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ePlus Inc (NASDAQ:PLUS)
Q3 2020 Earnings Call
Feb 5, 2020, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, welcome to the ePlus Earnings Results Conference Call. [Operator Instructions]. I would like to introduce your host for today's conference, Mr. Kley Parkhurst, SVP. Sir, you may begin.

Kleyton Parkhurst -- Senior Vice President and Assistant Secretary

Thank you for joining us today. On the call is Mark Marron, CEO and President; Darren Raiguel, Chief Operating Officer, 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 31st, 2019, and our Form 10-Q for the quarter ended December 31st, 2019, 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've included a GAAP financial reconciliation in our earnings release, which is posted on the Investor Information section of our website at www.eplus.com.

I'd now like to turn the call over to Mark Marron. Mark?

Mark Marron -- Director, President and Chief Executive Officer

Thank you, Kley. And thank you, everyone, for participating in today's call to discuss our third quarter. We are pleased to report solid fiscal 2020 third quarter results which built upon a strong first half and position us for a year of significant growth. There are several important takeaways from our year-to-date results.

First, we are successfully executing on our strategy of investing in the higher growth areas of cloud, security and digital infrastructure adding customer facing headcount, up selling our products and services and executing strategic acquisitions to expand our customer base and in solution offerings.

Second, our balanced approach of organic and acquisition growth is enabling ePlus to gain market share and build a base of annuity quality revenue that provides a growing source of predictable business. Lastly, our third quarter and year-to-date results highlight that our portfolio approach of offering technology solutions, supported by a broad range of additional services and financing options, resonates well with our expanding base of mid-market and enterprise customers.

In the third quarter, we posted a 24% increase in net sales and our gross profit grew 25% due to improved gross margin, while operating income increased 31%. Technology product sales were up 20% year-on-year and services increased an impressive 43%. Both of these areas showed acceleration from the pace of growth in the first half of the year.

Our financing segment is benefiting from synergies with our technology segment, demand from our vendor financing programs, and federal IT spending. Transaction sizes in the federal marketplace are large and flows are difficult to project, but we believe federal IT spending offers future opportunities for ePlus.

Let me speak more on our 24% sales growth in the third quarter which compared favorably with the 13% that we reported for the first half of this fiscal year. We had several successful wins via our land and expand initiative where we aggressively pursue business with new customers or broaden our reach within existing customers with the intention to sell other technologies and services at higher margins.

Also, we saw a considerable pickup in our service offering sales in the third quarter, particularly in staff augmentation which can increase customer stickiness and is a high demand solution in today's job market. Staff augmentation service margins are generally higher than our product margins, but tend to yield lower margins than our professional and managed services. From a strategic standpoint however, staff augmentation can be a gateway to expanding customer wallet share. Security products and services grew 15% year-on-year on a trailing 12-month basis and represented roughly one-fifth of our adjusted gross billings.

Security continues to offer a solid runway for growth for ePlus. ePlus retained its industry-leading margin profile in the third quarter, expanding gross margin to 24.2%, 20 basis points ahead of the same period last year. We continue to invest into people, solutions and acquisitions needed to serve our customers' needs today and in the future. Our investments to date have paid off in sales growth and industry leading margins, and we are committed to staying ahead of the curve.

Some examples of this include providing cloud assessments that uncover challenges our customers face in the current IT infrastructure, identifying areas of potential cost savings and efficiency gains and creating strategies to help our customers meet current and future business needs. These often result in structured multi-year contracts to help customers offset large capital expenses upfront and realize the full benefit of hybrid cloud solutions to meet their growing needs.

Other examples include helping customers streamline their operations and minimize the number of outsourced providers by providing a complete lifecycle program for IT infrastructure management, and finding ways to make it easier for our customers to acquire needed technology such as providing automated ordering processes for pre-selected equipment bundles or utilizing a finance structure that can provide capital and budgetary benefits to the customer.

Turning to the ABS acquisition, which closed in late August. The business has integrated well into our portfolio expanding our Mid-Atlantic footprint while adding to our service offerings and boosting our managed service capabilities in particular. The combination has brought additional selling opportunities in both the ABS and ePlus client base and we are in the early stages of capitalizing on these and converting them to revenue.

