PART I. FINANCIAL INFORMATION
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion is intended to further the reader’s understanding of our consolidated financial condition and results of operations. It should be read in conjunction with the financial statements included in this quarterly report on Form 10-Q and our 2020 Annual Report. These historical financial statements may not be indicative of our future performance. This Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risks described in Part I, Item 1A, “Risk Factors,” in our 2020 Annual Report., and in Part II, Item 1A. “Risk Factors” in this Report.
EXECUTIVE OVERVIEW
Business Description
We are a leading solutions provider that delivers actionable outcomes for organizations by using IT and consulting solutions to drive business agility and innovation. Leveraging our engineering talent, we assess, plan, deliver, and secure solutions comprised of leading technologies and consumption models aligned with our customers’ needs. Our expertise and experience enable ePlus to craft optimized solutions that take advantage of the cost, scale and efficiency of private, public and hybrid cloud in an evolving market. We also provide consulting, staffing, professional, managed, IT staff augmentation, and complete lifecycle management services including flexible financing and solutions in the areas of security, cloud, networking, data center, collaboration and emerging technologies. We have been in the business of selling, leasing, financing, and managing IT and other assets for more than 30 years.
Our primary focus is to deliver integrated solutions that address our customers’ business needs, leveraging the appropriate technologies, both on-premise and in the cloud. Our approach is to lead with advisory consulting to understand our customers’ needs, design, deploy and manage solutions aligned to their objectives. Underpinning the broader areas of Cloud, Security, Networking, Data Center and Collaboration are specific skills in orchestration and automation, application modernization, DevOps, data management, data visualization, analytics, network modernization, edge compute and other advanced and emerging technologies. These solutions are comprised of class leading technologies from partners such as Amazon Web Services, Arista Networks, Blue Coat, Check Point, Cisco Systems, Citrix, Commvault, Dell EMC, Extreme Networks, F5 Networks, Fortinet, Gigamon, HPE, Juniper Networks, Lenovo, Microsoft, NetApp, Nutanix, NVIDIA, Oracle, Palo Alto Networks, Proofpoint, Pure Storage, Qumulo, Rubrik, Splunk, Symantec and VMware, among many others. We possess top-level engineering certifications with a broad range of leading IT vendors that enable us to offer multi-vendor IT solutions that are optimized for each of our customers’ specific requirements. Our hosted, proprietary software solutions are focused on giving our customers more control over their IT supply chain, by automating and optimizing the procurement and management of their owned, leased, and consumption-based assets.
Our scale and financial resources have enabled us to continue investing in engineering and technology resources to stay current with emerging technology trends. Our expertise in core and emerging technologies, buttressed by our robust portfolio of consulting, professional, and managed services has enabled ePlus to remain a trusted advisor for our customers. In addition, we offer a wide range of consumption options including leasing and financing for technology and other capital assets. We believe our lifecycle approach offering of integrated solutions, services, financing, and our proprietary supply chain software, are unique in the industry. This broad portfolio enables us to deliver a unique customer experience that spans the continuum from fast delivery of competitively priced products, services, subsequent management and upkeep, through to end-of-life disposal services. This approach permits ePlus to deploy ever-more-sophisticated solutions enabling our customers’ business outcomes.
Our go-to-market strategy focuses primarily on diverse end-markets for middle market to large enterprises. For the trailing twelve-month period ended June 30, 2020, the percentage of revenue by customer end market within our technology segment includes technology industry 21%, telecommunications, media and entertainment 19%, state and local government and educational institutions (“SLED”) 16%, healthcare 15%, and financial services 13%. The majority of our sales were generated within the United States (“US”); however, we have the ability to support our customers nationally and internationally, including physical locations in the United Kingdom (“UK”) and India. Our technology segment accounts for 96% of our net sales, and 70% of our operating income, while our financing segment accounts for 4% of our net sales, and 30% of our operating income, for the three months ended June 30, 2020.
