ePlus inc. (PLUS) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the ePlus Earnings Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time [Operator Instructions] As a reminder, this conference call is being recorded. I would like to introduce your host for today’s conference Mr. Kley Parkhurst, Senior Vice President. Sir you may begin.

Thank you, Tyria, and thank you everyone for joining us today. With 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, 2015, and our Form 10-Q for the quarter ended September 30, 2015, when filed. The company undertakes no new 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 would now like to turn the call over to Phil Norton. Phil.

Thank you, Kley. As a result, for the second quarter and first half of fiscal 2016 demonstrates the success of our go-to-market strategy. We are growing our customers account and expanding geographically tapping into strong customer demand for our services led advanced IT solutions. We are steadily taking market share and are well positioned for intended success. Results for the first half of fiscal 2016 included net sales growth of 6.4% and gross margin on products and services of 19.7%, which is a 70 basis point expansion from the first half of fiscal 2015. Revenue growth translated well into the bottom-line with earnings per diluted share increasing 21.8% as compared to non-GAAP diluted earnings per share in the first half of fiscal year 2015. Looking specifically at the results for the second quarter, we posted double-digit revenue growth and positive operating leverage. Net sales grew 13% to 336 million and non-GAAP gross sales of products and services grew approximately 10%. Fully diluted earnings per share grew from $1.63 to $2.15. This acceleration in revenue performance has several components. First, we are continuing to sell wider and deeper into our existing client base, capturing wallet share. Second, we are adding new logos through focused demand generation activities and third, we benefited from increased demand in the technology and healthcare sectors and a strong close from Cisco’s year end in July. We posted double-digit growth in key metrics including gross profit, adjusted EBITDA and earnings per diluted share in second quarter. While we maintain strong margins, we believe we are well positioned to continue to grow revenue at a higher rate than the overall IT market and we will continue to make the necessary investments in customers facing headcount such as sales people and engineers, and invest in emerging technologies to service our customers and meet their complex IT requirements. With that, I will turn the call over to Mark for a more detailed discussion of the business.

