and support offerings in both traditional and emerging technologies and building out our national footprint. Now I would like to turn over the call to Elaine Marion, our CFO, who will discuss our financial results.

Thanks, Mark. As Phil mentioned earlier, our fourth quarter results came in as anticipated in our pre-release. The 10% increase in total revenues to $259.9 million was led by an increase of 11.6% in the technology segment, which more than offset the decline in the financing segment where year-over-year comps were skewed by several large transactions that generated post-contract earnings and transactional gains in last year's second half. Gross margin for the quarter was 21%, a composite of 18.8% on products and services and a margin contribution from our financing segment. Earnings per diluted share increased 8.4% in the quarter to $1.03 on a relatively flat share count after absorbing a 10% increase in total costs and expenses, primarily reflecting the increased growth of our business and a 6.8% increase in services and sales and marketing headcount. Our performance for fiscal 2014 was basically a tale of 2 halves. In the first half of the fiscal year, we saw slower growth in corporate IT spending due to the economy and uncertainties caused by the federal government. IT spending accelerated in the third and fourth quarters, driving a 7.6% revenue increase to almost $1.1 billion for the full year. We attribute our ability to outperform the overall industry to market share gains derived from increased sales to existing customers and our focus and capabilities in the faster-growing segments of the market that Phil and Mark has spoken about. We also have added new customers through our sales and marketing programs and as well as from vendor referrals. Gross margin for the year was 20.5%, comprised of 18.3% on products and services and the remainder from financing activity. Earnings per diluted share increased 1.2% to $4.37 per share, up from $4.32 on a similar share count, again after absorbing a 7.9% increase of total costs and expenses primarily tied to our higher revenue base and increased headcount. Moving to our segment results. Our technology segment accounted for approximately 97% of total revenues in both the fourth quarter and fiscal year, respectively. In the fourth quarter, gross margin on products and services was 18.8% as compared to 19.7% in the prior year. For comparative purposes, the prior quarter included a change in product mix that was above the norm as we explained last year. For the full year, gross margin on products and services increased 30 basis points to 18.3% due in part to an increase in services revenue. On an annual basis, services revenue grew faster than technology segment revenues, and services headcount increased 11% compared to fiscal 2013. In fact, our services headcount is up 93% since 2010, during which time we've expanded the number of managed service centers from 1 to 3. Looking at other key items, we produced technology segment earnings growth of 20.4% and 10.3% for the fourth quarter and full year, respectively, benefiting from the business trends we mentioned and lower professional fees, while absorbing higher salaries, general and administrative expenses associated with our long-term growth strategy. Technology segment headcount increased 5.3% for the year with over 90% of the increase related to sales and professional services personnel, while consolidated revenue for sales and marketing employee and revenue per employee increased 3.8% and 2.5%, respectively, over fiscal year 2013 levels. In the financing segment, the financial results have historically fluctuated due to the timing and nature of originations, post-contract transactions and sales of transaction. In both the fourth quarter and full year fiscal 2014, the major variation was the decline in financing revenues. The decrease in revenues in the fourth quarter was due to lower transactional gains. The decrease for the full year was primarily due to lower post-contract earnings compared to fiscal 2013 when we had net gains resulting from the early termination of certain lease agreements, which were offset by higher transactional gains. As a result, segment earnings declined 28.1% for the year to $8.8 million and were down 43.4% in the fourth quarter. We did, however, see a 19% increase for the transactional gains for the full year of 2014 compared to 2013 due to a higher volume of deals. Our financing portfolio amounted to $143.7 million at fiscal year end, representing investment leases and notes, part of which could be monetized to raise additional cash when needed. ePlus ended the year with a strong balance sheet that provides us with significant financial flexibility. At fiscal year end, the company had cash and cash equivalents of over $80 million and total stockholders' equity of $266.4 million, up from $238.2 million at the end of fiscal 2013. In May of this year, we repurchased 400,000 shares of ePlus common stock for $19 million in connection with the completion of a secondary stock offering by existing shareholders of 1,810,000 shares. We used proceeds generated from funding a portion of our financing portfolio with nonrecourse notes payable to acquire these shares. I would now like to turn the call back to Phil for his closing comments.

