ePlus inc. (PLUS) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the ePlus earnings results call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to Kley Parkhurst, Senior Vice President. Sir, you may begin.

Thank you, Destiny, and thank you, everyone, for joining us today. With me 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, 2014 and our 10-Q for the quarter ended June 30, 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 good afternoon, everyone. Thank you for participating in our call to review first quarter fiscal 2015 results and discuss our views on business trends. This was another successful quarter for ePlus as we executed on our strategy to continue to achieve profitability, sustainable growth. This included providing increasingly complex IT solutions by leveraging our expertise in the high-end segments of the market such as mobility, cloud, storage and security. Increasing our service business, which goes hand-in-hand with these more complex solutions; expanding our industry-leading technical staff and sales team, who both drive and support our continued growth; and maintaining and building upon the strong relationships we have with both our traditional vendor partners and leading players in emerging technologies. First quarter revenues increased 5% on a year-over-year basis, led by a 6% increase in products and services revenues from our technology segment, which accounted for 97% of our business this quarter. This more than offset the year-over-year decline in revenues from our financing segment, where quarterly revenue tends -- trends tend to be uneven. The percentage increase in operating income was twice that of sales in the first quarter, primarily reflecting an improved sales mix and our focus on higher-margin products. This was driven by an 80 basis point expansion in technology segments, gross margin on products and services to 18.5%, and a 40 basis point increase in company-wide gross margin to 20.7%. These are both industry-leading numbers that see to ePlus' transition to an IT solutions company. And we continued to add our technical services and sales teams to support this transition and to expand our platform for future growth and ending first quarter with a total of 957 employees, of which 72% represent sales, marketing and engineering personnel. Reported diluted EPS for the quarter was $1.25, 29% ahead of -- on a year-over-year basis. Excluding a special gain, first quarter non-GAAP diluted EPS increased 17.5% to $1.14, benefiting from the solid operating and financial performance of the quarter, as well as a 5.3% reduction in the weighted average of shares outstanding, thanks to our stock buyback program. While one quarter does not make a trend, we are encouraged by the solid demand we are seeing across our expanded customer base. And I'd like to ask our Chief Operating Officer, Mark Marron, to give you more insight into our market position and business plans.

Thank you, Phil. The strategy that Phil outlined in his remarks is addressing the need that we are seeing every day in the marketplace, particularly with reference to the cloud and security, along with all the value-added services and support customers expect. Our customers are facing challenges of selecting and, in some cases, building the appropriate cloud that will provide a long-term home for their business data. The next hurdle is moving huge quantities of data from legacy data centers onto the cloud. When you add this to the increasingly more complicated security environment and the multiple point solutions available, you can easily see why CIOs need a partner for their IT needs rather than simply a vendor. One of the ways we're trying to help is through value-added assessments in our executive services portfolio of offerings. One offering that we provide to our customers is what we call a virtual chief security officer, or vCISO, engagement that helps them build a 3- to 5-year roadmap to secure and protect their IT environment. It's a great service for midsize customers who are struggling to create a comprehensive, long-term and integrated security plan made essentially difficult given the myriad of point solutions available and the fast-moving pace of technology amid ever-changing security threats. Midsize customers cannot always afford the armed [ph] theft expertise to do this in-house and are relying on vCISO services from ePlus. And to put the impact of security on our overall business in perspective, our security pipeline has grown in the last 12 months through June 30, 2014 by more than 50%. In regards to services, our integrated consultative approach enables us to partner with our customers to understand their current environment, build and support their infrastructure and then provide managed and other services such as supplemental staffing to support their business needs going forward. We then utilize our PBSO services model, which stands for plan, build, support and optimize. And really, what that does, it helps our customers match their business needs and IT concerns. Part of the success of this model can be seen in the 80 basis points improvement that Phil mentioned in our gross margin on products and services that we achieved in the first quarter. Our service offerings are an essential part of our business model. Our professional services business was the fastest-growing portion of our technology business. In our managed service business, we continue to invest in the resources, tools and facilities to expand our capabilities in order to meet customer demand and provide additional value-added, higher-margin services. Another value-added service we are focused on is enhanced maintenance services, or EMS, a one-stop bundled solution that combines our managed services with vendor maintenance and warranty services. This provides customers with a one-stop solution through ePlus to maximize efficiency and optimize services for the maintenance and support of their IT infrastructure. In the first quarter of fiscal year 2015, we continued to hire top-tier talent in customer-facing positions. The technology segment grew its headcount by 5.2%, and almost 1/2 of the new hires were in services. This has obviously increased expenses in the technology segment, but with our transition to higher-margin products and services, this is, of course, a cost we are more than able to absorb. Turning to our customer base. We now have over 2,800 customers, an increase of 28% -- 20% during our last fiscal year. In addition to our focus of adding net new customers throughout our platform and diverse industries and geographies, we're also keenly focused on steadily growing our wallet share with existing customers. This gives us the ability to go wider and deeper with our customers across hardware, software, services and financing solutions. Our financing business segment continues to be well positioned for growth as well in that customers are focused on consumption-based monthly payment type structures that fit into the CIOs' operating budget, with payments spread over multiple years rather than an upfront payment coming out of the capital budget. In that sense, financing is moving towards an as-a-service model, just like software and infrastructure. We believe that we can leverage our 20-plus years of expertise in this area to benefit both our customers and vendors. We also continue to achieve important recognition from our key partners. We received multiple recognitions at the Cisco Partner Summit, including Cloud Builder of the Year, Commercial Partner of the Year for the Americas and SLED Partner of the Year for U.S./Canada: West. We were also recognized by HP as Top Growth Partner for HP Storage. To sum it up, we see opportunities to add new customers and expand our business with existing customers, and our range of products and services continues to grow in traditional and emerging technologies. I would now like to turn over the call to our CFO, Elaine Marion, for a financial review of the quarter's results.