Thank you Phil. As Phil said, the second quarter and first half of fiscal 2016 was a period of continued focus and execution on our corporate objectives of expanding our customer base, investing in customer facing sales and engineering personnel, capturing emerging technology trends and increasing services penetration. Our ability to provide the advanced IT solutions our diverse customers demand helped us deliver positive results across the critical metrics of revenue, adjusted EBITDA, operating income and diluted earnings per share. We have spoken in the past of our strategy to outgrow the overall IT market and expand our gross margin by focusing on some of the highest growth areas of the industries, specifically security, converge, and hyper convergent infrastructure, cloud and mobility. This quarter’s 13% revenue growth demonstrates that we are successfully creating and capturing these opportunities with existing as well as new customers. Crucial to our growth is our ability to execute on our go-to-market strategies by going wider and deeper with our clients. We have successfully developed an effective cross disciplined sales and engineering teams, which focus on business development for specific technologies or ePlus Solutions within our customer base. These themes are being supported by our subject matter experts that help sell increased solutions in the security, services, software and financing areas. We are continuing to better utilize internal and external analytics to create focused demand generation activities within our more than 3000 customers nationwide and we are highly focused on adding new customers as well with targeted marketing campaigns focused on specific geographies, verticals and solution areas. We have shown in the past that we can capture demand in the faster growing segments of the market and we are confident in our ability to continue growing our client base. Today’s customer is dealing with more IT complexity than ever before and the range of vendor options continues to grow. Our focus on a comprehensive lifecycle services approach utilizing our plan, build, support and optimize model provides business outcomes and measurable value rather than side-load IT solutions and is proving to resonate with new as well as existing customers and partners. It’s important to stretch the role of our services business, both professional engineering services as well as annuity services such as managed services and staffing in this growth. We have invested heavily in building up the services business in recent years including expanding headcount and increasing our managed service centers from one to three to provide redundant 24 hour nationwide coverage. We have built teams that focus on emerging technologies and bringing these solutions to market that leverage our overall lifecycle services model. This helps our customers from the assessment and design phases all the way through to optimizing their IT environments. In fiscal 2015 gross profit from our services business grew 14.8% from the prior year and we comfortably exceeded that figure in the first half of fiscal 2016. In addition, our service business can act as the tip of the sphere establishing our expertise with clients and position us for future wins that integrates both products and services. In a recent analysis of our managed services client base we found that the typical client increases their IT spending with ePlus by more than 20% within 12-months of their first managed service engagement with a significant expansion in gross margin. I am going to close by touching on security. This is one of the best examples of an area, where clients are under increasing pressure to upgrade their capabilities and have a wide array of IT options. We identified this trend several years ago, built up our security capabilities and have reaped the benefit in recent quarters. In the second quarter of fiscal 2016, security product services and solutions represented approximately 15.5% of non-GAAP gross sales of products and services, up from 15.2% in the first quarter. And we believe there is still room for future growth as we continue to invest in the security space and make report of every solution we sell. A good example is, is a healthcare win we had recently. The driver for this project was a security audit that highlighted some vulnerabilities followed by minor security breach. These factors made security as the top priority for the organization. Management adjusted their IT budget to reflect this and engaged ePlus to provide a comprehensive security plan. By utilizing our Plan, Build, Support and optimized our PBS approach and our project management office, our first priority was to identify and remedy critical security gaps. From there, we implemented and upgrades to the parameter security, we're now currently building out the remainder of the plan to provide a comprehensive and integrated security stack that will allow them to operate there IT infrastructure in a secure and regulatory compliant manner. This modular service strategy approached offers customers pervasive threat defense from the edge throughout the interior of their network, while providing the visibility and analytics needed to maintain a secure environment. In summary, we believe we have both the expertise and scale to meet our client's needs and add value to their businesses and outpace the market. We have to identified the key areas of growth, the clients with the greatest demand for our solutions and the right people and methods to reach them. So we believe, we're well positioned to continue our track record of outgrowing the overall IT market. I'll now turn the call over to Elaine for a closer look at our financials.