Thank you, Elaine. Before opening the call to questions, let me just go over a few key points that we recently emphasized. First, we are confident that ePlus will continue to gain market share and grow at a faster rate than that of the overall IT market, which industry analysts forecast at around 4%. Second, our existing customer base provides us with tremendous cross-selling opportunities, and we can leverage our positioning in growing end markets and with OEMs to gain new customers. Third, you can expect us to continue to invest to build our managed services business, but also to maintain our focus on improving operating efficiency and controlling corporate overhead. Fourth, we will continue to explore accretive and strategic acquisitions while maintaining a conservative approach that has served us well in the past. Fifth, we will continue to hire, train and retain the best talent in the industry. Operator, I would now like to open the call to questions. Thank you.

[Operator Instructions] And our first question comes from Matt Sheerin from Stifel.

The first question, either Phil or Mark, could you just give us some color on -- I know that the March quarter for a lot of your competitors and distributors was fairly choppy, a lot of back-end loaded; some competitors and distributors talk about pushouts and in fact, these numbers were your -- your numbers came in line or better than the analysts' expectations. Could you give us color on what you saw in the quarter? And you're 2 months into your June quarter now. I know you're talking above market growth. Obviously, that's a sort of open-ended statement. You're coming off a double-digit growth in your technology segment. Would you expect to grow at that level on the year-over-year basis still, or would it be more like high-single digits?

So Matt, it's Mark here. So on the Q1 forecast and forward-looking, I'll turn that one over to Phil, but on the Q4 choppiness, what we saw in the market in Q4, you had a lot of weather-related stuff that affected our revenue in the kind of mid-February to mid-March time frame. What we were seeing throughout the entire quarter, though, the deals weren't slipping, or I should say we weren't losing the deals. They were pushed out a little bit further in the quarter. But as you can see from the numbers, we were able to bring those deals in at a pretty good growth rate year-over-year across-the-board both -- from a technology segment standpoint. As for Q1, we don't -- as you know, we don't do any forward-looking kind of forecasting, if you will. So not much that I can add to help you on that one right now.

Well, maybe if I can just ask another way, I mean, you're 2 months into the quarter. Are you seeing -- and if you go back, you're typically -- you seem to be up in sort of the mid-single digits on a sequential basis in your technology segment on seasonality. Are you still seeing normal seasonal trends?

We haven't seen anything different in the market that would suggest either an uptick or a decline in the activity with our customers. We're seeing the normal demand that we've seen in every quarter for Q1.

Okay. And the breakout of end markets in your press release was certainly helpful. Could you give us an idea of those markets, SLED, technology, health care, et cetera, which ones are growing faster than the overall business and which ones are maybe laggards and what your expectations for the year are there?

Okay. Well, here's the thing about -- year-over-year, it's pretty much about the same percentages as they were last year, give or take. Matt, you're always going to have potentially a few deals, large deals that may skew the percentages either quarter-over-quarter or year-over-year. But across those verticals that we mentioned, we feel pretty good about what we put in place as it relates to our go-to-market plan. So for example, in the SLED space, the state, local and education space, we've got a dedicated, focused team focused on that space and they're working very hard. As you know, Q1 and Q2 is when a lot of that revenue comes into play with those customers. So we're still on track with that. Health care, as you know, there's a lot going on in the health care space overall. As the baby boomers continue -- start to retire, there's more people that need these different type of health care programs. They're looking to digitize a lot of the records, so there is a lot of opportunity within that space not only from a kind of cloud/storage space, but also telehealth and other areas that our customers are looking for. And I'm just trying to think of some of the other verticals, pretty much the same across the rest of the verticals. We're not seeing anything either up or down in those verticals, Matt.

