Safe Harbor Statement

This transcript of the earnings call that occurred on November 7, 2018, contains certain statements that are, or may be deemed to be, “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or “Exchange Act,” and are made in reliance upon the protections provided by such acts for forward-looking statements. Such statements are not based on historical fact, but are based upon numerous assumptions about future conditions that may not occur. Forward-looking statements are generally identifiable by use of forward-looking words such as “may,” “should,” “intend,” “estimate,” “will,” “potential,” “could,” “believe,” “expect,” “anticipate,” “project,” and similar expressions. Readers are cautioned not to place undue reliance on any forward-looking statements made by us or on our behalf. Forward-looking statements are made based upon information that is currently available or management’s current expectations and beliefs concerning future developments and their potential effects upon us, speak only as of the date of the earnings call, and are subject to certain risks and uncertainties. We do not undertake any obligation to publicly update or correct any forward-looking statements to reflect events or circumstances that subsequently occur, or of which we hereafter become aware. Actual events, transactions and results may materially differ from the anticipated events, transactions or results described in such statements. Our ability to consummate such transactions and achieve such events or results is subject to certain risks and uncertainties. Such risks and uncertainties include, but are not limited to, the matters set forth below:

• ·national and international political instability fostering uncertainty and volatility in the global economy including exposure to fluctuations in foreign currency rates , interest rates, and downward pressure on prices;
• domestic and international economic regulations uncertainty (e.g. tariffs, North American Free Trade Agreement, and Trans-Pacific Partnership);
• exposure to changes in, interpretation of, or enforcement trends in legislation and regulatory matters;
• managing a diverse product set of solutions in highly competitive markets with a small number of key vendors;
• increasing the total number of customers using integrated solutions by up-selling within our customer base and gaining new customers;
• adapting to meet changes in markets and competitive developments;
• maintaining and increasing advanced professional services by recruiting and retaining highly skilled, competent personnel and vendor certifications;
• increasing the total number of customers who use our managed services and professional services and continuing to enhance our managed services offerings to remain competitive in the marketplace;
• performing professional and managed services competently;
• maintaining our proprietary software and updating our technology infrastructure to remain competitive in the marketplace;
• reliance on third parties to perform some of our service obligations to our customers;
• ·our dependence on key personnel to maintain certain customer relationships, and our ability to hire, train and retain sufficient qualified personnel;
• ·our ability to implement comprehensive plans for the integration of sales forces, cost containment, asset rationalization, systems integration and other key strategies;
• a possible decrease in the capital spending budgets of our customers or a decrease in purchases from us;
• ·our ability to protect our intellectual property rights and successfully defend any challenges to the validity of our patents, or allegations that we are infringing upon any third party patents, and the costs associated with those actions, and, when appropriate, license required technology;
• the creditworthiness of our customers and our ability to reserve adequately for credit losses;
• the possibility of goodwill impairment charges in the future;
• changes in the IT industry and/or rapid changes in product offerings, including the proliferation of the cloud, infrastructure as a service and software as a service, and our dependency on continued innovations in hardware, software and services offerings by our vendors and our ability to partner with them;
• ·our contracts may not be adequate to protect us, and we are subject to audit in which we may not pass, and our professional and liability insurance policies coverage may be insufficient to cover a claim;
• future growth rates in our core businesses;
• significant adverse changes in, reductions in, or loss of our largest volume customer or one or more of our large volume customers or vendors;
• reduction of vendor incentives provided to us;
• failure to comply with public sector contracts or applicable laws or regulations;
• ·our ability to secure our own customers’ electronic and other confidential information, and remain secure during a cyber-security attack;
• ·our ability to raise capital, maintain or increase as needed our lines of credit with vendors or floor planning facility, or obtain debt for our financing transactions or the effect of those changes on our common stock or its holders;
• changes to or loss of members of our senior management team and/or failure to successfully implement succession plans;
• disruptions or a security breach in our or our vendors’ IT systems and data and audio communications networks;
• ·our ability to realize our investment in leased equipment;
• ·our ability to successfully perform due diligence and integrate acquired businesses; and
• significant changes in accounting standards including changes to the financial reporting of leases which could impact the demand for our leasing services, or misclassification of products and services we sell resulting in the misapplication of revenue recognition policies or inaccurate costs and completion dates for our services which could effect our estimates.