Thank you, Mark and good afternoon everyone. Results for the second quarter of fiscal 2016 showed strong year-over-year comparisons in key metrics such as operating income, adjusted EBITDA and earnings per diluted share. Our results were driven by our scaled service-led business model and our gross margins. Net sales for the quarter increased 13% to $336.3 million due to demand from our complex IT solutions across our customer base. As Phil mentioned, technology segment sales received some additional momentum from customers and the technology in healthcare sectors, non-GAAP gross sales of products and services rose 9.9% to $431.1 million. Consolidated gross profit for the was up 12.5% to $71.9 million, consolidated gross margin and gross margin on product and services were both flat when compared to a year ago at 21.4% and 19.4% respectively. Recently we began reporting adjusted EBITDA, a metric we believe gives insight into the operating performance of our business. We calculate this metric by taking net earnings and adding back interest expense, depreciation and amortization for assets used internally and the provision for income taxes and subtracting other income. We consider the interest on notes payable from our financing segment as well as depreciation on assets financed as operating leases to be operating expenses. As such, they are not included in the amounts added back to net earnings in the Adjusted EBITDA calculation. Adjusted EBITDA and operating income for the second quarter both grew significantly faster than revenue as we maintained a relatively flat cost structure in our technology segment. Adjusted EBITDA rose 30.3% to $27.9 million, while operating income was up 31.2% to $26.7 million. Net earnings for the quarter totaled $15.7 million or $2.15 for diluted share for the second quarter of fiscal 2016, representing growth of 31.9% year-on-year. Now moving to our individual segment results, revenues in our technology segment, which accounts for 97% as net sales grew 13% to $326 million. Our non-GAAP gross sales of product and services increased 9.9% to $431.1 million. We saw a lower proportion of sales derive from third-party maintenance in software assurance contracts when compared to a year earlier. These transactions are recorded on a net basis. In terms of the breakdown of our revenue by end markets, we maintained the balance group of plan for the trailing 12-month led with our largest end market with 23% of the total followed by technology with 21%, telecom, media and entertainment represented 17% of the total, while financial services and healthcare each had 10%. This balanced client base is an important part of our strategy and we see room for growth in all sectors. Gross profit in the technology segment increased 12.4% to $64.8 million. Operating expenses increased 5.3% from a year ago, well below to rate of revenue growth. The key factor in this was limited growth in salaries and benefits, which accounts for more than three quarters to technology segment operating expenses. Going forward, we expect this expense category to align more closely with our trailing 12-months metrics. G&A expenses were higher at $7.3 million largely due to the amortization of intangible assets as a result of the acquisition of evolved technology in 2014. Technology segment earnings rose 28.5% to $22.6 million. Moving into the financing segment. We saw a revenues raise to 13.2% to $10.3 million from $9.1 million in the second quarter of fiscal 2015. As you know, results from the financing segment tend to uneven. In this quarter, the increase in revenue was the result of higher transactional gains. Operating expenses declined 12.7% to $3.1 million due to a higher reserve credit losses in the year ago quarter. Segment earnings totaled $4 million versus $2.7 million a year ago. Now, I will briefly address our consolidated year to date results. Net sales were up 6.4% to $606.2 million compared to $569.8 million a year ago, non-GAAP gross sales of product and services were up 6.4% to $763.4 million. The strong sales performance was driven by our technology segment, which was up 6.5% $587.5 million for the first half of fiscal 2016. Consolidated gross profit for the first six months of fiscal 2016 increased 8.9% to $131.1 million, compared to $120.4 million in the same period last year. Consolidated gross margin was 21.6% up from 21.1% in the first half of fiscal 2015, while gross margin on product and services was 19.7% an increase of 70 basis points. Adjusted EBITDA rose 19.3% to $44.1 million up from $37 million in the first half of fiscal 2015. Operating income rose 19%, $41.7 million up from $35.1 million in the first half of fiscal 2015. We had earnings per diluted share of $3.35 up 17.1% from $2.86 a year ago, excluding the gain resulting from the retirement of a liability in the first half of fiscal 2015 earnings per diluted share increased 21.8%. Turning now to the balance sheet, we ended the quarter with a cash position of $62.8 million compared to $76.2 million at the end of March, this reduced cash position was the result of working capital needs and the investment in our financing portfolio. While we saw an increase in the account receivable during the quarter, our cash conversion cycle in the technology segment remained consistent with last year at 12 days. As a result, we feel our balance sheet is very strong with a cash position to support both organic and accretive acquisitions. I’ll now turn the call over to Phil for closing remarks.

Thanks Elaine. In closing, I would like to like to reiterate that we believe our long-term strategy as proving successful as evidenced by our strong performance in the first half of fiscal 2016. The technology landscape continues to evolve and client - on our trusted partner to help them determine, identify and implement the best IT solutions both for today and for the future. The solid performance of our business particularly in focus areas like services and security, highlight our competitive advantages, again this quarter, we received several recognition awards from key partners including Cisco and Palo Alto Networks among others. As we continue to strengthen our relationships with the established and emerging vendors. Additionally, our balance sheet remain strong, providing financial flexibility to take advantage of opportunities to build our business. We continue to evaluate strategic acquisitions to expand our business, we also seek to investment in new sales and engineering resources and expanded our human capital to better serve our clients. With that operator, please open the call to questions.

[Operator Instructions] Our first question comes from the line of Bhavan Suri of William Blair. Your line is now open.

Hi guys this is Alfred tweaking in for Bhavan. Congrats on the quarter.

Thanks Al.

Thanks.