Thanks, Mark. As Phil said earlier, our first quarter results demonstrated solid revenue growth and significant growth margin expansion. Consolidated revenues were up 5%, led by 6% growth in the technology segment, which more than offset the decline in the financing segment caused primarily by a gain on sale in the first quarter of fiscal 2014. Gross margin for the quarter was 20.7%, up 20.3% -- up from 20.3% in the first quarter of fiscal 2014, led by an 80 basis point improvement in the margin for products and services. Operating income increased 10.4% to $14.7 million after absorbing a 6% increase in operating expenses, resulting primarily from a 4.1% increase in headcount and higher compensation related to our growth in gross profit. Most of our sales force cost is commission-based, and thus, costs vary with our gross profits. Our reported net income this quarter included a nonoperating gain of $1.4 million in the financing segment related to the repurchase of a financing arrangement, which had been accounted for previously as a secured borrowing. Our earnings per diluted share were $1.25, up 29% from $0.97 on a 5.3% decrease in weighted average shares outstanding to 7.6 million from 8 million. Excluding the onetime net gain of $1.4 million, our non-GAAP earnings per diluted share were $1.14, an increase of 17.5% from last year. Drilling down to our segment results, technology revenue was up 6% to $263.4 million, with strong demand especially from our large and middle market commercial customers. Similar to previous quarters, we saw revenue growth in services, outpacing the growth in products. Gross margin on products and services in the technology segment expanded 80 basis points to 18.5%, driven by higher product margin, a higher proportion of revenue coming from services and also sales of third-party software assurance, which are reported on a net basis. Technology segment earnings were $12.4 million, an increase of 30% from last year's first quarter. This strong performance was achieved despite a 6.9% increase in operating expenses, resulting primarily from salary and G&A increases of 10% and 20%, respectively. These increases reflect a 5.2% increase in headcount, in line with our strategy of adding staff in the professional services and sales areas, higher compensation and also various G&A expenses such as software licenses, maintenance and advertising. These additional operating costs were offset in part by a year-on-year reduction in legal expenses of approximately $1 million, primarily from our patent litigation case. In our financing segment, revenue was $8.9 million, down from $10.8 million a year earlier. Revenue in this segment tends to be uneven from quarter-to-quarter, with results fluctuating due to the timing of post-contract transactions and sales transactions. In the first quarter of the prior fiscal year, we had gains on sales of transactions of $4.3 million, while in the first quarter of fiscal 2015, these sales totaled $2.1 million. That delta largely accounts for the lower year-on-year revenue. On a GAAP basis, which included the nonrecurring $1.4 million gain on the retirement of a liability I mentioned earlier, segment earnings were $3.7 million, essentially flat from a year earlier. Excluding that gain, non-GAAP segment earnings were $2.3 million. Looking quickly at the balance sheet, our cash position was $67 million from $80 million on June 30, 2014. The main contributing factor was share repurchases of $27.2 million, which included the 400,000 shares repurchased for $19 million as part of the secondary offering. The balance sheet remained very strong, with total shareholders' equity of $249 million, up from $246 million a year earlier. Yesterday, we announced that we've amended our credit facility with GE Capital, Commercial Distribution Finance to increase our credit limit by $50 million to $225 million. This expansion strengthens our ability to support our customers with advanced technology solution and enhances our financial flexibility as we continue to grow the business. I would now like to turn the call back to Phil.

