Edited Transcript of PLUS earnings conference call or presentation 7-Nov-18 9:30pm GMT

As we've discussed for several quarters, our business model is changing as a result of our larger portion of sales recognized on a net basis and the effect of ratably recognized revenues, which is overall, very favorable to our gross profit and will, over the long term, lessen quarterly volatility but does add to the pressure on top line comparisons.

Given these marketplace changes and that our business is solution-oriented and not focused on commodity products, we have pointed to gross profit as an important metric for investors to use to track progress at ePlus. This quarter is a good example of this trend as our technology segment year-on-year gross profit increased slightly to $77 million, an all-time high, despite revenues declining 6.7%. Sequentially, gross profit increased by almost 5.7% against the 3.5% decrease in revenues.

Our focus on transforming our business to meet the high demand areas of cloud, security and digital infrastructure, areas with faster growth in general IT spending, continues to help us gain share with existing midmarket and enterprise clients and expands our customer base. We will continue to drive collaboration between our cloud, security and digital infrastructure practices to expand the value we provide to them. This includes leading with our consultative and advisory services and then providing managed services to create value and impact for our customers.

Our security practice continues to move beyond point solution sales to provide business outcome bundles. Examples of these bundles include helping to stop disruptive cyber-threats, finding ways to reduce the attack service and securing multicloud workloads. Recently, we provided a cloud usage and risk workshop that led to a multimillion dollar deal with a healthcare customer. We provided a risk assessment and gap analysis that helped the customer understand what data was critical and where it resided. This led to additional opportunities around managed security incident and event management and a next gen firewall replacement. These types of solutions and deals have helped to increase our sales of security products and services by 9.1% for the trailing 12 months ending September 30, and represented nearly 19% of our adjusted gross billings. As cyberattacks make headlines every day, demand for enhanced security products, software and services will continue to grow, and ePlus is positioned to help our customers with these mission critical time-sensitive needs. Additionally, our customers increasingly require project lifecycle solutions from strategic planning through deployment and ongoing support. A good example of how ePlus is succeeding in delivering these services to an enterprise customer is our recent project for an international automotive manufacturer. This engagement allowed ePlus to provide an upfront assessment, design an implementation services, product sales as well as create long-term follow-on revenue, including enhanced maintenance support, managed out tasking and provisioning full-time staffing resources to help with support and management of their IT environments.

This is a prime example of how our business has transitioned to a more services-led comprehensive customer engagement model. Also ePlus industry-leading gross margins are closely tied to our investments in highly qualified customer-facing technical and sales professionals that have enabled us to develop a more profitable business mix and evolve into an IT solutions and services company.

In the second quarter, we saw the continued expansion of our enhanced maintenance and managed services portfolio, which are recognized ratably but carry higher margins and give us improved visibility and the ability to build annuity-quality revenue streams.

We continue to realign resources to ensure that our engineering and sales talent is fully utilized and that their capabilities are closely tied to customer demand dynamics. This has involved rationalizing and realigning certain areas and building out others. While the new professionals require some time to ramp, the staff that we brought on board enhance our competitive positioning and give you further insight into the growth potential we see for our business.

As you know, we have added our capabilities in our high-growth areas with acquisitions like OneCloud and IDS that have expanded and enhanced our cloud capabilities and offerings. ePlus has the ability to invest in newer technologies, solutions and services that our customers need to succeed in today's market. By leveraging our strong balance sheet and financial resources, we continue to seek acquisitions that will add to our service offerings and geographic footprint.

With that overview, I'll now turn the call over to our CFO, Elaine Marion, to review our second quarter and year-to-date fiscal 2019 results. Elaine?

--------------------------------------------------------------------------------

Elaine D. Marion, ePlus inc. - CFO [4]

--------------------------------------------------------------------------------

Thank you, Mark, and thanks to everyone for joining our call. I am pleased with our ability to continually improve gross margin by remaining focused on a more profitable business mix as well as capitalizing on the industry shift towards as-a-service or subscription models, which we generally recognize on a net basis. We are also seeing the benefit of expansion of ePlus enhanced maintenance support for top tier vendors. The changing industry landscape can create pressure on our top line growth, but over time, annuity services will provide additional visibility and revenue stability.

Our net sales in the second quarter of fiscal 2019 were $345 million, down 7.1% year-over-year, reflecting the impact of a large project that we partially delivered to a major enterprise customer in the year-ago quarter, and a larger proportion of sales recognized on a net basis. The decline in revenue, coupled with lower postcontract earnings due to early terminations of several large leases last year in our financing business, led to a 2.4% year-over-year gross profit decrease to $85.5 million. Despite the decline, we still reported 120 basis point gross margin expansion to 24.8%, mainly driven by business mix in our Technology segment.

Operating expenses increased 3.7% to $60.9 million, primarily due to higher salaries and benefits despite a year-over-year headcount decrease of 2.1% to 1,255 employees. The increase was primarily due to the inclusion of IDS for the full quarter of fiscal 2019 compared to less than 1 month a year ago. Sequentially, our headcount increased modestly from 1,249 at the end of the first quarter as we continue to opportunistically hire, while at the same time, rationalize our overall headcount. As a result of lower gross profit and higher operating expenses year-to-year, our operating income of $24.6 million declined 14.8% year-over-year. Adjusted EBITDA was down 10.3% year-over-year and amounted to $29.9 million due to the same reasons I just mentioned. While our adjusted EBITDA margin declined 30 basis points to 8.7%.

Our net earnings increased by 4.5% to $18 million, while fully diluted earnings per share were $1.33, up 8.1% from last year's $1.23, due to the benefit of a lower effective tax rate of 27.7% compared to 40% in the year-ago quarter.

Adjusted to reflect this tax benefit and excluding acquisition-related expenses, other income on a tax-adjusted basis and share-based compensation during the quarter, non-GAAP diluted EPS were $1.53, down 8.9% year-to-year. Our weighted average diluted share count was 13.6 million for the September quarter, down from the prior-year second quarter share count of 14 million due to share repurchases. Note that sequentially, our tax rate went up from 25.7% to 27.7%, and we expect our tax rate to be between 28% and 29% in the remaining quarters of fiscal 2019.

Now let me give you more color on our Technology segment performance, which accounted for 97% of revenue this quarter. Net sales amounted to $334.8 million, 6.7% below last year's second quarter due to the impact of a large project that we partially delivered to a major enterprise customer in last year's second quarter, and a larger proportion of sales recorded on a net basis. While the majority of the revenues on this project were recognized in the first half of last year, there was some contribution in the third quarter and a small tail in the fourth quarter.

In terms of the customer mix in the Technology segment, technology and SLED continue to be our largest end markets on a trailing 12-month basis, accounting for 23% and 17% of the Technology segment net sales, respectively. Telecom, Media and Entertainment represented approximately 13% of net sales, and Healthcare, 15%. The remainder includes Financial Services at 15% and 17% from several other client types. Adjusted gross billings amounted to $485.9 million compared to $504.5 million in the same period a year ago, reflecting a 3.7% decrease due to the large delivery last year I mentioned.