ePlus inc (PLUS) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the ePlus Inc. annual earnings conference call. At this time, all lines have been placed on a listen-only mode and the floor will be open for questions following today's presentation. It is now my pleasure to turn the full floor over to your host, Mr. Kley Parkhurst. Sir, the floor is yours.

Thank you, Matt. Good morning. This is Kley Parkhurst, Senior Vice President of ePlus and I'd like to welcome you to our conference call to discuss our financial results for the quarter and fiscal year ended March 31, 2005. The conference call this morning will include prepared remarks followed by a questions and answer period. Joining me today is Phil Norton, the Chairman, Chief Executive Officer and President of ePlus and Steve Mencarini, Senior Vice President and Chief Financial Officer.

Before we begin the formal presentation, allow me to read our Safe Harbor statement. The statements made during this call which are not historical facts may be deemed to be forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may vary due to general economic conditions and other risks and uncertainties, including those risks and uncertainties detailed in our Securities and Exchange Commission filings. We refer you to the disclosure contained in our annual report on Form 10-K for the year ended March 31, 2005 under the headings Risk Factors.

All information discussed during this conference call is as of July 1, 2005. EPlus Inc. undertakes no duty to update this information. More information about potential factors that could effect ePlus Inc.'s business and financial results is included in the Company's annual report on Form 10-K for the fiscal year ended March 31, 2005, including without limitation under the captions Risk Factors and Management's Discussion and Analysis of Results of Operations, Financial Condition, Liquidity and Capital Resources.

A live webcast of this call playback and audio playback are available. Please refer to our June 27th press release, e-mail info@ePlus.com or go to our website, www.ePlus.com for more information. It's now my pleasure to introduce Phil Norton, the Chairman, CEO and President of ePlus Inc.

Thank you, Kley and thank you for joining us. Our physical year ended March 31, 2005 was a year of notable achievements offset by increased competition in all our business lines. We had many successes; 74% revenue growth from $331 million to $576 million driven by organic growth and the acquisition of Manchester's IT sales and professional services business.

Net earnings increased 149% to $25.3 million from $10.2 million and fully diluted earnings per share increased 164% to $2.68 from $1.02 per share. The validation at trial and affirmation of our patent and a settlement and licensing agreement, which resulted in a payment of $37 million in cash. The addition of new products to our Enterprise Cost Management solution, including Spend Analytics and the addition of notable and new customers such as PepsiCo.

The centralization of our software development infrastructure and under new leadership to improve time to market. Building stronger relationships with tier 1 vendors, such as Cisco, HP, and Microsoft and becoming the go-to partner in many of our markets. Our Cisco business has increased 300% year-over-year. We netted approximately $20 million in cash from the settlement and had our 15th year of positive earnings. As a result, we finished the year with almost $39 million of cash and cash equivalents on the balance sheet and shareholders equity of $132 million or $15.40.

We purchased 448,616 shares of common stock during the year bringing the total since inception to $23 million spent on 2 million shares. The average share price of all of our repurchases is $10.28 per share.

We moved into a new headquarters, which is a showcase for our professional services and our patent pending Serverless Office advanced technologies. We consolidated the management of our development teams for Procure+, Content+, Manage+, Spend+ and DigitalPaper under the leadership of ePlus Consulting to enable us to rapidly develop our enterprise software at a lower cost by better planning and management of a new long-term outsourcing program with our India-based partner.

Offsetting these achievements from a margin perspective was increased competition in all of our product lines and higher costs resulting from Sarbanes-Oxley both in the terms of actual direct costs and the indirect costs of pulling people off of other projects.

For the quarter ended March 31, 2005, net earnings increased 646% to $19.4 million from $2,600,000 the prior year and the fully diluted earnings per share increased 692% to $2.06 from $0.26. Revenues for the quarter increased 97% to $168,300,000 as compared to $85,300,000 recorded in the fourth quarter of 2004. Net of the patent settlement, our pretax earnings for the fourth quarter was approximately $66,000. This figure can be derived from our 10-K financials and footnotes and the December 10-Q.

As the economy has recovered and the IT space has become more competitive, we have chosen to compete and retain bigger customers such as Citigroup, AOL, and Quest Diagnostics. Although these types of customers generate lower margins than the sales of product, they provide an opportunity to compete for professional services and to sell Enterprise Cost Management solutions. We believe that we can compete with any competitor in the marketplace because our Enterprise Cost Management solution meets the requirements of middle market and larger customers better than any other solution.

