ePlus inc. (PLUS) Q2 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 Erica Stoecker, General Counsel. You may begin.

Thank you, Destiny, 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 Elaine Marion, Chief Financial Officer. 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 that 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 Form 10-Q for the quarter ended September 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, Erica, and good afternoon, everyone. Thank you for joining us to review our second quarter and first half fiscal 2015 results and discuss our views on industry trends. This was another quarter of solid execution for ePlus. We continue to execute on our strategy by providing products and services that address our client's IT needs, specifically in the areas of cloud, mobility, security, storage and managed services, attracting and training the best engineering talent in the business in order to build our professional capabilities and increasing the work we do for existing clients as well as expanding our client roster. Total revenues were up 9.7% in the quarter, driven primarily by a 9.6% increase in our technology segment revenues, which accounted for 97% of total revenues for the period. This quarter's results also benefited from 13.6% revenue growth in our financing business. A key take away from our second quarter and first half performance is the market improvement in gross margin on products and services, which is a metric that has been consistently expanding as we transition from a value-added reseller to an IT solutions provider. We have truly emerged as a go-to resource for our clients by providing them with the consulting and professional services they need to executive their most critical IT projects in the areas of cloud, security, data center and managed services. Another important achievement is the strong growth in operating income, which substantially outpaced revenue growth again in this year's second quarter, up by a factor of almost 4. And for the first half, operating income increased at a rate almost 3.5x higher than revenue growth. We consider this performance very impressive in light of our ongoing investment in engineers and professional salespeople that are supporting the growth of our higher margin services business, driving new business with both existing and new customers. We ended the first half with a total of 920 employees in our technology segment, of which 75% represented engineers, sales and other client-facing personnel. Diluted earnings per share for the second quarter is $1.63, a 53.8% increase over the same period last year benefiting from our strong operating performance as well as an 8.4% reduction in the weighted average number of shares outstanding thanks to our stock buyback program. For the first half of fiscal 2014, our reported diluted earnings per share was $2.86. Exclusive of a special gain in this year's first quarter, non-GAAP diluted EPS was $2.75, very strong comparisons over the $2.03 reported in last year's first half and reflective of the high-level of customer demand for our products and services. Now I'd like to ask our Chief Operating Officer, Mark Marron, to provide additional color on business development at ePlus.

