EPLUS INC annual report, FY2013

Business context and reporting period

ePlus inc. filed this Form 10-K for the fiscal year ended March 31, 2013. It sells IT products, software and services and provides equipment financing and leasing. The technology segment generated about 96% of annual revenue; financing generated about 4%. The filing also reports fiscal fourth-quarter results for the three months ended March 31, 2013.

Key financial metrics

FY2013 operating cash flow was $41.3 million, versus cash used of $21.6 million in FY2012. The filing separately presents an adjusted, non-GAAP operating cash flow measure of $57.1 million, adding lease payments made directly by customers to lenders. Investing activities used $12.7 million; financing activities used $9.7 million. The company paid a $20.1 million special dividend.

At March 31, 2013, total assets were $437.9 million and stockholders’ equity was $238.2 million. The technology segment’s GE Commercial Distribution Finance facility had a $175 million limit and $66.3 million outstanding under its floor-plan component; no accounts-receivable-component balance was outstanding. The company reported compliance with facility covenants. Its $0.5 million general credit facility had no outstanding balance.

Fiscal Q4 revenue was $236.3 million, pretax earnings $12.7 million and net earnings $7.7 million; basic and diluted EPS were $0.96 and $0.95. In FY2012 Q4, revenue was $219.0 million, pretax earnings $7.0 million, net earnings $3.9 million and diluted EPS $0.48.

Material changes versus prior period

• Annual revenue increased 19.1% and net earnings increased 49.1%; diluted EPS rose 54.8%.
• Technology segment revenue rose 19.0% and segment earnings rose 47.6%. Financing segment revenue rose 20.4% and segment earnings rose 51.8%.
• Product and services gross margin improved 0.2 percentage points, reflecting better product margins and higher service revenue, partly offset by lower vendor incentives.
• Lease and financing originations increased to $219.5 million from $162.3 million. Investments in notes and leases declined to $122.6 million from $140.3 million, primarily following portfolio sales.
• Cash increased, while short-term investments declined. Operating cash flow turned positive, although the filing’s narrative description of FY2013 operating cash flow conflicts with the positive figure in its cash-flow table and audited statement.

Outlook, risks, contingencies and unusual items

The filing provides no company-specific numeric earnings or revenue guidance. Management cited analyst expectations of average U.S. IT spending growth below 3% in calendar 2013 and said it planned to pursue geographic expansion, hiring and advanced technology offerings; these investments could weigh on near-term results. Management said existing cash, operating funds and available credit were expected to meet requirements for at least the next 12 months.

• Customer and supplier concentration: one telecommunications customer represented 14% of FY2013 revenue. Cisco products represented 48% and Hewlett Packard products 11% of product and services sales.
• Credit exposure: the reserve for credit losses was $5.1 million, including a $2.8 million specific reserve related to a law firm that filed for bankruptcy. Management reduced the reserve by $333,000 during FY2013; actual credit losses were $144,000.
• Vendor incentives: changes in incentive programs reduced FY2013 product and services gross margin by 0.1 percentage point. The company warned that reductions in incentives could pressure margins.
• Legal matters: the Federal Circuit upheld an infringement finding and injunction against Lawson, but upheld the denial of monetary damages and remanded the matter on the injunction’s terms. ePlus sought contempt damages; a hearing occurred in April 2013, with no ruling date stated. Separately, the Sixth Circuit affirmed summary judgment for Huntington in a case related to former customer Cyberco.
• Unusual income and expenses: ePlus recorded $7.1 million of gains from sales of financing receivables, compared with $3.9 million in FY2012. Patent-protection legal fees were $3.3 million, down from $6.0 million.
• Reporting change: ePlus corrected comparative EPS using the two-class method because certain restricted stock awards had non-forfeitable dividend rights. The filing states FY2012 basic EPS was reduced by $0.10 and diluted EPS by $0.05.
• Management and Deloitte & Touche reported effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

1. Reconcile the positive $41.3 million FY2013 operating cash flow in the audited statement with the conflicting “cash used” wording in the MD&A, and distinguish GAAP from adjusted cash flow.
2. Assess the sustainability of earnings growth, including the contribution of financing-receivable sale gains and changing vendor incentives.
3. Review the telecommunications customer concentration and dependence on Cisco and HP, including any subsequent changes in sales or vendor terms.
4. Track recoveries and reserve adequacy for the bankrupt law-firm exposure, along with the company’s broader credit and lease residual-value risks.
5. Check subsequent developments in the Lawson and Huntington litigation and related costs or potential recoveries.
6. Evaluate liquidity and borrowing availability under the GE facility, including its asset-based limits, covenants, guaranty and termination provisions.