We cannot be certain that our business strategy will be successful or that we will successfully address these and other challenges, risks and uncertainties. For a further list and description of various risks, relevant factors and uncertainties that could cause future results or events to differ materially from those expressed or implied in our forward-looking statements, see the Item 1A, “Risk Factors” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections in the Form 10-K for the year ended March 31, 2018, as well as other reports that we file with the SEC.

This document may also contain non-GAAP financial information. Management uses this information in its internal analysis of results and believes that this information may be informative to investors in gauging the quality of our financial performance, identifying trends in our results and providing meaningful period-to-period comparisons. For a reconciliation of non-GAAP measures presented in this document, see our earnings press release issued November 7, 2018, a copy of which is posted on our website at www.eplus.com/investors.

November 7, 2018 – FY18Q2

Prepared Remarks

Operator

Good day, ladies and gentlemen. Welcome to the ePlus earnings results conference call. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Kley Parkhurst, Senior Vice President. Sir, you may begin.

Kleyton L. Parkhurst, SVP

Thank you for joining us today.  On the call is Mark Marron, Chief Executive Officer & President, 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 & Exchange Commission including our form 10-K for the year ended March 31, 2018, and our form 10-Q for the quarter ended September 30, 2018, 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 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, CEO & President

Thanks, Kley, and thank you all for participating in today's call to discuss our second quarter 2019 results. This was another quarter of strong gross margin performance for ePlus, demonstrating the positive impact of our focus on services, emerging technology and the impact of beneficial changes in our business mix.

Our consolidated gross margin of 24.8% was up 120 basis points, among the highest in the industry, and reflective of our continued transformation to higher-valued solutions and our gross margin in the technology segment was up 160 basis points in the quarter due to several factors, namely: growth in our higher margin services business lines, a portion of which is annuity-based; a shift in mix to higher-margin products; and an increase in the portion of our revenue recognized on a net basis. Importantly, these positive results were achieved on lower revenues due to several factors that we signaled last quarter. Primarily, this year's revenue comparison reflected a large competitively bid project which we've discussed previously. While most of the project was delivered in last year's first half, it's important to note that looking forward to our third quarter comparisons, there was some delivery in last year's third quarter as well.

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've provided a cloud usage and risk workshop that led to a multimillion dollar deal with a health care customer. We provided a risk assessment and gap analysis that help 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 cyber attacks 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 Marion, CFO

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 points 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 health care, 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.

The adjustment from adjusted gross billings to net sales was $151.1 million or 31.1% compared to $145.8 million or 28.9% in the year-ago quarter, reflecting the increase in sales of third-party maintenance, subscription and SaaS software and services.

Despite these year-over-year declines, our technology segment gross profit increased slightly to $77 million. While our gross margin expanded by 160 basis points year-over-year to 23%, we benefited from a more profitable mix of products and services and increased sales of professional, managed and consultative services. Technology segment operating expenses of $57.9 million increased 4% from the prior year's second quarter. This was primarily due to higher salaries and benefits which were up $1.6 million or 3.7%. This increase reflects higher personnel costs due to the inclusion of IDS for a full quarter as I mentioned earlier. As of September 30, 2018, we had 1,213 employees in our technology segment, a 1.6% decrease compared with 1,233 employees at the quarter end last year. Sequentially, however, our headcount increased from 1,206 in the first quarter.

Our technology segment operating income amounted to $19.1 million compared to $21.2 million in the year-ago quarter, primarily due to higher operating expenses. Adjusted EBITDA was down 5.2% to $24.3 million.

Now let me share more details about the financing segment performance. We reported net sales of $10.3 million, representing a 19% decline from $12.7 million in the year-ago quarter as a result of lower post contract revenues. Just a reminder that our results last year benefited from higher post contract earnings due to early terminations of several large leases. Financing gross profit in the second quarter of fiscal 2019 declined 20.3% year-over-year to $8.5 million, given the gain last year related to determinations. Operating expenses were down 1.9% to $3.1 million due to lower variable compensation as a result of a decrease in gross profit. Operating income amounted to $5.5 million, down 27.8%. Adjusted EBITDA was $5.6 million compared to $7.7 million in the year-ago quarter.