Thanks, Phil. As Phil just mentioned, we've been focused on the high-end IT solutions that are growing faster than the overall market, mainly security, cloud, storage and mobility. Now this is in line with trends that are becoming increasingly apparent to us in the first half of this fiscal year, namely the changes in CIO priorities within a more complex IT environment. Where previously CIOs were more focused on managing IT infrastructure for efficiency, today, the real mandate is to have the right technology in place to drive revenue growth, increase employee productivity and most importantly, provide data and parameter security. As a result, CIOs now, more than ever, have to turn to a partner to manage the day-to-day IT needs of the company. This environment makes our integrated consultative approach a major competitive advantage. We can partner with our clients to understand their environment, build and support their infrastructure, then provide managed and other services going forward. This is our PBSO services methodology, which stands for plan, build, support and optimize. Now one example of this is a large contract we've won from an international law firm that was moving its data storage to another state. This would be a complex project for any client, but with a legal firm, security of the data is paramount. Additionally, management of the data would have required 2 engineers: 1 at headquarters and 1 at the storage center, which would have been counter to the CIO's mandate to improve the productivity of the firm's attorneys and administrative staff. The customer decided that ePlus was the right choice. The 5-year contract that we won this quarter calls for us to provide stamp on site at the data storage location to manage day-to-day operations, supported by remote monitoring of their system 24/7. So if there's an issue at 2:00 a.m. for example, ePlus managed services team can both identify the problem and provide a solution with little or no involvement by the client. The benefit of this type of project is that we're regularly in contact with the CIO now. We know their business. We are in a position to meet additional requirements they have, whether related to product sales, financing or additional value-added services. Another good example of this is in the area of security. We've all seen the headlines and security breaches are growing at a double-digit rate every year. Yet a recent survey found that more than 40% of CIOs are working with a flat or declining security budget. We're engaged on a small contract to examine the security needs of a company in the financial sector, one whose research regularly moves the financial markets. We came in with our vCISO program or Virtual Chief Information Security Officer program to assess their security needs and how they could be addressed. After providing this assessment, the company decided that we are their ideal partner actually execute the project. They hired us on this $2 million contract to upgrade their security and cloud infrastructure then provide managed services to ensure the systems remain at the cutting edge of information security. Now with respect to new offerings for our clients, one important development is to rollout an ePlus On-Demand IT Services. This is literally a 1 (800) number that a customer can call and say, "I need some IT support or staff," and receive assistance on short notice. These national services include short-term staff needs, staging and deployment and managed outcasting and they can cover a period of time ranging from a few hours to a period of several years. This flexibility means that clients can match their IT resources to their IT needs almost in real time. For ePlus, we can just demonstrate our expertise, get to know the client's needs and then build relationships for future business. Another area that we're very excited is the continued development of our cloud practice and specifically today, our FlexPod business, where NetApp recently named us FlexPod Partner of the Year. FlexPod is an increasingly popular option for medium and enterprise-sized businesses looking for a flexible, multi-vendor, convergent infrastructure option as they transition into the cloud. We have the ability to fully integrate these complex multi-vendor solutions in our nationwide integration centers. ePlus now provides Flexpod managed services as well and we're certified for Level 1 maintenance calls for both Cisco and NetApp. What that means is that we can rollout FlexPod to medium and enterprise-sized businesses, we can monitor and manage the product we install, we're able to handle the Level 1 maintenance calls. So effectively, we become the single responsible party for the entire life cycle. So we're able to handle more of the day-to-day operations for our CIO clients, our partners have fewer maintenance calls to deal with and most importantly, from our end, we're seeing improved margins. Okay, to sum up. Not only are we expanding our customer base organically and through acquisitions, such as our acquisition of Evolve Technology Group in August, a leading reseller in the California SLED market, but we're really going deeper into each individual-client relationship. As Phil mentioned earlier, we're adding client-facing staffs and we have better resources available to meet the needs of both new and existing clients in today's must-have technologies. All this means we believe we are well-positioned to take market share and grow our margins. I'll now turn the call over to our CFO, Elaine Marion, for a financial review of the quarter's results.

