ePlus Inc (PLUS) Q3 2019 Earnings Conference Call Transcript

Protection and data loss were their key concerns. ePlus delivered a cloud usage and risk workshop to help the customer understand the challenges they would face from a business, technical and compliance standpoint in these SaaS environments. ePlus helped the customer evaluate the top cloud security solutions in the market and facilitated the selection of the best tools and processes to gain and maintain compliance with multiple internal and external rules, while securing their data.

Finally in the third quarter, we successfully negotiated the SLAIT acquisition which was completed in mid-January. SLAIT satisfies many elements of our acquisition strategy. Based in Virginia Beach, it strengthens our geographic presence in key markets including the Tidewater and Richmond regions. With annual revenues of over $100 million, this acquisition brings us a large customer base with concentration in the higher education and state and local government space and in the healthcare verticals.

Importantly, SLAIT complements our existing expertise and national practices focus on IT security and hybrid cloud and brings ePlus additional consultative services in the areas of governance, risk and compliance or GRC and adds bespoke helpdesk and managed services solutions as well as a strong staffing practice. Over time we will bring these new capabilities to our existing clients and bring core ePlus services and offerings to SLAIT's customer base.

SLAIT's focus on providing consultative solutions along with security, advisory and managed services is fully aligned with the offerings that ePlus has been building out over the last several years which tend to be higher margin and represent recurring demand. From a strategic standpoint, we are very enthusiastic about this combination and we are pleased to welcome SLAIT's 300 associates to the ePlus team.

In closing, we are very pleased with the progress we have made in building our footprint and geographic reach, expanding and enhancing our solutions and service offerings and growing our annuity services and revenues. The expansion of ePlus services business has been a positive contributor to our gross profit performance and we have acquired a complementary services portfolio through the SLAIT transaction.

With that, I will turn the call over to Elaine Marion, our CFO to review our third quarter and nine month results. Elaine?

Elaine Marion -- Chief Financial Officer

Thank you, Mark and thanks to everyone for joining our call. Our net sales in the third quarter of fiscal 2019 increased 0.4% year-over-year to $345.7 million and gross profit increased 8.1% to $82.9 million. Our consolidated gross margin expanded 170 basis points to 24%, driven by a 160 basis points of margin improvement in the technology segment which I'll discuss further in a moment with the remaining contribution from the financing segment.

Operating income increased 22.2% to $20 million year-over-year more than compensating for a 4.3% increase in operating expenses. Higher operating expenses reflected a 4.7% increase in salaries and benefits, resulting from higher variable compensation that was directly tied to higher gross profit. Our headcount was down 19 employees year-over-year, however, our headcount increased modestly from 1,255 at the end of the second quarter to 1,265 at the end of the third quarter. Adjusted EBITDA was up 17.7% year-over-year and amounted to $25.6 million, while our adjusted EBITDA margin expanded 90 basis points to 7.4%.

In the last year's third quarter, we had a 4.2% tax rate due to the provisional adjustment for our deferred tax balance as well as an adjustment of our tax provision for the new corporate tax rate which resulted in a tax benefit of $5.7 million. This year, our third quarter tax rate was 28.3% resulting a net earnings of $14.9 million, a decrease of 4.6%.

Note that sequentially our tax rate went up from 27.7% to 28.3% as we have had said on our previous calls, we expect our tax rate to range from 28% to 29% for fiscal 2019. Fully diluted earnings per share were $1.10, down slightly from last year's $1.11. Conversely, non-GAAP diluted EPS amounted to $1.29, representing a 17.3% year-over-year increase. Our weighted average diluted share count totaled $13.5 million compared to $14 million in the year ago quarter.

Now, let me give you more color on our technology segment performance. Net sales amounted to $334.7 million, 0.8% ahead of last year's third quarter mainly reflecting higher demand for our products and services that more than offset the last portion of the competitive -- competitively bid project we completed in last year's third quarter. Technology in SLED continue to be our largest end markets on the trailing 12-month basis accounting for 22% and 17% of the technology segment net sales respectively. Telecom, media and entertainment represented approximately 14% of net sales and healthcare 14%. The balance includes financial services at 15% and 18% from several other client types.

Adjusted gross billings amounted to $478.4 million compared to $465.2 million in the same period a year ago, reflecting a 2.8% increase. The adjustment from adjusted gross billings to net sales was $143.7 million, representing 30% compared to $133.2 million or 28.6% in the year ago quarter, as a greater proportion of sales derived from third-party maintenance, subscriptions and services.

Our gross profit grew 8.6% to $74 million while our gross margin expanded by a 160 basis points year-over-year to 22.1%, reflecting the benefit from a more profitable product mix and higher sales of third-party maintenance and subscription. As we previously mentioned in last year's third quarter, we completed the remainder of a large competitively bid price project that partially contributed to the year-over-year increase in our gross margin. Our technology segment operating income amounted to $14.7 million, up 28.4% compared to a $11.4 million in the year ago quarter, reflecting our higher gross profit year-to-year and operating leverage. Adjusted EBITDA increased 20.7% to $20.1 million.

Now let me share more details about the financing segment performance. As a reminder, the results from the financing segment had historically fluctuated due to the timing and nature of originations, transaction gains and post-contract transactions. We reported net sales of a $11 million representing a 10% decline from $12.2 million in the year ago quarter as a result of lower proceeds from a large sale of off lease equipment which was partially offset by higher portfolio earnings and transaction gains. Despite lower net sales, our financing segment gross profit in the third quarter for fiscal 2019 was up 4.6% year-over-year to $8.9 million. Operating expenses were flat at $3.6 million, operating income amounted to $5.4 million, up 8%.

I will now turn to our consolidated year-to-date results. Net sales for the first nine months of fiscal 2019 decreased 3.8% to $1.05 billion. Net sales in our technology segment decreased 3.5% to $1.02 billion. Adjusted gross billings of products and services decreased 0.7% to $1.45 billion, while consolidated gross profit increased 3% to $249.1 million.

Our consolidated gross margin expanded by a 160 basis points to 23.8% and this was supported by gross margin in the technology segment which increased by 160 basis points to 22%. Adjusted EBITDA increased 1.7% to $80.8 million while net earnings grew 4.1% to $48.1 million and EPS grew 7.3% to $3.54 per diluted share. Non-GAAP diluted earnings per share were $4.10, representing a 3% year-over-year increase.

Moving to the balance sheet. We ended the quarter with cash and cash equivalents of $84.3 million as compared to $118.2 million at March 31st, 2018, mainly due to an increase in working capital for the technology segment, investments in our financing portfolio and approximately 160,000 shares repurchased for $12 million. Inventory levels increased a $11.5 million to $51.4 million from the fiscal year end.

As we have previously mentioned our inventory levels vary and are dependent upon customer-specific projects. Our cash conversion cycle increased 26 days, up from 25 days in the second quarter of fiscal 2019 and up from 24 days a year ago. Overall, our balance sheet provides us with significant financial flexibility. Lastly, we are very pleased with our recent acquisition of SLAIT. Let me give you some color on key financial aspects of this transaction.