One example of this is a large transaction in the educational space from an ABS customer that we were recently awarded that leveraged our financing capabilities to help them procure the technology they needed now while meeting budgetary constraints. In summary, the third quarter was a period of strong execution and market share gains for ePlus. I will now turn the call over to our CFO, Elaine Marion, who will walk you through a detailed review of our third quarter results. Elaine?

Elaine Marion -- Chief Financial Officer

Thank you, Mark, and thank you everyone for joining us today. Let me share some more details of our strong financial performance in the third quarter of fiscal 2020. Net sales increased 24.1% to $429 million from the prior fiscal year's third quarter, driven by strong performance and market share growth from both segments.

Net sales in the Technology segment increased 22.7% year-over-year to $410.6 million reflecting 20.3% and 43.2% growth in product sales and service revenue, respectively. Similar to the second quarter of fiscal 2020, the increase in services revenue was across the board in professional services, managed services and staff augmentation.

While the SLAIT and ABS acquisitions were the primary contributors to service growth for the technology segment overall, organic was the primary growth driver generating roughly 65% of the increase in adjusted gross billings. Financing segment revenue of $18.4 million was up 67.7% year-over-year, mainly due to higher transactional gains primarily from large government-related business.

Please keep in mind that results from our financing segment tend to be uneven from period to period and may be driven by large transactions. Looking at our end markets in the technology segment, on a trailing 12-month basis, our largest customer vertical continues to be technology, accounting for 22% with SLED and telecom, media and entertainment each accounting for 17%. Healthcare and financial services accounted for 15% and 14% respectively, while the remaining 15% was distributed among several other client types.

Adjusted gross billings in the technology segment of $586.3 million increased 22.5% compared to $478.4 million in the same period a year ago, mainly driven by strong demand from larger customers, new wins from existing customers as well as contributions from the acquisitions of SLAIT and ABS technology.

The adjustment to adjusted gross billings to net sales was 30% flat year-over-year and declined sequentially. Consolidated gross profit was up 25.1% and amounted to $103.7 million compared to $82.9 million in the prior fiscal year third quarter. Consolidated gross margin expanded 20 basis points to 24.2% year-over-year. Gross profit for the technology segment increased 18.4% to $87.6 million and gross margin was 21.3% compared to 22.1% in the year ago quarter.

Technology product margins narrowed 70 basis points to 19.2% due to competitive pricing for existing customers in an effort to expand our sales positioning as well as additional sales to large customers. Services gross margin was 36.4% compared to 40.7% in the third quarter of fiscal 2019 due to a larger proportion of staff augmentation and enhanced managed services that yield lower margins. In the financing segment, gross profit increased 80.5% to $16.1 million primarily due to the increase in transactional gains.

Our consolidated headcount at the end of the third quarter was 1,602 compared to 1,265 in the year ago quarter, the addition of SLAIT and ABS technology added an additional 301 employees as of December 31st, 2019. Consolidated operating expenses increased 23.1% to $77.4 million reflecting increases in headcount as well as salaries and benefits, variable compensation, and healthcare costs.

Salaries and benefits rose primarily due to SLAIT and ABS acquisitions, and higher variable compensation resulted from the increase in gross profit. We are very pleased with our consolidated operating income increase of 31.2% to $26.3 million. Consolidated net income and diluted earnings per share were up 31.5% and 32.7% respectively to $19.6 million or $1.46 per diluted share.

Our effective tax rate for the quarter was 28.3% consistent with the prior year third quarter. In the fourth quarter of fiscal 2020, we expect our tax rate to be approximately 28.5%. Adjusted EBITDA increased 24.7% year-over-year to $31.9 million. While our adjusted EBITDA margin was 7.4%, flat when compared to the third quarter of fiscal 2019.

