ePlus inc. (PLUS) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, thank you for standing by, and welcome to the ePlus Third Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to turn the conference to our host, Mr. Kley Parkhurst. Sir, you we may begin.

Thank you, Eric. And thank you, everyone, for joining us today. Joining me today are: Phil Norton, Chairman, President and CEO of ePlus; Mark Marron, our 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 December 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. In addition, during the call, we may make reference to non-GAAP financial measures. And we have posted the GAAP financial reconciliation on our website at www.eplus.com. I'd now like to turn the call over to Phil Norton. Phil?

Thank you, Kley. And good afternoon, everyone. Thanks for participating in today's call to review third quarter and 9 months results and the trends that we have seen to date in fiscal 2015. To summarize, we are pleased to report our excellent Q3 results in which we saw double-digit revenue growth, significant gross margin expansion and 61.4% increase in diluted earnings per share on a reported basis or 24.2% increase if you exclude nonoperating earnings related to a class action lawsuit claim. We think this performance is particularly noteworthy as it was achieved while we continued to make investments in people and technology in order to support future growth. Our results today support the strategy that we have discussed with investors and that is understood and rewarded throughout our organization, namely that we expect our market share gains to come from our focus on the fastest-growing segments in the market, including data center infrastructure, networking, security, cloud and collaboration. And we have built a solid professional services capability to provide customers with complex IT solutions around these needs. This is differentiating ePlus in the marketplace and has enabled us to report revenue growth of almost 10% for the 9 months ended December 31, 2014, well ahead of the industry forecast that we have seen for domestic IT spending on both product and services. Year-to-date, profitability was driven in part by a 90 basis point increase in our consolidated gross margin to 21.2%. Operating income was up 20.7%, and non-GAAP diluted EPS, excluding nonoperating income, increased 31% to $4.38. Our share count decreased 7.5%, primarily due to share repurchases. Nine-month figures from our Technology segment further substantiates how ePlus positioning as an advanced solution provider with an emphasis on consultative selling, multiple vendor integration and focus on the fastest-growing segments and vendors in the industry is resonating with clients. Segment revenues increased 10.4%, and segment earnings were up 24.9%, thanks to a more favorable business mix and increased services penetration. The leasing segment has slightly lower operating income for the quarter and 9-month periods due to a shift in business mix from end-user F&B type leases to vendor-originated, full-payout leases and a lower volume of financing transactions with federal government integrators. Also during the quarter, we received nonoperating income of $6.2 million related to a claim in a class action suit. The leasing segment continues to be an important facilitator and competitive differentiation for technology sales transactions, and Mark Marron, our COO, will provide an example later in this call. Now I'd like to turn the call over to Mark, who will provide additional detail on third quarter business developments at ePlus. Mark?