Thank you, Mark. As you have heard, our results for the second quarter of fiscal 2015 were strong across all key metrics: Revenues, gross margins, operating income and diluted EPS. Consolidated revenues were up 9.7%, led by increased revenues in both our business segments: technology and financing. Consolidated gross margin for the quarter was 21.5%, up sequentially from 20.7% in the first quarter and 19.5% in the second quarter of fiscal 2014. Our second fiscal quarter is generally our strongest quarter for our third-party maintenance contract sales. These sales are accounted for on a net basis and were an important contributor to the improvement of our gross margin this quarter. Turning to expenses. Our operating expenses were up by $5.5 million or about 14.5% compared to the year-ago quarter. Nearly 50% of this increase was due to an increase in variable compensation, mainly commissions and bonuses, linked to our improved revenue and gross margins. The next biggest factor in higher expenses was headcount growth, which was up by about 4% from a year ago. Operating income was up 38.3% to $20.3 million with about 2/3 of that growth coming from the technology segment. Operating margin for the quarter was 6.8% compared with 5.4% in the second quarter of fiscal 2014. Net income for the quarter was $12 million, an increase of 39% from $8.6 million we reported in the second quarter of fiscal 2014. Earnings per share were $1.63 on a share count of 7.3 million compared to $1.06 in the second quarter of fiscal 2014 on a share count of approximately 8 million. Drilling down to our segment results. The technology segment saw a 9.6% increase in revenue to $288.4 million, driven by a strong demand from existing customers and our ability to expand our customer base. Trailing 12-month revenues, as of September 30, 2014, were all well diversified across our customer's vertical markets. The technology market accounted for approximately 21%; telecom, media and entertainment was 18%; financial services represented 11%, SLED was 21%; health care was 9% and other, which include professional services, energy, retail, aerospace, et cetera was 20%. Gross margin on product and services was 19.5% compared to 17.8% a year earlier, benefiting in part from the greater proportion of revenue from the sales of third-party maintenance contract. Operating expenses grew 15.8%, led by higher variable costs from higher gross profits, such as commissions and bonuses combined with growing headcount, most of which is customer facing. Segment earnings were up 28.5%, almost 3x more than the total segment revenue. Moving to the financing segment. We had positive comparisons from a year ago. Segment revenue was up 13.6% to $9.1 million. In the second quarter, we benefited from increased post-contract earnings and renewal of rents. And expenses were down in the quarter, with lower direct lease costs due to lower depreciation expense from investments and operating leases. Operating income rose by approximately $1.7 million to $2.7 million. Looking briefly at our consolidated year-to-date results. Similar to the results for the quarter, the trend is very much solid revenue growth and expanding margins. Revenues grew 7.4% to $569.8 million, led by a 7.9% increase in the technology segment. Financing revenues fell by approximately $800,000, due to a high base of comparison in the first half of 2014 when we had large transactional gain. Gross profit was up 14.1%, again led by the technology segment, with a consolidated gross margin of 21.1%. As in the second quarter, we saw higher proportion of revenue consolidated on a net basis. Operating expenses were up 10.1% with an increase in headcount in variable compensation. Operating income grew 25% to $35.1 million and operating margin was 6.2% compared to $28 million and 5.3% the year earlier. Net income for the first half of the fiscal year was $21.4 million, including a gain related to retirement of a liability in the first quarter. Excluding this gain, non-GAAP income was $20.6 million, an increase of 25.2% from the first half of fiscal 2014. Reported earnings per diluted share for the first half were $2.86, up from $2.03 from a year earlier. Excluding the gains, non-GAAP diluted earnings per share were 2.75% compared to $2.03 a year before, an increase of 35.5%. Moving to the balance sheet. We had cash and cash equivalents of $62.9 million, down from $80.2 million at the end of fiscal 2014. The cash position is lower as we used cash generated from our business for certain strategic investments, such as share repurchases and the acquisition of Evolve Technology Group. Total shareholders' equity was $256.1 million with 7.5 million shares outstanding. To summarize, we produced strong quarterly and year-to-date results and our balance sheet remains robust. This gives us flexibility to continue to invest in strategic initiatives to drive organic revenue growth, make acquisitions that are accretive and strategic and to continue to invest in building our services and advanced technology solutions that are most in demand from our customers. I will now turn the call back to Phil for closing comments.

Thanks, Elaine. To sum up, this has been a strong first-half for ePlus. We remain focused on delivering products and services in areas that are growing faster than the overall IT spending. Our technical expertise enables us to provide solutions in an increasingly complex IT environment, and we are focused on driving both organic growth as well as execute on strategic acquisition, driven by our strong balance sheet and integration expertise. All of this confidence into ePlus growth prospects for the remainder of the fiscal year 2015 and beyond. Operator, we would now like to open the call for questions.

[Operator Instructions] And our first question comes from Bhavan Suri of William Blair. Bhavan Suri - William Blair & Company L.L.C., Research Division: But just wanted to touch bases and see if you could give a little color on what percentage of revenue was recurring. I know you don't have to give us exact list [ph], sort of a little color on how those project went because obviously the gross margins ticked up nicely.