Non-GAAP earnings were $1.64 per diluted share, up 27.1% from the third quarter of fiscal 2019. Our diluted shares outstanding totaled $13.38 million compared to $13.54 million in the year ago quarter due to share repurchases. I will now turn to our consolidated year-to-date results. Net sales for the first nine months of fiscal 2020 increased 16.7% to $1.22 billion.

Net sales in the Technology segment were up 15.8% to $1.18 billion and adjusted gross billings increased 18.5% to $1.71 billion. Consolidated gross profit amounted to $299.4 million, reflecting a 20.2% increase. Our consolidated gross margin expanded by 70 basis points to 24.5% and our technology segment gross margin increased 20 basis points to 22.2%. Net earnings grew 16% to $55.8 million, diluted earnings per share were $4.16, 17.5% ahead of last year.

Adjusted EBITDA increased 18.6% to $95.8 million and non-GAAP diluted earnings per share increased 19.3% to $4.89. Moving to the balance sheet, we ended the quarter with cash and cash equivalents of $59.6 million compared to $79.8 million at March 31st, 2019. The decrease is attributable to the ABS acquisition in August 2019, investments in our financing portfolio and share repurchases.

Inventory levels increased 20.9% to $61.1 million compared to the end of fiscal 2019. As a reminder, our inventory levels vary depending on specific customer projects under way. Our cash conversion cycle at the end of the quarter was 26 days, similar to the year-ago quarter and up from 23 days in the second quarter of fiscal 2020. In terms of capital allocation, we strategically balanced making investments in our business through acquisitions and financing portfolio investments to drive growth as well as share repurchases.

Thank you for your time today. I will now turn the call back to Mark.

Mark Marron -- Director, President and Chief Executive Officer

Thanks Elaine. Our year-to-date results have set the stage for fiscal 2020 to be a year of considerable growth for ePlus. We have proven our ability to capture demand from our base of mid-market and enterprise customers for complex solutions that optimize and protect their IT initiatives. And we continue to explore opportunities to complement our organic growth with acquisitions that would expand our technology capabilities and geographic reach. Operator, I would now like to open the call for questions.

Questions and Answers:

Operator

[Operator Instructions]. Your first question comes from the line of Maggie Nolan from William Blair.

Maggie Nolan -- William Blair -- Analyst

Hi. Strong quarter. I was interested in the nature of the land and expand engagements that you commented Mark, that you saw success this quarter. Can you give us a little more detail on what type of work this is and maybe the longevity of these types of engagements?

Mark Marron -- Director, President and Chief Executive Officer

So, hey Maggie, first off Mark here. Thanks for the question. On the land and expand, that's something, as you know, we've been doing for years we've been fairly successful both in terms of bringing on net new customers and/or working within existing customers to get into new divisions. Normally the way it works is across all the different solution sets that we sell, everything from our cloud, security, digital infrastructure offerings as well as staffing and services. So it really varies based on the customer. What it normally does in the beginning, the margins are a little bit lower and then over time, we try to show the value within the customer of all the different types of ways we might be able to help them.

So land and expand will normally drive up our sales originally and potentially affect our gross margins a little bit in the beginning and then over time they come back to the levels that they're at.

Maggie Nolan -- William Blair -- Analyst

Now, these engagements that affected this quarter, were these with new customers or existing customers?

Mark Marron -- Director, President and Chief Executive Officer

Both.

Maggie Nolan -- William Blair -- Analyst

And how -- roughly how many were there in and do the margin profiles vary across those given that it was both new and existing customers?

Mark Marron -- Director, President and Chief Executive Officer

Yeah. It varies. The margin profile vary. To give you a feel at a very high level, our top 20 customers as well as our, what I'll call other customers both grew at significant rates. With the land and expand, we had a few large customers that grew nicely on net sales with a little bit lower margins than we're used to, and then we would expect over time to kind of grow that.

To give you a little more color maybe on sales overall, in terms of our overall adjusted gross billings, two-thirds was organic and a third was from M&A, just to maybe fill in the picture, if you will.

Maggie Nolan -- William Blair -- Analyst

Thank you. And then, as you see services continue to increase as a percentage of the business and the mix obviously is changing. How much has annuity revenue changed as a mix of total revenue over the last couple of years?