Thank you, Phil. And good afternoon, everyone. ePlus has many advantages in the marketplace that distinguish us from both the traditional IT reseller as well as single-point solution providers and also make ePlus the preferred go-to-partner of leading technology vendors. I'd like to provide some additional color on the results for our quarter and talk about why we believe ePlus is able to compete and win market share in the high-growth IT areas that Phil discussed. First, we have an engineering-centric consultative approach to all our customer engagements. This is where we leverage our PBSO model, which stands for plan, build, support and optimize. This model allows us to provide the services and support our customers need from the upfront analysis and design to configuration and integration of solutions all the way through to proactive monitoring and managing their environments. It gives us multiple regular touch points with our clients that allow us to understand their business requirements better and build technology roadmaps through which we can provide additional product and services. Second, as a nimble company with expertise in the most in-demand solutions and excellent relationships with emerging vendors, we can tailor our offerings to be responsive to the needs of today's CIOs who face pressure to maximize their IT budgets and deliver business outcomes. In many cases, our customers' business is IT, and the CIO is directly responsible for revenue growth and profitability. They need a partner like ePlus to facilitate their plans. Third, our vendor relationships and certifications give us flexibility to approach IT challenges from a variety of different angles, and our highly trained technical staff will enable us to provide clients with increasingly complex solutions to their IT problems. Now let me spend a few minutes highlighting some real examples of how we leverage these advantages and provide value to our customers. One example of how these differentiators drive business development is the case of an international financial institution, one that has traditionally outsourced a significant portion of its IT needs. They've reached the expiration of their Cisco's SmartNET maintenance contract, which had been provided by another vendor, and were initially looking for just a few competing bids on the procurement side to award their renewal primarily based on price. We took a more value-added approach. We examined their networking infrastructure, identifying numerous areas that were deficient and needed to be optimized. During the sales process, we brought our security experts into the customer to better understand their long-term requirements for security and how that aligned with our managed services strategy. The key to winning the contract was our ability to provide security assessments and remediation services. At the end of the process, the customer signed a multimillion dollar, multiyear contract covering SmartNET maintenance, managed services and ongoing security services. The contract has healthy gross margins, and the ongoing multi-year provides us with a platform for continuous interaction with the customer's IT infrastructure, giving us unique insight into this customer's IT needs and the opportunities to cross-sell and upsell synergistic products and services in the future. Another example of our ability to tailor our solutions to respond to individual CI needs relates to a recent win we had in the mobility space. In the third quarter, we spoke to an insurer with a national footprint who was seeking to upgrade their Citrix technology for their insurance agents in the field. The CIO's mandate was clear. They needed to add users to the Citrix system, and he also had to upgrade functionality, specifically in file sharing between agents, and he had to accomplishment this by the end of 2015. Execution of the project, which was urgent, was going to be delayed until -- due to budgetary constraints. Their budget wasn't going to increase until 2016. This is the common dichotomy between real-time business needs and IT budget shortfalls that our customers face all that time. In this situation, ePlus financing capability was crucial. We were able to leverage our finance knowledge to sell the urgently needed solution. From our perspective, we had facilitated a sale that might have been delayed or not happen at all, increasing revenue in gross margin. From the customer's perspective, they used a single point provider to meet their business needs in an easily and timely manner. Our financing intellect was definitely the differentiator in the sale, and it is a competitive advantage that ePlus has in our marketplace. Another example. Last quarter, we discussed the launch of our new on-demand staffing business. I'm pleased to report that demand for the service among with our customer base has been strong. To take a single example, we have a major New York area hospital that was an existing client and it recently purchased technology for a network refresh. As you can imagine, this is a major undertaking that requires extra staffing but only for a temporary period. The management at the hospital [indiscernible] ePlus staffing for these extra resources. At the end of December, we had 6 team members working on site, and it soon grew to 10. Our client benefited by having the temporary staff needed to support the network refresh without having to take on any additional full-time employees. From ePlus perspective, not only are we generating significant revenue per month; but because our staff is engaged in the everyday IT organization of this client, we have excellent visibility into the customer's IT and business requirements, and we have the opportunity to provide additional products and services as opportunities arise. Before I turn the call over to Elaine for a closer look at our financials, I want to mention some of the ways we're expanding our capabilities. In November, we announced that we are now certified to provide managed services for FlexPod. We're already NetApp's FlexPod National Partner of the Year, and we're certified by both NetApp and Cisco to handle implementing and configuring virtualized data center solutions and can provide level 1 support. With the addition of FlexPod managed services, we're able to help our customers through the entire life cycle, including assessment, design configuration and logistic services in our integration centers, installing and implementing the solutions and providing proactive managed services and staffing to optimize their environments. Another interesting offer is our video managed services. Videoconferencing is an increasingly popular solution among businesses to enhance collaboration, accelerate business outcomes and reduce travel costs and is a natural solution for mid-market and enterprise accounts. We are providing technology so that anyone with a screen can video chat, which is a real advantage for these customers. Being able to proactively monitor and support these environments for our customers is key to delivering return on their investment. Last but not least, we were recently certified by HP as a Gold Cloud Builder Specialist Partner, allowing us to work with clients to transition them to the cloud with HP's industry-leading private HP CloudSystem. HP is a key vendor in the space, and this certification is just one of the ways we're staying at the leading edge of cloud solutions to further expand our capabilities and solutions we can provide to our customers. To sum up, we continue to build and improve the solutions our customers are looking for in today's complex IT marketplace, while optimizing, simplifying and providing flexibility in how they purchase and pay for these solutions. I will now turn the call over to Elaine for a closer look at our results for the quarter and the first 9 months of the year.