Thanks, Elaine. To sum up, first quarter results represented a strong start to fiscal 2015. ePlus continued to gain market share by providing customers sophisticated solutions for complex IT issues and supporting them with a full suite of IT services. As Mark mentioned, we are addressing a larger and more diversified customer base today than we had 1 year ago, providing significant cross-sell opportunities and the vertical expertise that helps bring in new customers. At the same time, we plan to continue to be a consolidator in our industry by considering accretive acquisitions that expand our geographical reach, adding software to enhance our customized solutions and to deepen our services offerings. We have sufficient resources to support organic growth, as well as investments and acquisitions to enable us to grow faster than the industry average. I would now like to open the call to questions.

[Operator Instructions] Our first question comes from Matt Sheerin of Stifel. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: A question for Mark. Could you give us a little bit more color, Mark, in terms of the strength that you saw in terms of the verticals and also give us an idea, maybe rough percentage, of your breakdown of end markets in the technology segment by vertical?

Okay. Matt, first of all, thanks for joining. First thing is the verticals as a percentage of our overall business really hasn't changed quarter-over-quarter. As we've mentioned on the last call, we're vertical independent, if you will, so we're not tied to any one vertical. So they're rolling anywhere from 10% to 12% to maybe 20% range that you're looking at across some of the bigger verticals, which would be technology, telecommunications, financial services, media and entertainment and SLED, just to give you a few. As it relates to -- sorry, your first piece was a little more color as it relates to... Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Yes, just in terms of, like, where -- I mean, it sounds like -- I mean, you're saying that the demand you saw across your customer base -- was there any one stronger or where you saw your more market share opportunities, for instance, in one area versus the other?

Matt, maybe to put that in perspective, really, where we're seeing that is really from the large enterprise through to the mid-market. As I've mentioned in my piece, is that last -- this previous fiscal year or the year before, we've actually added over 20% net new customers, up to over 2,800 customers. And most of those are in the mid-market or enterprise phase, so we're still seeing significant interest from those size customers across all of our offerings, whether they be cloud-related, security-related and all the associated services that go with it. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. And then a bigger picture. I know, Phil -- I appreciate that you don't give specific guidance, and you have a ton of visibility going forward. But if you look at the growth rates that you are growing, basically, high single digit to low double digit, in technology in the last 2 quarters of last year -- or your last fiscal year and slowed a little bit, still mid-single-digit growth, and which is probably closer to end market. Do you feel, particularly given that you're adding your services capability and your headcount that you should be able to grow at a faster rate than kind of mid-single digits?

Basically, I don't think we would add headcount if we didn't believe that we would continue to grow at a faster pace. We have a lot of opportunities that are out there, and our pipelines appear very good. And we think that we need the additional people in place and investing in them. And unless we believe that we would do better, then we would not be hiring these people.

And if you don't mind, if I could jump in, Matt, one thing that we feel pretty -- we believe, IDC is stating that the IT spend is expected to increase by 4% this year. We believe we'll continue to exceed that expectation, market expectations. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. And just last for me. Disregarding the finance segment, which has been trending down in revenue, it sounds like, though, you think that there's another cycle coming, where your customers may shift to more of a leasing model. Do you have any visibility into when do you think that's going to pick up?

I don't know if we have any visibility, Matt. What I think we're starting to see from a lot of our customers, they're continuing to look at the different types of OpEx or consumption models that are out there, specifically, in the software space. They're looking to, instead of a capital, take it as an OpEx. And we're seeing some of our larger customers coming to us, looking to see what we can do with our leasing capabilities and from a technology standpoint, putting solutions together to take advantage of that.

Our next question will come from Prab Gowrisankaran of Canaccord.

Just piggybacking on Matt's questions. In the technology segment, you talked about cloud and security. Was there anything specific in security or specific vendor that you saw strength in, in terms of these new large enterprise and mid-market customers?

Prab, it's Mark here. I don't think it was any one particular vendor, so we're really kind of focused on -- if you think of what's going on in the market, everybody's trying to secure their perimeter to kind of keep the bad guys out, and then making sure that they don't have -- securing the data so they don't have data loss prevention. So we've got most of our focus, as it relates to both the vendors and the solutions, in those space. And then what we're doing on top of it is providing the services that our customers are looking for, which is a combination of assessments, where we'll go in and do all the types of assessments to let them know where their existing infrastructure stands and the potential holes that they have. We'll also do, as I mentioned earlier, we've got a vCISO capability, where we'll actually help build 3- to 5-year roadmaps for our customers, and that's not just your quick fix, where, "Here's a point solution that solves an initial problem." It's something that's building a roadmap to make sure that as we continue to go with all the hackers and cyber security initiatives that are going on, we're building a long-term footprint that they will be successful and hopefully not have any breaches or data loss, if you will. And as I think you know, in the market, a lot of regulation and authorities out there are looking to have more, I'll call it, tightness around security space as it relates to companies understanding if they've been attacked, if they've had any incidences that they should be aware of, and I think customers are becoming more and more cognizant of having those tools in place.