Mark Marron -- Director, President and Chief Executive Officer

Annuity is a nice piece for us, Maggi. It continues to grow in terms of total contract value, MRR, and as we move through the process, with this, if we run our business right, our margin should continue to increase in the annuity space. What you're seeing with some of our service margins right now we've actually increased our staffing revenues as it relates to services which the margins are a little bit smaller than our traditional annuity and professional services. What's nice about it, it's kind of the foot in the door sometimes into customers that we then go back and try to sell everything else that we have. But annuity is growing nicely, quarter-over-quarter, year-over-year.

Maggie Nolan -- William Blair -- Analyst

Thank you. And then last one from me. Just your updated thoughts on the macro environment, thoughts around what demand looks like, the supply chain, all those types of things. Thank you.

Mark Marron -- Director, President and Chief Executive Officer

Okay. So far in terms of overall demand, haven't seen any slowdown in terms of demand. In terms of our forecast for the quarter and looking at another quarter still have not -- have not changed from prior quarters. A lot of things going on, obviously in an election year that you never know what's going to happen. And then the coronavirus, two pieces to it, if maybe you're touching on that somewhat. One in terms of actual revenue we have little to no exposure as it relates to Asia-Pac. We are tracking it from a supply chain logistics with our different vendor partners, it's a little early, as everybody knows they've kind of pushed some things out in China.

So we're going to track that closely and see if it potentially could affect things over time, but so far, nothing there. Well, I should say it's too early, Maggie.

Maggie Nolan -- William Blair -- Analyst

Thanks, Mark.

Mark Marron -- Director, President and Chief Executive Officer

Okay. We'll see you soon, Maggie.

Operator

Your next question comes from the line of Matt Sheerin from Stifel.

Kurt Swartz -- Stifel Financial Corp. -- Analyst

Yes, hi, this is Kurt Swartz on for Matt Sheerin. Thank you for taking my questions.

Elaine Marion -- Chief Financial Officer

Hey, Kurt.

Mark Marron -- Director, President and Chief Executive Officer

Hey, Kurt.

Kurt Swartz -- Stifel Financial Corp. -- Analyst

So, just starting off touching on the operating margin profile, I'm wondering how we should perhaps think about that going forward, it seems as though the gross margin has been steadily improving, but opex has been growing as a percentage of sales over the past few quarters.

So I'm wondering if that, first of all, reflects sort of continued investments in the business overall, or whether that's more related to the acquisitions and also when we should perhaps be expecting to see some leverage kick in and drive operating margins higher?

Mark Marron -- Director, President and Chief Executive Officer

Yeah, good question. So it's actually two things. It's the acquisitions and some of the acquisition-related costs at this point. And also the investments that we're making. So we've been fairly clear cut over the -- over the prior years, as we believe we have the ability to grab market share based on our capabilities in some of the focus areas that we have. So we're going to continue to invest not only in customer-facing headcount, meaning sales and services that can support our existing customers, but also reach out and touch new customers. And we're also investing in some of the newer technologies that are coming out.

So it is affecting our opex margins currently. We watch it closely and over time we would expect to get operating leverage.

Kurt Swartz -- Stifel Financial Corp. -- Analyst

Understood. And then just following up on your commentary on the demand outlook, particularly for 2020. As you know, we've been coming off of a very strong PC refresh cycle in 2019. And I know that's not really an area you particularly play too much in. But as we sort of move into 2020, I guess part of the expectation is that maybe some of that spending may shift into areas such as software and security.

So I'm wondering how you think ePlus is positioned sort of moving into the year and whether you stand to potentially benefit from some of these spending shifts?

Mark Marron -- Director, President and Chief Executive Officer

Yeah. And Kurt, I think we're really well positioned. So you hit on something that is true. In terms of the PC refresh Windows 10, we didn't really play in that, I'll call it a commodity play, maybe a little bit more than that, but we didn't get the uptick in sales because we rarely if ever played in that space.