I just have a first question, you guys had a nice speed up for the gross sales, I remember last quarter, if I remember correctly, you had more companies that were having contracts on subscription and term based contracts. And I was just kind of wondering how that activity looked this quarter, when looking at the perpetual license deals versus some of those subscription and term based license deals and how that affected both net sales and your gross sales?

So I’ll try to take a shot at that Al. I don't have anything off the top of my head that I can give you exact percentages, but as the market continues to evolve and move to more of subscription model, consumption model, as a service model, we’re moving the solutions that we deliver to our customers to accommodate what they are looking for. I think if you look at our gross margins, we feel like we had a really good quarter for our gross margins. We feel that our gross margins are probably the highest in the industry that Phil had talked about. Our gross margins were 21.4% for the quarter, which is some of the highest in the industry and then in terms of when we look at the gross margins as well they were affected a little bit by a lower portion of gross sales that were classified as net. So that's kind of the pieces that I think would tie back to what you asked there. Did that give what you were looking for Al?

Yes that's exactly what I was looking for. And then just one additional question from me, for the tech segment earnings rose 28.5%, you guys are seeing nice leverage from a margin perspective and outside of gross margins which you said, you are an industry leader. Do you think the operating margins that you have today are sustainable throughout the end of the year?

So, no I think on that you have to really look at our historical results for the operating margins. We’re going to continue to invest in what I call customer facing sales and services headcount to address what I call the four Ss that we are trying to tackle with our customer services, security, software and solutions. So I think going forward with investing in net headcount, you would have to look more at the historical trends as it relates to operating margins.

Okay. Thank you guys very much and again congrats on the quarter.

Thank you.

Thank you.

Thank you. Our next question comes from Prabh Gowrisankaran of Canaccord. Your line is now open.

Hi, thanks for taking my question and congrats on a strong quarter.

Thanks Prabh.

Thanks.

Yes, the first question I had was just in terms of the strength that you saw in the Cisco practice, I know usually Q2 is a strong quarter and Q3 is slightly better. You hinted to Cisco being really strong with their year-end finish. Was there a particular area of strength, was it data center, routing switching, if you can add more color on the Cisco strength?

Well there is a couple of different things as you known Prabh, Cisco was about 50% of our revenue for this quarter. What’s nice about Cisco is they go across a lot of different areas meaning compute, security, data center and all the services that go with it. So as that kind of continues to evolve with some of the converged infrastructure plays that are out there with FlexPod and Vblock and so forth. I think you will continue to see that grow. We are also actively working with Cisco on building out our software capabilities. So they are a big part of strategy, they are about 50% of our revenue and I think you will continue to see that in future based on historical trends.

Good. And then the other question I had was just in terms of the security practice that you talked about. It looks it expanded - it’s still at 50% level, right. Do you see an inflection there as you are starting to creating it and hiring more people into the security practice?

Yes, Prabh if you saw we had 30 basis point bump from Q2 versus Q1 and it’s a total of our gross product and services. It’s one of the key focus areas. We believe it’s a hot market. And with some of the regulatory and compliance issues that are out there for our customers, we think it’s a big market that we can continue to grow in and outpace the market.

And then the other question I had was just in terms of the overall IT spend. I know storage has been soft, but other areas looks they are strong. If you can add any color on the macro that you are seeing in terms of what we should expect going forward?

Sure, I think from what we are seeing and what we are hearing from our customers that the market is stable. There is a nice demand for services and security in the market. In this quarter, we had a nice uptick in some verticals such as technology that made a difference in our numbers for this quarter. And I think cloud is kind of cooler more flexible option if you will as it continues to involve. So the hyper converged and place like that I think will continue to evolve as well. And as it relates to storage, I think a lot of customers are taking a look at both the legacy players in terms of what they have in the flash space, well as some of the emerging technologies and trying to make those decisions as they move forward.

The last question I had was just in terms of the receivables, it’s at all time high. Is it just the linearity in the quarter and that’s why it’s high at these levels. If you can provide any color in terms of is this new norm or how we should think about receivables?