Okay, great. And the other question I had was on the gross margin. You saw a nice pickup. Is that more because you're selling higher-end security and the routers and stuff? Is this margin level sustainable in terms of product margins?

Well, Prab, I think what you see is, over time, we've continued to evolve as a company, and what we're really focused on is your more margin-rich solutions, which are normally -- you're not -- if not product fulfillment-like solutions, if you will, there's going to be services. So if you listened a lot of what we talked about with the headcount that we're adding, it's all customer-facing. Over 50% of it was in the services space, so those are your presales and post-sales resources that clients need in order to bring together these complex integrated solutions. So yes, that's why the margins are going up, and we believe that we're very well positioned as we go forward.

Okay. And the last question I had was on the financing segment. You talked about the consumption model. Is that leasing across mainly in, like, cloud build-out? Do you see it in specific areas that this new leasing model is taking hold, or is it just your existing customer base trying to add on more infrastructure?

Well, what it is, Prab, really, we're not limited if you think about it. So as the world moves to these OpEx and consumption models, you've got Infrastructure as a Service. You've got Software as a Service. You've got Video as a Service. You have Disaster Recovery and Backup as a Service. What we're seeing from our customers is the need -- instead of having a big upfront capital expense, they're looking to do the monthly payments kind of OpEx play, if you will, and we're leveraging our leasing capabilities to provide the solution to the customer's need now with a payment term over a 3-year or 5-year period.

This is Phil Norton. I think also, it's very important to understand that vendors are looking for that same type of structure so that they're able to meet the customers' needs. So it could broaden our reach into several other vendors than we're dealing with today. And I think it's very positive for a leasing company.

And our next question comes from Bhavan Suri of William Blair. Bhavan Suri - William Blair & Company L.L.C., Research Division: I apologize. There've been a bunch of earnings calls, so I might be asking a question that may have been asked. But one thing I wanted to focus on was, was there any areas where you're seeing clients specifically interested in that you think are sort of a little immature and that you need to sort of go out and invest and to build? Or do you feel that in terms of what the clients are looking for, you've got pretty good coverage from a technology perspective?

Okay, all right. Bhavan, I believe that we're -- there's 2 things. Let me take a step back, so you know how we look at technology. So we obviously work very closely with our key vendors to understand where they're going with their technology. We also have an Advanced Technology Group and an Emerging Technology Group within ePlus that are chartered with understanding where the market's going and what are the right solutions. So we do believe that we are adding the headcount in the right spaces, where the market is either hot or growing. Some of the easy ones, obviously, cloud, security. As you look at ACI and all the software-defined plays that are out there over time, we're going to continue to look at those and have headcount where we can help our customers. Some of the bigger areas, as we've noted previously, that we're adding headcount is in the services space. And if you think about it, what a lot of customers are chartered with -- so if you -- and Bhavan, you know this better than me. If you look at the cloud, everybody talks about security, which is a big piece, but there are so many cloud offerings out there. Customers are confused on what's the right one for them based on their size, based on what efficiency, based on whatever cost savings they're looking for. And the way that you're able to help the customers is by having those services or systems engineers that are available to sit with them, understand their legacy systems and, as they move to the cloud, make the recommended suggestions on what's the right either cloud architecture or public cloud for them. So that's why we do believe we're getting headcount in the right spaces that are, what I call, margin-rich. Bhavan Suri - William Blair & Company L.L.C., Research Division: Great. That's helpful. And then as you look at your sales hires and, at one point, the services hires you made and you're thinking about sort of the ramp -- and you obviously have changed incentive program for the sales force to be gross margin-related. As you look at the close rates for new business, new business that involves services, that might involve some finance bundling, how do those close rates -- do you feel like they've ticked up over the last year? Do you feel like they've kind of been at a steady state? How should we think about the trend there?