We've stayed in the cloud, security digital infrastructure. Do we think we're positioned in the software and security? Yeah, very much. Our security was up 15% trailing 12 months from an adjusted gross billings standpoint and our software subscription licenses were up significantly, I want to say 57%. I'd have to double check that. But it's in that range.

But I think we're well positioned with where we think the market is going and where we are investing in resources and new technologies.

Kurt Swartz -- Stifel Financial Corp. -- Analyst

Great, thank you very much. That's all from me.

Mark Marron -- Director, President and Chief Executive Officer

Okay, Kurt. Take care. We'll see you soon.

Operator

Your next question comes from the line of Greg Burns from Sidoti & Company.

Gregory Burns -- Sidoti & Company , LLC -- Analyst

Good afternoon. I just wanted to touch on some of the larger land and expand deals that you -- you had mentioned. Was there any one or two deals in particular that landed in the quarter or was it just kind of a more broad based number of larger type products -- projects that closed in the quarter. I just wanted to kind of get a feel for -- as we look forward are we going to be coming up against tough comps because of any one large particular deal this quarter or was it just kind of a broad-based band [Phonetic] that you saw in the quarter?

Mark Marron -- Director, President and Chief Executive Officer

Yeah. Hey, Greg. Good question. So two things, one, it was across multiple customers, if you will, but there was some pull forward deals probably to the tune of about $15 million or $20 million that would probably be tough to replicate, not so much from the land and expand, but more year-end, I'll call it budget flush, if you will.

So across multiple customers, probably $15 million to $20 million that was kind of a pull-through or pull forward if you want to call it from year-end budgets and that would be about it from this end.

Gregory Burns -- Sidoti & Company , LLC -- Analyst

Okay. Is that pull forward something you see every year or was that kind of unusual for this quarter?

Mark Marron -- Director, President and Chief Executive Officer

I think that was a little -- a little unusual for the quarter. You always see pull forward in every -- I'll call it calendar year end, but this was a little outside the norm in terms of this customer and size. So I would say it's -- it's not the norm as it relates to that. The other thing is, related to our numbers overall, may be a little bit different than land and expand. We also had a real solid quarter in terms of some large deals with our finance group.

So there were two things that kind of came into play there. Not so much to the land and expand on finance, but just also plays in.

Gregory Burns -- Sidoti & Company , LLC -- Analyst

Okay. And that -- I guess leads to my next question. Those -- the large transaction games in that side of the business, do you have visibility into -- I mean it's difficult to model, I guess when these large it actually deals on the financing side of the business portfolio [Phonetic]. Is there any kind of color or commentary you can give us? Do you have a pipeline of these potential transactions, or do they just come when they come, like how should we think about modeling that side of the business?

Mark Marron -- Director, President and Chief Executive Officer

Yeah, I -- that's a tough one. Greg, we've talked about it throughout the years and the quarters. Our leasing, our financing business is a lumpy business always was, always will be. These deals, bigger deals are hard to forecast only because of their size, how often they come up, all the different variables that go into selling them. So when we get them, we kind of pat ourselves on the back, when we don't, we're worried about the compare. What I'd tell you is, they're tough to forecast and to predict. They're not easy to replicate. This was a real solid quarter for our finance team in terms of some of these transactions.

But it is a lumpy business that's tough to forecast or predict.

Gregory Burns -- Sidoti & Company , LLC -- Analyst

Okay, thanks. And lastly -- [Speech Overlap]

Mark Marron -- Director, President and Chief Executive Officer

All right. See you soon.

Gregory Burns -- Sidoti & Company , LLC -- Analyst

So I got one more if it's OK.

Mark Marron -- Director, President and Chief Executive Officer

Okay, go ahead. Sorry, not rushing you up. What's it?

Gregory Burns -- Sidoti & Company , LLC -- Analyst

So the last two quarters, revenue and adjusted gross billings have grown roughly in line with each other. I think prior to this, you saw adjusted gross billings growing at a faster pace than revenue, could you just go over that dynamic? Why that is, why they're growing in line more closely in line now, has there been a shift in the mix of what you're selling quarters like what is the dynamic there?