Sure. In terms of our total accounts receivable, we have a near investment grade portfolio of accounts receivable. I talked earlier about our cash conversion cycle this quarter was comparable to the same quarter last year at a 12 day cash conversion cycle which is pretty good in the industry. In terms of the dollar amount, this particular quarter was a little bit back ended in terms of the amount that we invoiced. So I’m not expecting - there is no issues in our AR. We are very pleased with the progress that we are making in the collections process in the AR.

Great. And that’s all the questions I had.

Thanks Prabh.

Thank you. Our next question comes from Matt Sheerin of Stifel. Your line is now open.

Yes thanks and good afternoon everyone. Just a couple of questions from me. Just obviously you had a very, very strong quarter and last quarter I think you were talking just growing modestly above market obviously with this double-digit growth here much better. It sounds like it’s somewhat backend loaded. I’m trying to figure out the seasonality of your business and maybe it’s changed because of the focus of the business and the product focus. But as we look to the December quarter which going back years look like it’s up a couple of points sequentially. After this very strong quarter are you still expecting sequential growth in December or maybe a little bit more conservative for this very strong quarter here. Just trying to get a sense of the trajectory of your growth whether it will continue to accelerate or not?

Well a couple of different things Matt. So as it relates to the revenue side we agree with you. We feel we had a very good quarter and we are happy with the results. The sales and services team did a really nice job of executing on our overall plans as an organization and we believe we will continue to outpace the market as it relates to where the industry is going from an industry average standpoint. There are a couple of things that I think always happened in this quarter, you got fiscal year end which is in July and as noted little bit earlier with Prabh in terms of the percentage of our business with Cisco US led and the other few other verticals if you will that contributed to our numbers for this quarter. So, net-net we're happy with the results, the team really executed well for the quarter and we believe we’ll continue to outpace the market as we move forward.

Okay. I appreciate, that doesn't really answer the question, which is do you expect to growth sequentially in December? Which would be or basically, you are coming off of a 13% year-over-year growth which is very strong, are you expecting to continue that year-over-year growth rates?

So in terms of - as you know, Matt from our numerous meetings, we don't give forward-looking statements as it relates to that. So, I think, you are going to have to take a look at the historical and that's probably the best way for you to take a look at it.

Okay. That's fair enough. And on the SG&A, it was up only about 1.5 million or so on a very strong revenue growth and how much of the - I know that, as I think you said, Elaine 75% of the SG&A is tied to salaries and comp, are they variable comps? So, given the very strong sales in the quarter are variable comps that are either paid out in September or December, just trying to get a sense of what that SG&A number might look like in the December quarter?

Matt, I think as I said in my comments, I think you really should look at our historical norms in order to look at the quarters to come in terms of our SG&A percentage in OpEx percentages going forward.

Okay. So does that mean, because SG&A as percentage fell well below where you have been? You have been 14% or higher, so would that mean that you are expecting to go back above that? And then also I guess related to that Mark you talked about some headcount additions, can you be more specific about what you're looking to doing and what the investments might entail in terms of SG&A?

Well in terms of headcount is pretty simple, as what we've called customer facing both sales and services. So, on the sale side it be in the security space and folks that consult services as well as software and other services side, it's continuing to add both presales, additional managed services headcount and things along those lines as we go forward. So, if I could fence it in for you a little bit Matt, if you think about the four Ss in terms of services, security, software and solutions, those would be the areas that we're going to continue to invest and headcounts to provide the solution that our customers are looking for. As it relates to the SG&A, I think as Elaine alluded, I think the easiest way for you to look at the historical and as our variable comp, just so you understand, we just have standard comp plans where our reps are paid on gross profit. So, if that helps? I don't know if that helps around your variable piece.

Okay. And looking at the markets, the SLED market, it sounds like that was up sequentially, it was up primarily because I know you don't play very big in the federal market was that primarily state and local or was the education market also strong. CDW commented at this morning that the education was a little bit softer than they expected because of timing of e-rate funding, I'm not sure what you're seeing there?