I don't know -- Bhavan, I don't know if I could give you a trend of meaning things are closing quicker or whatever. What I'd put it in is, from an ePlus perspective, is I think what you're looking at is -- what's nice about ePlus is when we go to our customers, it's not just a product sale, if you will. What we have based on all the different things we have, we have the ability to kind of do the upfront assessment and consultative approach with our services team. We have the ability to potentially go in with maybe a leasing proposal or a solution, if you will, with our customers to kind of get the foot in the door and then look for technology and/or services. We also have proprietary procurement software that some of our customers are looking for from an asset management and spend management, that maybe we can leverage that to get in the door to provide some value and then look to expand both our technology and leasing capabilities. So I don't know if I can give you anything market-related that things are closing quicker. What I can tell you is -- whatever I tell you in terms of how fast we're growing our profits, it's never fast enough for Phil. So that's probably the easiest way to put it in perspective, all right? Bhavan Suri - William Blair & Company L.L.C., Research Division: That's good to see Phil still cracking the whip over there.

You got it, Bhavan. Bhavan Suri - William Blair & Company L.L.C., Research Division: And then when you look at -- a couple of my other companies on the software side have had pretty good quarters from a federal perspective, from a government spend perspective. And you guys had huge exposure, but are you seeing an uptick in that? And could that be a benefit as you look forward more near term than longer term?

We are seeing more business coming forward in the state and local, and that's where most of our focus is. We do deal with the systems integrators, and we've seen some pickup in that business that deal with the fed. But really, we do not really have a real direct sales group on the federal market. So most of our government spend is limited to the fed and systems integrators, and we see some pickup in both of those. Bhavan Suri - William Blair & Company L.L.C., Research Division: Okay. And then the last one from me is just, you've seen continued consolidation in the space. You've seen sort of some marginalization of the smaller players. Two questions, I guess, there. One, as you think about acquisitions, would you acquire some of these guys just to gain -- not that you need more scale, but to gain sort of customer scale? Or are you really focused on technology? And then two, sort of in that trend of consolidation in the space, do you worry that some of the other guys, like CDW, might try and move up markets to become more enterprise player rather than sort of the sub-2000 company type players?

Well, first of all, CDW -- in the higher level, we have enterprise. We really haven't seen them be competitive on solutions. We have seen them in several situations where it's more product-driven and price-driven. I think that's where we're seeing that. On the acquisition side, we have to look at it 2 ways. One is new technology or people that have started out and don't have the resources to grow but have really built new technology and the cloud and security and mobility that we're able to potentially buy. And then the other one is basically locations. And we still have several places in the country that we are not really well established, as well as some of the major areas in the country, New York, Irvine, San Jose, Washington, that we really can add additional companies at a much smaller scale. And we think that's very accretive and also enables us to do more of them and have a broader reach for what we can go after.

Bhavan, can I add one thing just to put in perspective what's nice? So with our acquisition strategy, it's territory coverage. It's technical expertise. It's accounts and people. And as it relates to accounts, when you talk about some of the smaller players out there, they may have some very nice accounts, but they didn't have either the financial capability or the resources to be able to sell some of these bigger, more complex, integrated solutions. That's where we -- potentially, if we acquire them, there's an upside for us because we have both the financial capability and the resources to help them go sell solutions they weren't able to sell before. Bhavan Suri - William Blair & Company L.L.C., Research Division: So just capture a larger share of that customer's wallet, so to speak?

Yes. Bhavan Suri - William Blair & Company L.L.C., Research Division: Yes, okay. So on just higher level, and maybe it's to Phil, but when you look at it, you guys have a really nice business of building out a cloud platform. Obviously, you've done that for Verizon and other folks. And then you have the managed services business that you're building out, just sort of help people migrate to the cloud, and then you can sort of provide them a pseudo-private cloud environment. If you look out 5 years, maybe even further, do you have any sense of sort of which one you think you'll be doing more of? Is it more of Verizon sort of public cloud or sort of the private cloud environments, where you'll create sort of the private infrastructure for these players?

I think 2 different ways we have to look at it. One is the private cloud or hybrid cloud, which is a big part of Verizon's business. I don't think we'll stop. I think that will continue for all the big players, and I think that's a great opportunity for us. On the public cloud side, we're investing in people to really understand how we can take advantage of it and deliver good options for our customers and making sure that we can be profitable there. And I think both of them will grow. I think the -- I think it's IHS, one of the Gartner folks, said that in 2017, there'll be a $2 trillion overall market for IT, and 12% would be cloud. So I think it's got a lot of hype. I think it's growing pretty fast. But I don't think it's going to be the main driver for a few more years, so it gives us a lot of opportunity to increase our capabilities and to drive more business in that area.

And I'm showing no further questions at this time. I'd like to turn the call back over to Phil Norton.

We'd like to thank you for joining our call today, and we hope to see you or hear from you 3 months from now. Thank you very much.