So Bhavan, as you know, we don't do forward-looking at -- with our services projection both from a transactional or from an annuity. Two of the examples that I gave in my presentation talked about managed services, which is an annuity service, if you will. We -- we're continuing to expand our capability in that space. So we've just recently added Flex-Pod managed service capabilities, Meraki managed service capabilities, and we're going to look to expand the offerings that our customers are looking for in that space. Also, as I've mentioned, we talked about some of the on-demand services. So basically, being able to provide real time services to our customers when they need them most, whether in a short burst of hours or days or over a multiple years. So we're going to continue to build out our service capabilities from assessment all the way through to optimization services. Bhavan Suri - William Blair & Company L.L.C., Research Division: Great. And then if you look at the business today, and you look at what customers are asking, is there an area where you feel you need to add incrementally or maybe it's a fire to serve that. Obviously, clearly, you're meeting most of their needs, but is there an area outside of security storage, the cloud-based services that customer is asking for that you feel like it's an area for investment you guys?

Well, is it -- Bhavan, there's a lot of things as you kind of touched on. So you got kind of the cloud computing, you've got the cyber security or security issues, you've got mobility issues, you've got big data, you got a lot of these software-defined stuff that's going on across some of the bigger vendors that are out there. You have CIOs that are really worried about how do they bring together these multi-vendor complex solutions if you will, not having the internal resources to do it. You got a lot of legacy monetization going on all while they're trying to consolidate vendors. So what we're trying to do from our end is we're going to continue to invest in what I'd call customer-facing sales and services personnel that can address the needs that our customers have across the areas that I addressed earlier. And then provide the services that they're looking for, which is really, at the beginning of the day, is the upfront kind of assessment looking at their system and walking them through what is the right solution. Well, let's just, for example, say from a cloud architecture standpoint, what's the right solution. But also being able to staff inform, provide managed services and provide the Level 1 support so they have one place to go instead of having to go to multiple vendors.

And our next question comes from Matt Sheerin of Stifel. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Just a couple of follow-ups, regarding the gross margin. Elaine, you talked about the third-party maintenance contracts being a big driver of sequential growth. But could you give us an idea of how much that contributed versus the fact that you're doing more services and as Mark talked about the full service component for your customers. Just trying to get an idea on a year-over-year basis. You're talking about a 130 basis point or more increase year-over-year. So I'm trying to figure out how much it added to services versus maintenance. And how sustainable are our gross margins relative to that kind of a 20% number?

So Matt, it's Mark here. Maybe I'll try a couple of different things on this since we don't really break it out on that. So the easiest thing, the good news on this for ePlus if you will, is the customers are voting with their dollars and they're to looking to support -- looking for the support and renewals from ePlus. We've got a dedicated team that works with our customers to understand all of their existing assets that they have out there and what becomes due for renewal. And then working with them on how they can potentially reduce costs, if stuff is end of life, end of support. The other thing that we're doing is we are looking to work with our customers on helping their spend we are breaking it out over 3- and 5-year periods. We also had an uptick quite honestly. Cisco's year-end ends in July. So there's normally a big uptick in what they call SmartNET renewals, which normally gives us a bigger uptick in that space. And then what we're trying to do with those customers is provide not only just the resell as a maintenance renewal. The services comes into play, Matt, with the stuff that I talked about in terms of the managed services around those units if you will, and then the Level 1 support. So the important thing about the Level 1 support, which we call enhanced maintenance support for our customers, if you got a multi-vendor solution like FlexPod, if you had an issue with that product, you'd have to call Cisco, NetApp, VMware and others. Being we provide that Level 1 support, they can come to ePlus. Now the good news for us is we understand what the issues are and we're able to work with the client and a lot of times, that opens up opportunities for additional sales into our services. For the customer, it makes a lot easier where they're not dealing with support calls. They're not dealing with the vendors, and I'm not saying the vendors do this where they are pointing at each other saying, "Hey, it's not us, it's the other guy." So we're kind of that one throat to choke, if you will. That helps us kind of, one, from a customer stickiness; and two, it helps us with our blended margins and services going forward. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. So it sounds like you feel like gross margin, at least on a year-over-year basis, should continue to move in the right direction. If so -- and then, talking about it, if I could ask you to...