Thank you, Mark. Results of the third quarter and year-to-date were strong, led by very positive year-over-year comparisons in our technology segment. On a consolidated basis, third quarter revenue rose 14.6% to $306.2 million, driven by a 15.5% increase in technology segment revenue. Consolidated gross margin was 21.4%, up 20 basis points from a year earlier. Operating income rose 13.9% or $2.5 million to $20.6 million, resulting in an operating margin of 6.7%. Net income was $15.5 million, including a nonoperating income of $6.2 million related to the company claim in a class action law suit. Excluding this nonoperating income, non-GAAP net earnings was $11.9 million, an increase of 12.4% from the $10.6 million reported in the third quarter of fiscal 2014. Non-GAAP earnings per diluted share were $1.64 on 7.3 million weighted average shares outstanding from $1.32 per diluted share in the third quarter of 2014 based on weighted average shares outstanding of 8 million. Turning to our segment results. Technology segment revenues rose 15.5% to $297.8 million, up from $257.9 million in the third quarter of fiscal 2014. This increase reflects the strong demand for our IT solutions for the product and services from our medium and large customers. Gross margin on sales of products and services expanded to 19.4% from 18.9% a year earlier. A major factor in this 50 basis point expansion was the positive growth in service revenue and margin. Operating expenses in the Technology segment grew 17.7% to $41.6 million. This was primarily the result of higher salaries and benefits expense from increased variable compensation as a result of increased gross profit and 24 additional employees. General and administrative expenses increased 36.1% as we incurred -- incremental expenses associated with recent acquisitions as well as higher depreciation expense stemming from an upgrade in our internal data center equipment. Segment earnings grew 18.3% to $18 million. Segment margin was 6%, up slightly from the third quarter of fiscal 2014. In the Financing segment, third quarter revenues were $8.4 million compared to $9.2 million a year earlier. The lower revenues were primarily attributable to lower transactional gains from financing transaction sold to third parties due to lower average margin on the volume of assets sold. Direct lease costs fell in the quarter as did operating expenses. Segment operating income for the quarter was $2.5 million compared to $2.8 million a year earlier. Our financing segment results includes the nonoperating income of $6.2 million previously discussed. As a result, the financing segment earnings were $8.7 million for the third quarter. Turning now to our year-to-date consolidated results. Our performance was strong with operating income and net income growing significantly ahead of revenue. Revenue in the first 9 months of fiscal 2015 was up 9.8% year-over-year, led by a 10.4% increase in Technology segment revenues. Consolidated gross margin for the first 9 months of the fiscal year was 21.2%, up from 20.3%. Gross margin on sales of product and services was 19.2% compared to 18.1% a year earlier, thanks to a significant increase in the sale of third-party maintenance contract, which are recorded on a net basis. The largest factor in the 21 -- in the 12.1% increase in operating expenses was higher salaries and benefits tied to the variable compensation. G&A expenses were also higher for several reasons, including acquisition expenses, software licenses and marketing and advertising. Consolidated operating income grew 20.7%, more than twice as much as revenue to $55.6 million. Consolidated operating margin year-to-date was 6.4% compared to 5.8% in the first 9 months. Nine-month net earnings was $36.9 million inclusive of nonoperating income of $7.6 million on a non-GAAP basis, which includes nonoperating income. Diluted earnings per share was $4.38, up 31.1% from last year. Moving to the balance sheet. At December 31, 2014, we had cash and cash equivalents of $51.1 million compared with $80.2 million at the end of fiscal 2014. The lower cash balance is due to the acquisition of Evolve Technology Group in August 2014 as well as the buyback of nearly 691,000 shares of common stock this fiscal year. Total stockholders' equity was $270.2 million, and total shares outstanding were 7.4 million. In summary, our third quarter and year-to-date results show positive comparison across key financial metrics, affirming our strategy to provide high-value complex IT solutions. I will now turn the call back to Phil for closing comments.