I will now turn to our consolidated year-to-date results. Net sales for the first 6 months of fiscal 2019 decreased 5.8% to $701.6 million. Net sales in our technology segment decreased 5.5% to $681.6 million. Adjusted gross billings decreased by 2.4% to $968.2 million, while consolidated gross profit was up slightly to $166.2 million.

Our consolidated gross margin expanded by 150 basis points to 23.7% and our technology segment gross margin increased by 170 basis points to 22%. Net earnings grew 8.6% to $33.3 million or 11.9% to $2.45 per diluted share, while adjusted EBITDA decreased 4.3% to $55.3 million. Non-GAAP diluted earnings per share decreased 2.4% to $2.81.

Moving to the balance sheet, we ended the quarter with cash and cash equivalents of $75.6 million as compared to $118.2 million at March 31, 2018. The decrease was primarily due to additional working capital needs from our technology segment. Inventory levels increased $16.8 million to $56.6 million from fiscal year-end. Our inventory levels vary and are dependent upon customer-specific projects. Our cash conversion cycle increased to 25 days, up from 22 days in the first quarter of fiscal 2019 and up from 23 days a year ago. Going forward, our capital allocation strategy remains the same, investing in our business and making acquisitions that expand our capabilities in cloud, security and digital infrastructure and share repurchases.

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

Mark Marron, CEO & President

Thanks, Elaine. Heading into the second half of this fiscal year, we continue to see favorable market conditions in our targeted solution areas and solid demand for solutions and service offerings that enable clients to evaluate and implement cloud strategies, digitally transform user experiences that drive customer and employee engagement and keep their businesses secure. With -- within this environment, we will continue to focus on anticipating customer needs and remaining a trusted vendor-agnostic solutions provider. Internally, we will continue to emphasize increasing our gross profit dollars and maintaining and expanding gross margin, while making sure that we have the talent and resources to deliver superior results to our customers.

Operator, I would now like to open the call for questions.

QUESTION AND ANSWER

Operator

Our first question comes from Maggie Nolan with William Blair.

Maggie Nolan – William Blair

I wanted to ask, how much of the decrease in sales year-over-year is related to that large project roll off? And if possible, can you quantify that for last quarter as well?

Mark Marron - ePlus Inc. - President and CEO

Okay. So on the large project, Maggie, it was, as you know, it was a tough compare for us. And it was a big portion of the dropoff that happened in this quarter.

Maggie Nolan – William Blair

Larger portion than the next change presumably?

Mark Marron - ePlus Inc. - President and CEO

Than in the next? Sorry, I'm not sure what you're asking there.

Maggie Nolan – William Blair

It had a larger impact on the decline in the quarter than any changes in the amount of revenue that was being recognized on a net basis?

Mark Marron - ePlus Inc. - President and CEO

On a -- so here if I were to try and back into that, Maggie, there's a couple of different things. So if that large project was not in this quarter, year-over-year, our adjusted gross billings would actually be up. The other thing that comes into play in this quarter as well that affected some of the sales is, as you know, we had a large early termination on the lease side that affected both the net sales as well as the operating income on that side. So we kind of had a -- kind of a double whammy, if you will, from a compare standpoint on both our resale and our technology business. What is still continuing to trend in a very positive way for us is our GP on our technology side was actually up even on these decreased net sales. And a lot of that's due to some of the transition that we've talked about over time where we're driving more in the solution-oriented and in the services space. What also kind of factors into some of this is some of the services we're driving are annuity-based or ratable. So although they are great in terms of visibility, they're great in terms of profitability. The effect it has in the quarter is actually very small. So there were a few things that affected the quarter. With all of that said, when we look at our gross margins, we're almost at 25% on the gross margins, which is, I believe, it's the highest in our industry. So we believe we're building the model in the right areas that we want to focus on. We believe that the solutions we're selling such as security, which is almost now 1/5 of our overall adjusted gross billings, is actually working. What we came up this quarter was just a real tough compare on both our technology side and leasing side.

Maggie Nolan – William Blair

Understood. And then I'm hoping you can provide an update, just your comments on the tariff, how that's affecting the business, how you plan to respond to any incremental costs?

Mark Marron  - ePlus Inc. - CEO

Just pretty simple, Maggie. So far, we've been passing those on to our customers. Really haven't seen anything. Haven't had a lot of issues with our customers. So I wouldn't say it's something that they are embracing. But I guess it's something that's expected. And then I think we're kind of waiting like everybody to see what happens as we get closer to January, which could affect the quarter in a positive or negative fashion based on how people look at it.