I'm not sure I said that so... Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay, well, okay, well maybe that's a question then.

All I'm saying is we're putting the headcount, the services and the programs in place to help our customers in today's challenging environments and we'll do everything we can to provide the solutions that they're looking for. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay, well maybe I can ask in another way, given – like, I know -- I appreciate [ph] that you don't give forward guidance. But looking at the December quarter, given that the September quarter's a big quarter on the maintenance contracts, and then the mix of business may be different, then would we expect the gross margin would be down sequentially?

Well, I don't know if you can predict that, Matt. Because if you think about it at the calendar year-end, you have a lot of year-end budget and year-end spend that a lot of times will come up, and customers are looking for. It opens up opportunities for us, quite honestly, with potentially with some of our leasing business as well because customers that may need technology now but don't have the budget and are looking for payment plans. It's tough to give you a real feel. And since we don't give that forward guidance, it's tough to give you a real concise answer here. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. That's fine. And could I ask you to go through the end market percentages again, because I didn't get all that down.

Okay, sure.

So telecom was 21% -- or technology, I'm sorry, was 21%; telecom, media and entertainment was 18%; financial services was 11%; SLED was 21%; healthcare, 9%; and other was 20%. And those will all be in our 10-Q as well. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. And relative to last year or maybe last quarter, which segments have recently been strongest for you?

In relation to the percentages that we disclosed at year-end, we've had very little changes. Everything is fairly stable across all customer end markets. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. And Mark, can I get you to maybe talk about the SLED market. I know it's been a focus for you. I know the K-12 new opportunities has been strong for a lot of resellers and distributors. How is that going, and what's left in terms of that whole upgrade cycle we're seeing in terms of school districts?

So a couple different things here, Matt. Elaine has alluded to the 5 verticals if you will and their percentages. Our SLED business is up a little over the trailing 12 months previously. We feel like we're well-positioned in terms of the contracts that we're on. So let me give you a couple different things here. One, the gentleman that actually built and ran our SLED business was just promoted to a Executive Vice President of Technology Sales for all of ePlus based on the programs of business and relationships he's built in that space. Secondly, we see a big upside as it relates to that space with the -- as per the acquisition with Evolve that we just made in this quarter. We see that. What's nice about that is we're able to pick up contracts and relationships that we didn't have in California and on the West Coast, that we now can expand to the rest of our sales team or SLED team out there. The benefit of the Evolve team, even though this is not a SLED piece, what we're saying is we're now able to go back into their customers and sell all the other technology that we're selling. But we do see a lot of opportunity across this SLED space as it relates to spend, Matt. We haven't seen any slowdown and we haven't seen anything both from a market share or pipeline standpoint. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay, great. And just a couple more if I can. Just regarding your OpEx, I know you're continuing to invest in sales and technical support and engineering. Could you give us an idea of any plans for a continued headcount additions, and what that might do to your SG&A?

Okay. Well, Matt, as I think you heard when Elaine went through the numbers. What I think is pretty good is we're continuing to invest in customer- facing sales and services reps, where there's opportunities, whether it's cost of cloud, security, big data and all the things that we discussed earlier. What's really nice about our numbers, at least in my opinion, is when you've got your EBT or your operating income growing at a bigger percentage than your GP and your revenue. That means, in my opinion, you're making the right investment in headcount and driving margin-rich solutions. So we're going to continue to invest as we see the market evolve. But as you know, this market is constantly changing, it's emerging. We brought on a cloud team. They help us build out our cloud practice even further in terms of the offerings we could make to our customers and how we help them make these moves to the cloud. We built -- we'll continue to build out our security practice because that's, as you know, the market's getting harder and harder. Most companies don't have the security camera. They have outdated systems and they need help. So we'll continue to invest in the customer-facing headcount in the areas that is -- are hard to market and our customers are looking for help. But the good news is, when I look at it, if you look at some of the stuff that Elaine talked about, a lot of the expense was up was commission. Well, that's good news because we're driving more GP's since our reps are paid on gross profit. And the headcount we're adding as a percentage is less than what we're driving to the bottom line.