All of these customers are looking to outsource and reduce the number of people involved, reduce the number of vendors they buy from, and optimize the transaction flow by minimizing invoicing, reducing payables, and streamlining the entire procurement process. Because we have captured the footprint of these larger customers, we can rebuild our margins by cross selling professional services and Enterprise Cost Management, which is the best outsourcing value in the market.

The leasing and financing business increased competition and excess capital in the market in addition to the maturation of our portfolio and the change in its earning characteristics have lowered yields. In the federal government financing space, historically a big source of upfront fee income for ePlus, we continue to live with a fewer number of transactions as the government seems to be purchasing rather than leasing its IT assets. The major increases in cost to ePlus were salaries and benefits, insurance costs, which increased by approximately 33% and the cost of section 404 compliance under Sarbanes-Oxley.

Over the long-term, both investors and ePlus will benefit from improved and optimized processes, which will lead to better efficiencies and lower costs in the future. However, for a company the size of ePlus, the cost, both in direct costs like software and outside consultants and indirect costs, taking key people out of line responsibilities have been significant. We have had to take a number of key operating managers off line, managers who would be spending their time optimizing vendor programs to enhance margins, analyzing branch office operations to reduce costs and put them out on our Sarbanes-Oxley team. This has had a direct effect on operating margins and our ability to streamline and enhance operations to reduce costs.

In the long term, this intense scrutiny and process re-engineering of our internal operations will allow us to scale faster and more efficiently, reduce costs, and improve earnings.

I would like to now speak about each of the businesses in more detail and provide our thoughts on how we will return the company to a higher level of profitability. First, the software business. We successfully defended our patent against Ariba and settled for $37 million. This was extremely important to ePlus and its shareholders. Not only did the jury render its decision that our patents were valid but the process solidified our standing in the market as being an original inventor in the business.

Since the end of the trial, we have seen increased activity and demand for our software, especially in subscription and hosted delivery model. These customers include Deaconess, Purdue University, Baylor College, PepsiCo, and Cisco Systems. These wins are an excellent indicator of our momentum in the marketplace.

We have recently filed a patent infringement lawsuit against another company, SAP. SAP is a leading enterprise software company. The pretrial hearing his July 28 and if it goes to trial, the trial is expected to take place in the first half of 2006. As with the Ariba infringement case, this type of litigation can be costly and the timing is uncertain. In the June quarter, we expect expenses to be as much as $200,000 and in subsequent quarters, until the matter is resolved, expenses could range up to $1.5 million per quarter.

The outcome of the litigation is never certain and we may not be successful nor recoup our costs. We have centralized our software development management in Rochester, New York under ePlus Consulting. The application development division we purchased in the Manchester acquisition, with all product management centralized, a new long-term contract with our Indian outsourcing company where costs are 50 to 70% less than in the U.S. and resources dedicated to rapid application development and intensive quality control and testing, we can deliver better software faster and a lower cost.

We have been providing these services for many years to ePlus Consulting customers such as Xerox, First American Title Insurance, W.P. Stewart and Snap-On Tools. Now, our own software will get the same benefits, faster time to market, lower costs, better support, and higher quality. At ePlus technology, our fulfillment and professional services organization for the fiscal year ended March 31, 2005, sales of product increased 80% while margin declined from 11.8% to 10%.

The increase in revenues is about 50% attributable to organic growth and about 50% to the acquisition of Manchester's IT sales and professional services assets. We began recording sales from the Manchester acquisition in the last two weeks of June, 2004. As mentioned previously, margins declined primarily because a higher percentage of sales with the larger accounts, such as AOL, CVS, and Visa. We will continue to capture the footprint of these customers and execute on selling more professional services and our ECM solution.

As we increase cross selling and hold the line on operating costs, our net earnings should improve. One key to reducing our operating costs in this business is to improve back office efficiencies by streamlining business processes, reducing headcount, and implementing better technology. In the September time frame, we will enhance our Enterprise Cost Management suite with a commercial version of OneSource. OneSource is a single portal to automate the customer order process and reduce administrative overhead for both buyer and seller, facilitate electronic commerce, and increase efficiency due to better information and transaction visibility.

OneSource will provide better access to product information, place and except orders, provide tracking an audit functionality, workflow, and invoicing. This product will be provided to customers at no cost. It will act as a front door to the full suite of ECM products and solutions. With OneSource, we believe the ePlus technology business can grow sales with current customers and attract new customers at higher margins.