Impact of COVID-19 on Our Business Operations
The COVID-19 pandemic continues to have widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. Federal, state and local governments and public health authorities have or may have future required measures to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work from home, supply chain logistical changes, and closure of non-essential businesses.
As COVID-19 impacts continue to expand across the country and globe, we have been adjusting our business activities for the safety of our employees and to best serve our customers in this rapidly evolving environment. We have implemented a flexible work from home strategy applicable to all offices and operational continuity plans to provide sufficient resources to continue supporting our customers. For employees who wish to return to the office, we have reopened our headquarters with limited capacity and required health and safety protocols in place. We plan to reopen our other offices using a phased approach but currently have not set a schedule to do so. Our configuration centers have remained open with our employees working in them following required health and safety protocols. In addition, we also have a procedure to review and approve engineers traveling to customer sites to perform work. Our managed service teams are distributed across the US with the ability to leverage technology to provide coverage while working from home. While we and many of our customers and vendor partners have restricted travel, we are leveraging video and other collaborative tools to continue to be responsive.
Our account relationship teams are actively engaging with our customers, to ensure they have the support needed in adjusting to changes in the business environment and government directives. For the quarter ended June 30, 2020, some of our customers’ locations were closed and therefore, unable to receive deliveries from us. In addition, we granted a limited number of customers temporary payment term extensions. Also, we are working closely with our vendor partners to address varying impacts on their supply chain to satisfy infrastructure needs. Certain of our vendor partners extended payment terms to us and our competitors.
We continue to execute against and adjust our business continuity plans to maximize our ability to support our employees and customers in concert with our partners. We have an internal resource page to support specific customer inquiries from security to collaboration to financing options. We remain committed to driving positive business outcomes.
The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic; governmental, business, and individuals' actions in response to the pandemic; and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact business, and government spending on technology as well as our customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects management’s accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions. Refer to Part I, Item 1A, “Risk Factors,” in our 2020 Annual Report.
Key Business Metrics
Our management monitors a number of financial and non-financial measures and ratios on a regular basis to track the progress of our business. We believe that the most important of these measures and ratios include net sales, gross margin, operating income margin, net earnings, net earnings per common share, adjusted EBITDA, adjusted EBITDA margin, adjusted gross billings, and non-GAAP net earnings per share. We use a variety of operating and other information to evaluate the operating performance of our business, develop financial forecasts, make strategic decisions, and prepare and approve annual budgets.
These key indicators include financial information that is prepared in accordance with US GAAP and presented in our unaudited condensed consolidated financial statements as well as non-GAAP performance measurement tools. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance or financial position that either excludes or includes amounts that are not normally included in the most directly comparable measure calculated and presented in accordance with US GAAP. Non-GAAP measures used by management may differ from similar measures used by other companies, even when similar terms are used to identify such measures.
Our key business metrics are as follows (dollars in thousands):
We use non-GAAP net earnings per common share as a supplemental measure of our performance to gain insight into our operating performance. We believe that the exclusion of other income (expense), share-based compensation, and acquisition-related amortization expense in calculating non-GAAP net earnings per common share provides management and investors a useful measure for period-to-period comparisons of our business and operating results by excluding items that management believes are not reflective of our underlying operating performance. Accordingly, we believe that non-GAAP net earnings per common share provide useful information to investors and others to understand and evaluate our operating results. However, our use of non-GAAP information as analytical tools has limitations, and you should not consider them in isolation or as substitutes for analysis of our financial results as reported under GAAP. In addition, other companies, including companies in our industry, might calculate similar non-GAAP net earnings and non-GAAP net earnings per common share or similarly titled measures differently, which may reduce their usefulness as comparative measures.