Thanks, Elaine. In summary, we are very pleased by our performance in the first 9 months of our fiscal 2015. We believe that ePlus is moving towards fiscal 2015 with positive momentum, and we plan to continue to invest in a measured way in technology and people and make sure that we anticipate and address customers' needs. We are specialized in IT areas that are growing faster than overall IT spending. Our technical expertise enables us to provide customized solutions in an increasingly complex IT environment. And we are continuing to focus on growth organically and through acquisitions. We have highly focused go-to-market and incentive plans for our sales people to sell wider and deeper within our own customer base and capture market share for competitors as well as the resources to make additional acquisitions that add to our capabilities and expand our geographic reach. All of this supports our confidence in ePlus' future growth prospects. Operator, we'd now like to open the call for questions.

[Operator Instructions] And our first question comes from Bhavan Suri from William Blair. Bhavan Suri - William Blair & Company L.L.C., Research Division: Just to jump in really quickly. As you look at the deals here, if you look at what happened in the quarter, any color on the percentage where customers bought or leveraged all 3, the VAR kind of product part of the business, the services, sort of the implementation, the consulting and then also the financing?

Bhavan, Mark here. We had numerous opportunities and deals that we closed that leverage everything from product, services and our leasing capabilities. In fact if you look at the one that I kind of highlighted, that was one leveraging our financing capabilities to help a client get technology now that they needed now but didn't have budget for another year. In addition to that, we provided both product and services, specifically in the Citrix kind of mobility space that they were looking for. But we had numerous other opportunities that we were leveraging both our services capabilities whether it be on-demand services with staffing, managed services or professional services with both product and financing involvement. There's one other thing, Bhavan, that we believe does sets us apart. Normally when you go in and you meet with a customer, you're trying to understand what their IT needs or initiatives are and what they're working on. And then based on that, you try to come up with the different solutions of how you can help them get there. And in a lot of cases, financing is something that they at least want to consider. Bhavan Suri - William Blair & Company L.L.C., Research Division: Yes. I guess -- so then just to put that question a little bit on its head, you're obviously clearly growing faster than the market. But there must be deals you lose. And the question is, given the 3-kind-of-pronged approach, plus the PBSO approach, why would you lose deals given that you could offer financing, you'll offer the services, support and manage services. And clearly you have great relations with NetApp, Cisco, HP, et cetera?

Bhavan, anybody that tells you they doesn't -- they don't lose deals, step back and watch for the lightning to hit and then kind of come back to the table. Here's what I would tell you. Every deal is different. So if you think about it, a customer may have an existing relationship with another reseller or systems integrator. Somebody may have -- they may lead on price where they're just basically giving it away, where you potentially is a lost leader for them. There's many different things that go into the equation that you could potentially lose. What we feel good is that we can address a lot of the customer's needs in the areas that are hot -- or I should say technologies in area that a lot of the CIOs have needs in, specifically trying to decide how and where to leverage the cloud. As we heard today or yesterday with Anthem in terms of what they went through with multiple other companies, security is top of mind and high on a lot of people's charts, if you will, of IT spend going forward. And then most of the companies, not all, don't have all the IT resources that they need to be able to implement and really get the benefit out of these solutions. And that's where we feel we have the ability to go across all those different areas and make a difference for our customers. Bhavan Suri - William Blair & Company L.L.C., Research Division: That's helpful. And then one quick one for Elaine here. When you look at the on-demand staffing business, how do those margins compare vis-à-vis, say, the managed services business or the consulting business? Or the gross margin?

Bhavan, I can probably handle that. So here's the easiest thing. Since we don't break out our services, the easiest thing traditionally in the market, if you think about it, the on-demand, you're normally looking at about 25 to 30 points in terms of margin is kind of what the industry average is. Bhavan Suri - William Blair & Company L.L.C., Research Division: From a gross margin perspective, right?

Yes.