Maggie Nolan – William Blair

Right. And did you see any pull forward in sales from customers as a response to the tariff?

Mark Marron  - ePlus Inc. - CEO

No. So far I haven't heard anything in the reviews, Maggie, where folks are pulling it forward. I do believe in December when I guess, they talk about the second tariff or second shoe should drop in January. You may have more people that consider pulling things forward potentially. But I think we've got to get a little bit closer and see what actually happens over the next month-or-so.

Operator

Our next question comes from Matt Sheerin with Stifel.

Alvin Park, Stifel

It's Alvin Park on behalf of Matt. Just following up, I know the Q3 and Q4 will have some tough comps because of the large enterprise rolloff that still had some sales in Q3 and Q4 prior year. Just talk about the magnitude of the headwinds of revenue -- headwinds you'll see in the second half of the year as well as incremental headwinds you might see because of a greater mix shift of sales in your net versus gross?

Mark Marron - ePlus Inc. - President and CEO

Net versus gross. Okay, so there's a couple of different things in that one, Alvin. In terms of the large project rolloff, a lot of that was in the first half. There is some in the third quarter and a very small amount in the fourth quarter, so I believe in Q3 and Q4, we won't see the compares that we've seen in this quarter and the prior quarter. So that's a positive, if you will, as it relates to year-over-year from a net sales perspective. On the mix, if you will, in terms of some of the things that we're seeing there. I think you'll continue to see us build on our -- some of the solutions in margins that we're actually selling to our customers, that'll be a positive thing. What's hard to tell, for example, we're building out our enhanced maintenance support. And it's actually our clients are responding very well to it. Traditionally, those margins are a lot better than just a traditional maintenance renewal resell. The good -- that's the good news. The bad news is that stuff that's recognized over a period of time. You've seen in this quarter our adjusted gross billings -- the gross to net, sorry, was actually -- there was a delta of about 210 basis points, I think it was. So I think you'll continue to see some of that as we go forward as we build out these programs with our customers.

Alvin Park, Stifel

And regarding that gross-to-net delta, when do you think this transition is going to equalize and be stable rather than having continuous sales headwinds but, of course, gross profit expansion going forward? But when do you think you'll be hitting a plateau and an equalization in this type of sales mix transition?

Mark Marron - ePlus Inc. - President and CEO

You know what's hard, I don't know if I'm worried about a plateau, Alvin, to be honest. As we mentioned, I think on the last call and previous calls, gross profit and gross margins are better metrics to kind of judge us on. So over the long term, a lot of these gross-to-net help your gross margins. But also the EMS programs that are recognized ratably as I mentioned, the margins are normally a lot better. The problem is they're normally over multiple years. So it's almost kind of that model where your net sales slow down a little bit, your GP even slows down a little bit because it's over a longer period of time. But over time, you're building up your annuity base in both your revenues as well as your profits. And it starts to turn in a positive way. Also if I look at it quite honestly with our quarter, on the technology side. Even though our sales were down fairly significantly due to that large project, our GP was actually up slightly. So that, I believe, is due to some of the -- both the solutions that we're selling and some of the services that are both consultative as well as annuity. The other thing I think that may have affected our sales, not so much as -- I think a lot of our peers kind of sell client device, PC refresh and we really don't play in that side of the sale. So we really didn't see an uptick there. But those would be some of the bigger things right now.

Alvin, Stifel

I see. And lastly, in terms of the Server 2008 Microsoft end-of-life coming in January 2020, do you think you could see potential headwinds in sales associated with that? I know you don't play in the client devices for the Windows 7 to Windows 10 upgrade, but do you see a potential catalyst of sales associated with that?

Mark Marron  - ePlus Inc. - CEO

Potentially. So right now, I think it might be a little bit early but potentially there could be plays there.

Operator

Thank you for participating in today's question-and-answer session. I would now like to turn the call back over to Mr. Mark Marron for any closing remarks.

Mark Marron - ePlus Inc. - President and CEO

Thank you, Sonia, and thank you, everyone, for joining us today. We appreciate that you took the time. I would like to wish everybody a healthy and happy holiday season since we won't be in all likelihood speaking to you again until the January time frame, January-February time frame. Enjoy the holidays, and thanks for spending the time with us today. Take care.