We use adjusted EBITDA as a supplemental measure of our performance to gain insight into our operating performance. We believe that the exclusion of other income in calculating adjusted EBITDA and adjusted EBITDA margin provides management and investors a useful measure for period-to-period comparisons of our business and operating results by excluding items that management believes are not reflective of our underlying operating performance. Accordingly, we believe that adjusted EBITDA and adjusted EBITDA margin provide useful information to investors and others to understand and evaluate our operating results. However, our use of adjusted EBITDA and adjusted EBITDA margin as analytical tools has limitations, and you should not consider them in isolation or as substitutes for analysis of our financial results as reported under GAAP. In addition, other companies, including companies in our industry, might calculate adjusted EBITDA and adjusted EBITDA margin or similarly titled measures differently, which may reduce their usefulness as a comparative measure.
We use adjusted gross billings as a supplemental measure of our performance to gain insight into the volume of business generated by our technology segment, and to analyze the changes to our accounts receivable and accounts payable. Our use of adjusted gross billings as an analytical tool has limitations, and you should not consider them in isolation or as substitutes for analysis of our financial results as reported under US GAAP. In addition, other companies, including companies in our industry, might calculate adjusted gross billings or a similarly titled measure differently, which may reduce its usefulness as a comparative measure.
Consolidated Results of Operations
During the three months ended June 30, 2020, net sales decreased 6.9%, or $26.3 million, to $355.0 million, as compared to $381.4 million for the same period in the prior fiscal year. Product sales for the three months ended June 30, 2020, decreased 8.5% to $307.2 million, or a decrease of $28.4 million from $335.6 million in the prior year. Services sales during the three months ended June 30, 2020, increased 4.4% to $47.8 million, or an increase of $2.0 million over prior year services sales of $45.8 million. The decrease in products sales was due to a shift in mix to higher third-party maintenance, software assurance, subscriptions/SaaS licenses, and services where we recognize revenue on a net basis. In addition, some orders could not be delivered to the customer because the customer’s offices were closed due to COVID-19. We saw decreases in net sales from our technology, telecom, media and entertainment, SLED, financial services, and all the other categories of customers, which was partially offset by a small increase in net sales to customers in the healthcare category, during the three months ended June 30, 2020, compared to the prior year.
Adjusted gross billings decreased 0.4%, or $2.0 million, to $546.4 million for the three months ended June 30, 2020, from $548.4 million for the same period in the prior fiscal year. There was a decrease in adjusted gross billings from our customers in the healthcare, telecom, media and entertainment, and all the other categories of customers which was almost entirely offset by increases in demand from SLED, financial services, and technology markets. For the three months ended June 30, 2020, there was an increase in adjusted gross billings of $25.3 million, to $205.2 million for products that we recognize revenue on a net basis, such as, third-party maintenance, software assurance, subscriptions/SaaS licenses, and services.
Consolidated gross profit for the three months ended June 30, 2020, rose 6.4% to $98.6 million, compared with $92.6 million for the three months ended June 30, 2019. Consolidated gross margins were 27.8% for the three months ended June 30, 2020, which is an increase of 350 basis points compared to 24.3% for the same period in the prior fiscal year. The increase in margins for the three-month period was due to a shift in product mix, as we sold a higher proportion of third-party maintenance, software assurance and subscription/SaaS licenses, and services, which are recognized on a net basis. Also contributing to the gross margin improvement was higher product margins, an increase in services revenue, and higher gross profit from of our financing segment.
Our operating expenses for the three months ended June 30, 2020, increased 5.3% to $73.6 million, as compared to $69.9 million for the prior year period. The majority of this increase reflects increase in selling, general, and administrative expense of 5.6% or $3.7 million, due, in part to increases in variable compensation, employee salaries and benefits, and allowance for credit losses, partially offset by reductions in travel and entertainment, and general office related expenses. As of June 30, 2020, we had 1,536 employees, a decrease of 2 from 1,538 last year. Depreciation and amortization expense increased $0.1 million, due to the ABS Technology acquisition in August 2019, and interest and financing costs decreased $0.1 million, due to a decrease in the average balance of non-recourse notes payable outstanding during the three months ended June 30, 2020, as compared to the prior year.
As a result, operating income increased $2.2 million, or 9.8%, to $25.0 million and operating margin increased by 100 basis points to 7.0%, as compared to the three months ended June 30, 2019.