Another area of focus is to grow our professional services significantly in the next year by focusing on selected vendor relationships. Over the past year, our Cisco business has increased 300% and we will continue to focus on Internet telephony and our patent pending Serverless Office. We have made a sizable investment to improve our engineering staff, which is now almost 200 strong, especially in the Cisco IPT space.

We are one of the eight vendors supported by Cisco's national accounts management team. With a high level of certifications with all of the tier 1 vendors and a national footprint, we can compete against the biggest systems integrators but we also have capabilities which make us unique in the middle market, such as our RNOT (ph), Enterprise Cost Management, and leasing.

Our sales of product gross margin increased 52% from $31,600,000 in fiscal year '04 to $48,200,000 in fiscal year '05. This is a $16.7 million increase, is a big opportunity for increasing net earnings if we can reduce costs. This year, we will be able to refocus our team on driving costs out of the business. We have a core team of senior managers who have been redeployed out of the operating business units and onto SOX issues, including compliance with 404 and internal audits, documentation, and testing. Because of this, the cost savings actions we anticipated subsequent to the Manchester acquisition have been delayed. Much of the work for our SOX compliant related to back office operations and has been completed as of June 30 and we are able to refocus on cost reduction immediately.

In the leasing business, assets have stabilized at approximately $189 million. The financial performance of the unit has been sub par for a few reasons. First, in the federal leasing business, which has historically created much of the fee income in this segment, leasing volume is down as the government seems to be purchasing rather than leasing its assets. The principles of ePlus have been in the federal leasing space for more than 15 years and we have been able -- and we have seen the pendulum swing between leasing and buying many times based on how funds are allocated in the federal budgets.

Based on recent activities, we expect to see a pickup in this business in the last three quarters of the calendar year. The second reason is our greater emphasis on healthcare equipment financing. These deals tend to be longer original term operating leases. In the past, we have originated a higher percentage of financed leases, which were sold or financed for an upfront profit.

The operating lease business provides a better potential opportunity for higher yields but has lower margins in the first half of the lease term and lower revenue. To facilitate growth in this market we have successfully entered into a program agreement with VHA, the nation's largest hospital consortium and we are a preferred leasing provider to their member hospitals. We believe the VHA program could produce a major producer of lease origination volume in the near future. We have taken several steps to right size and re-energize our leasing company. The most significant is a new product we have introduced, Finance+ Express, which is a small ticket program aimed at our bar customer base.

About 20% of all IT equipment is leased and with 500 million in technology sales and about 10% of our own IT sales is leased by us. We have an opportunity to increase our lease origination with our IT sales customers and we believe the opportunity can be up to $50 million per year in lease volume.

EPlus is positioned for growth. Over the past few years and with the Manchester acquisition, we have built a national footprint. We have made the investments in infrastructure, personnel, and technology to grow revenues and increase margins without significantly increasing fixed costs. Our product set is well positioned to capture two market trends; Internet telephony and outsourcing. Enterprise Cost Management is the best solution value to reduce administrative cost in the indirect supply chain and we have the national footprint and customer base to execute on these two opportunities.

We successfully defended our intellectual property and we will continue to prosecute infringement in a cautious and systematic approach. Thank you for your time and we are ready to answer questions you may have.

(OPERATOR INSTRUCTIONS). Chris Penny with Friedman, Billings, Ramsey.

Phil, can you talk a little bit more about margin contraction in the competition as it relates to the technology business division? It seems like -- it looks like in that division, that division lost money. Can you talk a little bit about competition and the margin compression you're seeing and kind of how long you see that playing out? Is that -- we're done with your first quarter now and you're in the new fiscal year, is that kind of the same situation in the first quarter than it was in the fourth quarter?

Well, I think there's a couple of things we have to look at there. I mean first of all, we believe long-term in capturing customers and growing the business, we are going to enhance the long-term profitability of the company. So we have been going after the larger accounts in order to establish a footprint and having to defend some of our customers against competition. So in fact, after we have captured the footprint, in general, the margins start to rise because you have less competitive pressure for a period of time. So I believe that we will see our margins increase and get back to the 11% range, which on 120 to $130 million in sales, is a significant increase and we believe that it will improve some this quarter and will improve more next quarter.

Where is the competition coming from? Where are you having to -- who are you having to compete against?

Well, you're having a couple of things happening in the marketplace and it seems that some of it is starting to subside. Number one is HP, has not had a real focused direction and whether they would be channel friendly or whether they would go directly after customers. Now that they have changed the CEO of that operation, I think they have, again, become more channel friendly. They've reduced the number of accounts they are going after directly and that takes some pressure off the margins.