Mark Marron -- Director, President and Chief Executive Officer

Well, yes, in terms of -- it comes down to maintenance renewals and subscriptions, which we talk about which is the gross to net effect. What we're seeing is that gross to net is now closer in line, year-over-year, prior quarters, there was a bigger delta between the gross to net year-over-year, which would affect the net sales and bring it down, if you will.

Gregory Burns -- Sidoti & Company , LLC -- Analyst

Okay, thank you.

Mark Marron -- Director, President and Chief Executive Officer

Yeah.

Operator

[Operator Instructions]. Your next question comes from the line of Brett Knoblauch from Berenberg Capital. Your line is open.

Brett Knoblauch -- Berenberg Capital Markets -- Analyst

Hi guys, thanks for taking my question. Hope all is well.

Mark Marron -- Director, President and Chief Executive Officer

Hey, Brett.

Elaine Marion -- Chief Financial Officer

Hey, Brett.

Brett Knoblauch -- Berenberg Capital Markets -- Analyst

The first one, kind of on the -- I guess, following up on the other question, talking about spending shifts from maybe product related spend to the upgrade cycle this year to maybe software security spend next year. Would that cause the delta in the gross to net to widen next year if you're anticipating more maybe software and securities spend?

Mark Marron -- Director, President and Chief Executive Officer

Potentially yes. A lot of the software vendors are moving to subscription models, which would be on a net basis. So potentially that could affect net sales, depending on the vendor and what they are selling or what we are selling of their product. Sure.

Brett Knoblauch -- Berenberg Capital Markets -- Analyst

Okay. And then just looking at the segment breakdown. I would say, you guys had a really strong, I guess, on a trailing 12 month basis in the telecom, media and entertainment. Is there anything maybe worth flagging in that?

Mark Marron -- Director, President and Chief Executive Officer

No, we're -- actually, we felt good. So for the quarter four of our five top verticals were up, the fifth vertical was kind of flat just down a little bit, so somewhat flat. But when we look at our top five verticals, year-to-date through the first nine months and trailing 12 months, they were all up nicely.

So we're seeing a nice progress and nice opportunities in the pipeline across all the verticals so far, or I should say, top five.

Brett Knoblauch -- Berenberg Capital Markets -- Analyst

Okay. And then just one more, I guess, you're going out and trying to compete for new business. I guess how important of a factor is the finance and capabilities you guys have to play? Like -- what do you think you would see similar growth in the product sales, if you didn't have the financing capability or is that really what drives new business wins?

Mark Marron -- Director, President and Chief Executive Officer

That's a good question, I think it's complementary, I don't think it would affect it per se, meaning, we've got two separate sales teams, but we've compensated them or put comp plans in place to get them to work together on deals. We have had some deals for example at year-end where folks don't have budget that were able to leverage our financing or I'd call it payment options for customers to make deals happen.

So it definitely helps, but I wouldn't say it's -- it would be the be-all, end-all if you will.

Brett Knoblauch -- Berenberg Capital Markets -- Analyst

All right, perfect. Thanks guys.

Mark Marron -- Director, President and Chief Executive Officer

All right. Take care. We'll see you soon. Okay?

Brett Knoblauch -- Berenberg Capital Markets -- Analyst

Yes. You too.

Operator

And there are no further questions at this time. I will turn the call back over to Mark Marron, CEO and President.

Mark Marron -- Director, President and Chief Executive Officer

All right, thank you. Hey, just want to thank everybody for participating in today's call. We look forward to seeing you in the upcoming investor meetings and to speaking on next quarter's call. Thanks for taking the time and have a great day. Take care.

Operator

[Operator Closing Remarks].

Duration: 29 minutes

Call participants:

Kleyton Parkhurst -- Senior Vice President and Assistant Secretary

Mark Marron -- Director, President and Chief Executive Officer

Elaine Marion -- Chief Financial Officer

Maggie Nolan -- William Blair -- Analyst

Kurt Swartz -- Stifel Financial Corp. -- Analyst

Gregory Burns -- Sidoti & Company , LLC -- Analyst

Brett Knoblauch -- Berenberg Capital Markets -- Analyst

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