And our next question comes from Prab Gowrisankaran of Canaccord.

Most of the questions have been asked. Let me ask a few more. One was I just want to see if you could provide more color on multi-year managed service contracts that you talked about. You gave one example. Do you think that, that will become a template where more and more customers will sign these multi-year contracts? If you can provide any color on that service side?

Yes, Prab, it's Mark. It's hard to give you a -- is it a template that we'd like to see, we could replicate going forward without a doubt. We've made -- as you know from previous calls, we've made major investments in our managed services, both from a resource, from the tools, we -- about 9 months ago, we opened our third managed service center. As I discussed earlier, we've increased the managed service offerings that we have across FlexPod, Meraki, with the wireless and everything along those lines. The intent is, we do want to become that sole provider to our customers of going in, assessing their environment, suggesting the solutions that they need, in a lot of cases, it's multi-vendor solutions that they need, building out those solutions in our integration centers, providing the managed services. So the proactive monitoring and managing of their environments. So it's not just the, "Here, the patient died and here's what they died of." It's, "Here's what the problem is and this is what we need to do to address it." And then providing the ongoing staffing needs that a lot of our customers need in this market, that they don't have the expertise. So that's kind of the model as we go forward and that's what we're training our sales team. Little off -- off the cuff a little bit but we just had our entire sales team kind of present our services methodology to all of their management and then did it on a national level. So it's that's important to us and we believe it's that important to our customers.

Great. The other question I have is just on the Evolve Technology acquisition. I know you talked about they're strong in California's land. Is their profile of product towards the services and the gross margin profile similar to ePlus or better. I know that you talked about they provide advanced IT solutions too -- similar to you, guys. So if you can provide any color there?

Yes, Prab, what we've seen so far -- obviously, it's only been a few months in terms of the acquisition. Prior to the acquisition, similar type margins, if you will. But if you remember our acquisition strategies, its territory, to build out our territory coverage. So we're now in Sacramento, where we weren't before. Second is they were on a lot of contracts that we were not on. So we're able to leverage those contracts to continue to grow our business across all of California now. Third is, they had a bunch of customers that were mainly Cisco only that we can go back in and sell additional vendors. And we've had multiple vendors coming to us to look -- to add us to their contracts based on the Evolve acquisition and the relationships they have within the state and other areas. So it's a nice -- it's a territory coverage. It's an expertise in the SLED space. And in terms of -- from a vendor perspective, we have the ability to go back and sell more technology to their customers. They also -- if I could add, one other thing they had, which continues with our strategy is they've got some nice security expertise and they also have a training center that we're able to leverage both internally and externally with customers.

Okay, great. And the last question I had was, I think this was asked before, in terms of the overall margin to the high watermark. If you look back 7, 8 quarters, I know you benefited from the maintenance contracts, but could you be close to these levels, assuming your services mix expand? And I'm assuming services margins are much higher than the product margins.

Prab, once again, that's a tough one without the forward-looking piece. So the one thing I'll say that we've said in prior is on your products, if you're doing it right, you may be getting 10 to 15 on services, you'll get 35 to 45 on managed services and staffing and things like that. You could potentially get more. Once you build your models and have all your expense in your business. So we see the renewals as the first place, if you will, to touch the customer, provide the support that they need and then they are looking to add on all these value-added services, if you will, that a lot of our customers have been asking for.

And I'm showing no further questions at this time. I'd like to turn it over for closing remarks.

Operator, I'd like to thank everyone for joining us today. Have a nice evening.

Take care.