Okay. That's helpful. And just a couple of questions before I get back in the queue. Could you tell us if you had any 10% -- well, I'm sure you did have 10% vendors and be specific there. And then also, whether you had any customers that represented 10% or more of sales either in the quarter or the fiscal year, however you report it?

So Matt, did you ask for the vendors? Or did you...

Yes, vendors and customers, so both.

Okay. So the -- and I'm doing this off the top of my head. I'll let Elaine correct me if I miss anything. The big 3 that you're looking at least over 10% is Cisco, HP and NetApp. And if you think of what those customers do across everything, from servers, storage, networking, some of the software plays that they have, the overall cloud play and our focus on security, it fits a lot in our sweet spot. I don't know if that address it, but I can give you the -- I can give you the percentage, just ballpark. You're looking at Cisco, that's about 48%; NetApp's about 10%, and HP is about 8% to 9% approximately.

Okay. And any customers? I know last year Verizon was a 10% -- plus customer. Are there any there now?

Yes. Verizon, once again, is over 10% customer. It's now at 11%. It was at 14% last year.

And our next question comes from Bhavan Suri from William Blair.

Just a couple of quick ones. It feels like you've accelerated the number of net new customer adds last year to this year. Mark and Phil, any sort of drivers or key services resonating with that group? Is it the bundling of services? Is it some of the newer Big Data offerings? Or what's driving sort of that sort of higher new customer addition kind of metric?

So Bhavan, it's Mark here. There's a few things that helped us in that space. From a go-to-market, we have very clear plans in each of our regions about focused name accounts and what we call territory accounts. The other thing is we also have a telesales and telemarketing team that kind of goaled and reward based on -- goaled and rewarded based on uncovering net new accounts as well as net new opportunities. I think some of the other things we're seeing with those customers is some of the value-added assessments that we provide to our customers, for example, whether it's a cloud readiness assessment or something that's kind of really relevant in the market, some of the security assessments that we do and provide for our customers around vulnerability assessment, Pen Testing, risk and compliance. We also have a virtual seesaw [ph] engagement that a lot of our newer customers are taking advantage of, help -- letting us help them build their 3- to 5-year road map. We've also, as we noted both in the press release and a few other things, is we're continuing to invest in our services, and that includes our presales resources. And these presales resources are goaled and rewarded with working with our sales team on selling the margin-rich solutions in the areas that we want to focus, and we think that's really helped us uncover a lot or a good portion of those net new customers.

Helpful, Mark, and I apologize for the background noise on my side. I'm at the airport here. But the other question I had for you was as you look at the specific partners you've had and you look at the growth in technology, any color on what areas were growing faster? You obviously touched on what's driving new customers. But any areas were driving some of the growth faster? Was this on the Big Data initiatives or the cloud initiatives in security? Was it sort of reasonable across some of the newer emerging areas?

So Bhavan, I apologize, I missed some of that in the middle. So was it where the growth is coming from, from a technology standpoint?

Yes, so I'm -- so obviously, technology performed well, and then my question was sort of, was there a specific area within that? Was it Big Data, not just for the new customers or for the existing customers? Was it cloud? Was it mobile? Sort of what drove that re-acceleration outside of the federal government and technology?

So that still was a lot of what we've done over the years at the data center cloud play, and that's everything from servers, storage. Networking is still a significant portion of where the growth is coming from. Security, I mentioned that we're outpacing the industry analysts, 8% growth expected in security. So especially with what's going on in the market and without naming some of the companies with the problems that we had, we've seen a big pickup in companies willing to sit down with us and understand how we can help them in the security space. And then quite honestly, the services that we talked about, some of the managed service offerings that we have in place with adding those customers and the offerings we had, we do quarterly business reviews and that's -- we've then been able to uncover other opportunities with our existing customer base based on doing those reviews.

So Bhavan, this is Phil Norton. There's one thing that you asked about the fed, and our fed business is really less than 2%. We do, however, sell to systems integrators who have longer contracts with the fed, but the fed is not a real factor on our numbers.