Well there is couple of things, as it relates to e-rate, you applied for e-rate you then accepted and then overtime you have to kind of pull that through to fruition. So, e-rate was a small part of that if you will, but it was a part of it. Our SLED business in the higher education space, we're starting to see lot more opportunities as it relates to security and some other areas that's we're starting to see come to fruition based on the security plans that we built in the SLED space. As it relates to verticals that we had a big uptick in our technology vertical compared to prior years and one other thing. We're continuing to build out healthcare plans with a lot of these major vendors and that includes some of these providers like Meditech and Epic, so we're starting to see that come to fruition as it relates to healthcare. So those would be the main ones and quite honestly our top five verticals are the same five verticals every times, so technology, telecom, SLED, healthcare and finance.

Okay. And did you have any 10% customers in the quarter?

Well we don't do it for the quarter, we only do that on an annual basis. So at the end of last fiscal 2015, we did not have any customers that were 10% of our revenues.

Okay. Thanks a lot Mark, I appreciate it.

No problem Matt, we will see you soon.

Thank you. Our next question comes from Matthew Galinko of Sidoti. Your line is now open.

Hey guys. Thanks for taking my question.

Hey Matt.

Hi Matt.

So, I guess you mentioned share gains a couple of times on your prepared script and I’m just wondering how you are measuring it, is it sort of just comparing your growth rate to the industry or are you noticing better win rates? Just a little more color on that.

Hey Matt a lot of that has to do with how we're going to market and what we're trying to sale, so part of our overall plans is getting a little tighter in our execution around how we're covering the accounts not only from a rep standpoint, but also from a marketing and social media and things along those lines. We also have more granular plans in terms of how we’re trying to uncover net new accounts and how we expand those into bigger existing accounts overtime. So those are some of the things that you see and as we noted, we got over 3,000 customers now that we can go back to and sell across a lot of different areas that’s helping us both from a revenue standpoint as well as from a GP standpoint, gross profit standpoint.

Got you and then maybe one more on the healthcare when you highlighted, I think you mentioned started with an audit progress to pretty involved process, so is that typically how you are seeing security engagements work their way in and do you pipeline of audits that you are performing and hope to expand into larger relationships or a little bit more of that as well?

All right Matt, just in case our competitors will listen, I won’t talk about our pipeline or forecast, but what I can tell you on the security side it’s pretty simple it’s all about kind of keeping the bad buys down in terms of securing the parameters. Once they are in if they are we are just keeping the data secure from a data center standpoint, but more importantly its start with our security services which is a combination of assessment and security health check. So what happen with this customer was it was the security health check that we did for the customer and found that they had [indiscernible] on an audit that was done and then from there we were able to go in and kind of create – here is we had a security gaps, where we solved that with the parameter solution that we did and then on top of it we then proposed our security stack which was really more of a combination, not only just on the end point, but also the analytics and intelligence they needed to kind of run their business going forward. I think the other thing to note from a security that I wanted to go back to - I want to mention that [indiscernible] as well as what we are seeing in this security space, if you look at Cisco’s acquisition of Lancope right. There is a vendor that we’re working with as it relates to source prior they are now expanding their capability into the networking analytics space, which is what we know very well from a networking standpoint. So we’re able to go back sell security in that space back to our existing customers. The other thing that’s probably important to note, we were just recently named Palo Alto Networks growth partner of the year as well. So we’re putting a lot of focus on the key vendors in each of those spaces and then manning our sales and services teams with the tools they need to go in and sit with our customers understand what their needs and issues are and then build solutions to address it. That's what happened with that customer.

Excellent, thank you.

No problem thanks, thank you.

Thank you. And at this time, I would like to turn the call over to Phil Norton for any closing remarks.

We would like to thank you for joining us today and we look forward to speaking with you again on the next quarter.

Ladies and gentlemen thank you for your participation on today’s conference. This concludes your program. You may now disconnect. Everyone have a great day.