Yes.

So -- and then managed services, it's actually higher. And we've kind of talked about this. Once you built your offerings, you've got your resources in place to support the customers, you've got all your processes in place, as you continue to grow that business you would hope that your margins would continue to grow. But more importantly, you're able to provide more value-add to the customer based on the size and capabilities of the offerings and the value in terms of the reporting that you give back to the executives in those companies. Bhavan Suri - William Blair & Company L.L.C., Research Division: Okay. And then -- yes, yes, And then when you look at the L1 support you're offering -- and I'll jump off after this. I apologize. This is the last quick one. When you look at L1 support, and clearly you're doing implementation consulting to some level of customizations, you go to L2, would you guys -- I mean is there an upsell in terms of price to do the difference between the L1 and L2 support?

Well, you're -- I'm assuming you're talking about level 1, level 2 when you say L1. Bhavan Suri - William Blair & Company L.L.C., Research Division: Exactly, yes.

Second -- one is we don't have the ability with the vendors to do level 2. So we provide the level 1, and then if we can't handle it, it's passed on to them. The easiest thing to say as it relates to your question a little, Bhavan, is that what we're starting to see is a lot of the traditional customers that were just renewing with us as it relates to what you'd call maintenance renewal are now seeing the value of both our managed service capabilities, which is that proactive monitoring and management, as well as the Level 1 support. Specifically, when you get into these multivendor kind of complex solutions, instead of having to try to call 3 different vendors, you can actually just call ePlus, and it's our responsibility to get the response and the answer that you need at the time you probably need it the most. One other small point just to kind of note out is that -- we kind of pride ourselves on, we just received, I think it was our 13th time, the Customer Sat award from Cisco. So it's just another proof positive of how seriously we take supporting our customers, not just in terms of selling them a solution, but the ongoing support and maintenance that they require.

Our next question comes from Matt Sheerin from Stifel. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Just a couple of questions from me. Regarding the growth that you saw in the Technology segment of 15.6% year-over-year, what was the pro forma organic growth versus acquisitions?

The majority of it was definitely organic, the vast majority of it.

Yes, Matt, I think we may have talked about this before. The acquisitions we've done so far recently have been relatively small, more kind of tuck-under acquisitions. And a lot of times, it's either to get a technical expertise or get access. For example, we did Aboad [ph] back in August -- thank you -- nice company with a lot of really good people from what we can see. They had SLED contracts that we're able to leverage. They had a security training center. And we think we're going to have the ability to go back to their customers and sell all the traditional ePlus stuff that we sell, whether it be Cisco, NetApp, EMC. Our service capabilities that we're going to help expand them, they have those capabilities as well as our financing capabilities. But don't know the percentage of, but it would be relatively small and mostly organic. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: I gotcha. I guess the point is that 3 quarters in a row here you've seen accelerating revenue growth on a year-over-year basis, and it sounds like the services and also the addition of your headcount. So as you look into the March quarter and then the rest of the year, how are you feeling about growth rates, how are you feeling about sort of the demand environment right now? And what are your plans for headcount additions this year?

So let me try and answer a couple of those. So in terms of the market, we haven't seen any decrease in terms of the IT demand, so whether that's at the mid-market or enterprise. So we still see it maintaining where it's at now. As it relates to headcount, as we've kind of talked about on numerous times -- and Elaine keep me honest here -- in terms of the past year, we added about, I think, 50 headcount year-over-year; and most of those are what I'd call customer-facing, meaning sales and/or services. We're going to continue to invest in our service offerings, both building out the service offerings and our capabilities and the resources to be able to support that. I'm trying to think of what else, Matt, to kind of help you -- give you an answer for what you're looking for. We see security is a hot topic. I mentioned Anthem before with Bhavan. We're seeing some nice uptick both in our customer base and in the market as it relates to security in some of these services that we can provide to our customers. So we're going to continue to invest in the headcount to kind of build that out. We believe we'll continue to outpace the market in terms of as it relates to growth. We believe our services will continue to outpace our product as a percentage of each. And we're going to target the high-growth areas in the market. One thing we may have touched on last time, Matt, and for everybody on the call, we do have an emerging technology/advanced technology team that is constantly looking at where the market's going, and that's part of the team that's helping us set the direction in terms of where we invest in offerings and where we invest in headcounts. And we're going to continue to kind of follow that lead as we go into this next year. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. That's helpful. And on the gross margin, that was basically just down a tad sequentially. Actually, the Technology segment margin were still good because I know last quarter you benefited from Cisco-related warranties, and it sounded like in the opening statement Phil talked about mix benefiting that. Could you maybe get into more detail about why the gross margin was a little bit better than perhaps we expected and expectations for that as you get through the year?