We are also seeing, even though Dell is increasing the product line, we are seeing that more and more customers, especially in the larger arena, are looking for a more integrated solution where instead of dealing with seven different manufacturers they would rather deal with one integrated supplier who can automate their processes, give them one bill, and also automate their payables. And I think that is going to be where the rubber meets the road that the manufacturers cannot consolidate all of the separate manufacturers together. So it gives companies like ePlus the opportunity to capture that business and therefore, even if the margins don't increase, the profitability for that account increases because you are able to capture all their business instead of just a portion of their business.

On the leasing side, what is the potential or how can you start growing leases again? Kind of on leases that you have on your balance sheet? Then just in general, just growing lease revenue?

I think there is really three areas that we focused on in the call. Number one is that -- when you look at last year, our sales were approximately 250 million in the hardware sales arena and it was spread out and we had acquired several different companies. The penetration into that base was stymied more because of Y2K and the fact that people had longer applications. They weren't putting in big product rollouts and that everyone had cash. So the amount of opportunities to lease into that customer base was not as fruitful as it had been in the past. We have seen all of the captive programs really putting pressure on their sales force and the customers to try to lease and to -- they have not had much success.

So one of the things that we have done in that arena is we have gone and set up a small ticket or, that is $150,000 or less program, so that we can go to all of our customers and be able to capture leases and give them instant credit approval so that we can make our process more efficient to deliver that product to the customer and be able to penetrate our customer base at a higher level with leasing. And we're starting to see people look at higher interest rates use their cash differently and starting to lease more technology equipment. I think that is number one where we are going to see a significant amount of increased volume and we already have seen some of that.

Number two is that we -- two years ago, started healthcare financing of which we have had a significant increase in that business. We have been able to put a master contract together with VHA, which is a consortium of over 1800 hospitals and 35,000 doctors. We intend to do two things there. One is to significantly focus on both the MRI and CT scans as well as the IT services part of the business for the healthcare. I think that's going to give us a huge opportunity to increase our leasing business. And then that will ultimately drive more IT sales.

The third part is the federal government. That is more cyclical and state and local government; but in particular, the federal government. What we have seen there, and we had a couple of opportunities in the last two quarters where there were very large opportunities, and at the last hour of the last week, the deal either was downsized and purchased or they were able to come up with the money from several different federal funding operations internally in order to fund the capital acquisitions.

We believe that we are going to see a significant change in that in the last quarter of this year and that normally happens. Our pipeline looks good but again it depends on what happens with the funding. From the past, it seems like they haven't been able to acquire as much equipment as they had money for and so therefore, they were paying for everything and I think there is a sea change in that, if not this quarter, it will be next year. But in the long run, that has been a good business and so I think we have to just get more efficient, work harder, get more opportunities in the pipeline and that business will pick back up.

A question on the -- You mentioned that for the quarter, if you back out the stuff that's related to the settlement, I think you mentioned like a number around 66,000. Can you walk us through real quick that calculation? How much did you -- obviously, you backed out 37 million in revenue. But how much of cost did you back out?

I'm going to have Steve Mencarini answer that question because he's the one that calculated those numbers.

Basically, you just take the earnings, quarter-to-quarter, go to the footnote in the 10-K and look at the quarter footnote for the settlement and pull it out (ph).

Well, you can't just give us those numbers on how you got 66?

It would be the 43 million minus the 9 9, minus the 33 million in the footnote. That's gets you 66.

I'll just have to relook at that. I guess, Phil, what you are saying is that increased competition, lower margins, you've got in kind of the both areas, you're going to continue legal fees. I'm just trying to get a sense of what the profitability is going to look like in this company over the next year aside from winning or not winning a lawsuit.

Well, as we said before, we're not basing the company going forward just winning lawsuits.

That's what I'm saying. Aside from all that, I'm trying to figure out --.

I think it boils down to this is that -- and I don't want to overemphasize Sarbanes-Oxley because I think, in the long run, we are using it as a Six Sigma process and really cleaning up any internal issues or any potential vulnerabilities and how to make the operation better. The real operating managers who help drive more efficiencies and reduce costs and reduce vendors and actually -- if you look at, prior to the Manchester acquisition and prior to the Sarbanes-Oxley drive, we were doing, I thought, a credible job on reducing our staff and our SG&A. In the last year, I can tell you that we have not had the luxury or opportunity to be able to do that with the Manchester acquisition, with the Ariba trial and with Sarbanes-Oxley. Even though we have the SAP trial coming, the resources now, since we have done all the prep work for the first trial is minimal on anybody in the company, other than one person. So therefore, that is not going to be a drag. Sarbanes-Oxley, we had set a timetable to finish the first pass on getting the internal audit compliance done September 30 and I think we're pretty much on target there.