Okay. And then just continuing on that line, Phil, maybe a little bit, you did see sort of an uptick given sort of some of the slowdown in the earlier part of the year. Do you consider that as pent-up demand, or do you think this is sort of a relative new normal, so to speak, as opposed to just a onetime or 2-quarter uptick in demand?

Well, I don't think we have to use the excuse to get there of weather or -- although weather had a factor as it got pushed towards the end. It's pretty hard to say whether it's a new normal and because you had all these different issues with weather and the shutdown, after 1 quarter or 2, the rest of this year, we'll now whether it's a new normal or not.

I do believe, Bhavan, I think some of the things that we talked about on prior calls where we've added headcount in the services and security space, when you add that headcount, it's originally just an expense. And then over time, you start to build opportunity pipeline. You make clients aware of the capabilities that you have in those spaces, and I think part of that is based on that headcount now being out there and being productive.

That makes sense. One last one for me just quickly, and I know you guys don't want to provide any forward-looking metrics. You've done a great job of sort of providing additions in sales and engineering presales. Any update when you expect to hire this year on either of those 2 segments?

Yes, Bhavan, that's a tough one. We have budgets, obviously, that we build with the expected headcount growth across those areas. I can tell you that most of our growth will continue to come in what I call the customer first facing headcount in both sales, presales and services is where we'll continue to invest. And if we see that the market cooperates and we continue to grow, obviously, we'll continue to add in those areas.

And our next question comes from Prab Gowrisankaran from Cannacord Genuity.

A couple of questions for me. Just in terms of what you're seeing -- I know other industries have talked about maybe a slowdown in storage [indiscernible] Strengthened networking and servers, but pushed out deals and allowing it in sales cycles for storage. Did you see any of that? Any color on that would be great.

It's funny. The way I look at storage, there's a couple of things. You've got a lot of the flash vendors out there, so you got a lot of customers trying to figure out how to take advantage of flash both from an efficiency standpoint and from a cost standpoint. So you may have people taking a little bit more time to evaluate. When I look at some of the things that happened in the storage space with some of the folks letting go some of their headcount, I actually see it as an opportunity for us because they'll be looking to ePlus to provide the resources and support that customers need in the storage space. Earlier, I think it was Matt that talked about Big Data a little bit. I think as people start to try to figure out how to leverage Big Data with trends and patterns, it's just -- it's only going to add more storage opportunities as we go forward. So I haven't seen anything either in actual numbers, pipeline or activity that would suggest any kind of major slowdown.

Okay. And the other question I had was on the financing segment. Do you -- Elaine, do you expect it to normalize at these levels? I know it's declined year-on-year in fiscal '14. Is this a good level to think about? Or is -- would there still be a lot of variability in the financing segment?

I think last year, we had some transactions that were early buyouts that really generated a lot of earnings for us. They didn't obviously replicate in this year being an early buyout. So if you look back in 2012, I believe that earnings were in the $8 million range. They went to $12 million and some change in 2013. In 2014, they're back down in the $8 million range. So although we are very focused on it, it does take time to build the earnings in this type of business because of the annuity and the portfolio income that you have from that, as well as getting good contracting to just to build up your balance sheet in order to provide residual value through maturing in a particular year. So it does take some time to build that back up again where we will see those type of gains in the future.

Okay. And then the technology segment, I know you talked about with your new managed service center in North Carolina. Do you expect managed services growth to outpace products in terms of -- I know you posted 8% growth in fiscal '14 for the technology segment. Looking forward for fiscal '15, I know you don't provide metrics, but do you see managed services driving a bigger portion of that growth?

Well, we would expect our services overall as a percentage growth to outpace our product growth similar to this year, and we would expect to see continued growth in managed services as we move forward based on the investment that we made both in resources, facilities, tools and also expanding the offerings that we have in that space.

And I'm showing no further questions at this time. I would like to hand the conference back over for closing remarks.

We'd like to thank you all for attending the conference call, and we appreciate all the questions. We will be talking to you in a few months. Thank you. Take care.

Thank you. And ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect, and have a wonderful day.