Yes, Matt. The expansion this quarter was primarily the result of the expansion of our -- of services revenue and also the gross margin of the services revenue that we had in the quarter. As you know, the third-party maintenance that we have that we sell throughout the year, that generally ranges about 20% of our growth revenue, and we do disclose that in the MD&A portion of our 10-Q. That generally ranges about 20%. Our second quarter, which is Cisco's year end, is in July. That does have an impact that quarter, a positive impact on our margins because we generally do have more renewals in that quarter than other quarters. For example, our -- that quarter in our fiscal year '15 that percentage went up to 27%, which had that positive impact on our margins for that quarter. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. And I appreciate the fact that you're not breaking out the services revenue or contribution to operating profit. But is there a plan at all to give us a little bit more visibility into that business?

Matt, it's Mark. We are discussing that as a management team. But at this point there's -- we're not prepared on this call to tell you what that'll be, but we are discussing different ways we might be able to provide additional information. Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. Fair enough. And then just, Elaine, on the cash flow, it looks like your cash flow is down. Could you just talk about the cash flow characteristics in the quarter and working capital requirements?

Sure. Generally our quarters are sort of back-end loaded in terms of build [ph] and AP. This quarter was particularly that way. So it did have an impact on our cash. In general, the change in cash from a year-end perspective is really -- the share buyback that was $19 million and also the acquisition of Evolve. But then that should all level out in terms of -- given some time.

[Operator Instructions] And the our next question comes from Prab Gowrisankaran from Canaccord.

I have a couple of questions, one on the Evolve acquisition. I know it is a slightly lower-margin business. If you can add any color on the cross-selling benefits you're seeing and how the integration is going? What are you seeing so far?

Prab, it's Mark here. It's still early. Obviously, we just did it in August. What we've seen is they've got a very nice management team in terms of the reps and the rest of the personnel. We think they'll fit nicely within ePlus. We see some of the contracts and some of their knowledge in the SLED space is going to help us in the California market that we traditionally didn't have. So we think we'll see some upside there potentially. As I think I mentioned earlier, they also have a security training centers. So there's some security expertise that we have that we believe we're going to be able to leverage across both Northern and Southern California. And then the third piece would be is we think we're going to be able to go back into their existing accounts and potentially sell other products and other offerings, like our financing capabilities that they didn't have the ability to do before.

And the second question I had was just on do you have any sort of long-term targets for your -- just qualitative colors in terms of Managed Services and Advance Services growth? I know you get the level 1 support and the renewals, but is there a target for you to try and get those advance services to a certain percentage of revenue? Or what are your plans there?

Prab, that's one of the things we've been talking about that so far we haven't broken out, but the easiest thing is most of where -- not most of, a lot of where we're investing is in our services personnel: So being able to provide both the upfront presales capabilities that our sales teams need; co-sales in terms of being able to install and implement; and then managed services; the on-demand with staffing; and the level 1 support. For example, 9 or 10 months ago, we added our third managed service center down in Raleigh. So we're going to continue to build out our capabilities in that space and continue to build out our offerings. A little bit earlier I had talked about how we just added managed services for FlexPod and for video. And we're going to continue to look at the market in terms of where we need to expand our service offerings and capabilities, and we'll continue to do that as we see the market change.

And there are no further questions at this time.

Thank you for joining us, and we're available for additional follow-up questions later today or tomorrow.

Thank you. Take care.