And the Manchester acquisition, we just now finished or this month, I think, moving the last facility that they had into other facilities to reduce those costs. So I would think that we are going to go back to a little better profit picture coming up this quarter coming up. And I think our margins appear to be increasing and I think our sales are still on the rise. So the only drag -- well, there's a couple of drags. One is the federal opportunities and closing those and them not becoming bought. And two is that the cost to finish the rollout of OneSource and the software products that we are continuing to develop, which is included in the technology sales, is very viable for us to be competitive. It's a question of finishing those. So that would be the only drag or the real drag on earnings going forward.

So you have been at a $1 per share roughly for the last couple of years and then this last year, given what happened in the quarter, I mean you are down to like roughly a $0.70 number. Do you think you could pick the company back up to that $1 level of earnings in going into the next six to nine months or are we going to have a continual drag for a while as you invest in your bigger clients and some of this Sarbanes-Oxley stuff? I'm just trying to get a feel for what the earnings power of this company is let's say the next year. We've always thought for a while that it was going to be a $1 going to $1.25, going $1.50 for the same reasons a couple of years ago that you're saying today; but we haven't seen those yet. I'm just trying to understand what the earnings power of the company really could be in a year to two years.

I'd like to tell you that I have that number right now today. It's really depending on those factors and us executing them. But I think -- let's not minimize the fact that everyone had some doubts about our capability of winning and prosecuting a patent infringement case against a bigger company with more resources and is winning on every case and that we did earn a significant amount more money, operations besides, that almost everyone was in doubt of. So let's not minimize the importance of that long term to our profitability. Let's not minimize the effort that it took for our size company to operate, go forward, grow revenues in a very very competitive market giving us the opportunity to reduce cost.

I think whether it is six months, a year, two years, we will be back at a higher level than we were on a track for doing before. Can I give you the exact timing of that? If I could I would. I don't think I can right now.

A quick question on -- what do you kind of consume your annualized Sarbanes-Oxley costs fall-out (ph)?

There is both indirect and direct. In our case, we took, with the Board's approval, we decided rather than going outside the company and hiring lots of consultants and spending, which are projection was a $1 million, that we would take people that would benefit from it and maintain the intellectual property. So we took six key people and management committed to the Board that we would maintain those people and use those people to be in compliance with Sarbanes-Oxley. And we have done that.

Now that has hurt us as far as streamlining the costs and we couldn't necessarily take costs out because key people making those decisions were involved in the Sarbanes-Oxley. Now on the reverse, we were able to have those people learn everything about the processes they were managing and would be managing and know where the errors and where the integration issues are necessary to make us more efficient and to be more productive and to increase the ability to grow without having issues in the future.

And so if you take those people out and the salaries of those people, it was approximately $750,000 because we did not have low-level people doing this. We had key people each part of the business. They are all going to be going back to their jobs and they will have been better trained and they will have gone through all the processes. So a long way around. I think it cost us at least $1,200,000 when you add in systems, time, process, and people, on direct or indirect cost. Also, when you talk about the Sarbanes-Oxley fall-out, our insurance costs have gone up significantly. Our health insurance costs went up 33%. Our ENO coverage went up by a significant amount of money. So I think my best guess is it cost us over $2 million when you add up all those things. But I don't know the exact numbers.

Just one last question, Phil. Given that cost, that's roughly, let's say, 15% to 20% of your pretax earnings on a normalized basis. Why not -- why would you not probably take the company private? Was that an alternative that maybe you are looking at or others are looking at? I'd just like to know your thoughts there.

Well, I think you've got to look at -- we made significant increase from 337 million to 570 some million in one year. We believe that we are going to continue to grow the revenues and the profitability will come. I think that gives the shareholders and gives the company a better opportunity to grow acquisition-wise and to make a bigger impact from a business standpoint in the long run. I think, in the long run, it will be better run as a public company as of today. Things could change. There could be reasons, other reasons, not to do it. But I think it gives us the ability to grow, ultimately the ability to make other acquisitions. I also think that once you've already gone through all the Sarbanes-Oxley stuff and you have spent all that money, it's not going to be as difficult going forward as being -- to be a public company at our size.

(OPERATOR INSTRUCTIONS). Sir, there appear to be no further questions at this time.

Thank you, Matt. Thank you, everyone for joining us. If there are any other questions, we will be here for the remainder of the today.

This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.