Consolidated net earnings for the three months ended June 30, 2020, were $17.4 million, an increase of 7.2%, or $1.2 million, over the prior year’s results, due to the increase in gross profit, partially offset by increased operating expenses. Our effective tax rate for the current quarter was 30.8%, compared with 28.7% in the prior year quarter. The change in our effective tax rate was due to an adjustment to the federal benefit on state taxes.
Adjusted EBITDA increased $2.1 million, or 7.5%, to $30.7 million and adjusted EBITDA margin increased 120 basis points to 8.7% for the three months ended June 30, 2020, as compared to the prior year period of 7.5%.
Diluted earnings per share increased 8.3%, or $0.10, to $1.30 per share for the three months ended June 30, 2020, as compared to $1.20 per share for the three months ended June 30, 2019. Non-GAAP diluted earnings per share increased 4.9% to $1.51 for the three months ended June 30, 2020, as compared to $1.44 for the three months ended June 30, 2019.
Cash and cash equivalents increased $58.2 million or 67.4% to $144.4 million at June 30, 2020, as compared to $86.2 million as of March 31, 2020. The increase is primarily the result of the extension of payment terms by 30 days from certain vendor partners that deferred $34.2 million in payments and a payroll tax deferral under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act that deferred $2.6 million in payments that will be paid in December 2021 and December 2022. Our cash on hand, funds generated from operations, amounts available under our credit facility, and the possible monetization of our investment portfolio have provided sufficient liquidity for our business.
The extent of the impact of COVID-19 is uncertain and may impact our liquidity position over the longer term. As credit markets have tightened as a result of COVID-19, we may have difficulty funding our financing transactions with lenders, which may result in the use of our cash or a decrease in financing originations.
Segment Overview
Our operations are conducted through two segments: technology and financing.
Technology Segment
The technology segment sells IT equipment and software and related services primarily to corporate customers, state and local governments, and higher education institutions on a nationwide basis, with geographic concentrations relating to our physical locations. The technology segment also provides Internet-based business-to-business supply chain management solutions for IT products.
Our technology segment derives revenue from the sales of new equipment and service engagements. Included in net sales are revenues derived from performing advanced IT professional and managed services that may be sold together with and integral to third-party products and software. Our service engagements are generally governed by statements of work and are primarily fixed price (with allowance for changes); however, some service agreements are based on time and materials.
Customers who purchase IT equipment and services from us may have customer master agreements, or CMAs, with our company, which stipulate the terms and conditions of the relationship. Some CMAs contain pricing arrangements, and most contain mutual voluntary termination clauses. Our other customers place orders using purchase orders without a CMA in place or with other documentation customary for the business. Often, our work with state and local governments is based on public bids and our written bid responses.
We endeavor to minimize our cost of sales through incentive programs provided by vendors and distributors. The programs for which we qualify are generally set by our reseller authorization level with the vendor. The authorization level we achieve and maintain governs the types of products we can resell as well as such items as pricing received, funds provided for the marketing of these products and other special promotions. These authorization levels are achieved by us through purchase volume, certifications held by sales executives or engineers and/or contractual commitments by us. The authorization levels are costly to maintain, and these programs continually change; therefore, there is no guarantee of future reductions of costs provided by these vendor consideration programs.
Financing Segment
Our financing segment offers financing solutions to corporations, governmental entities, and educational institutions nationwide, as well as internationally in the UK, Canada, Iceland, and Spain. The financing segment derives revenue from leasing IT and medical equipment and the disposition of that equipment at the end of the lease. The financing segment also derives revenues from the financing of third-party software licenses, software assurance, maintenance and other services.
Financing revenue generally falls into the following three categories:
Our financing segment sells the equipment underlying a lease to the lessee or a third-party other than the lessee. These sales occur at the end of the lease term and revenues from the sales of such equipment are recognized at the date of sale. We also recognize revenue from events that occur after the initial sale of a financial asset and remarketing fees from certain residual value investments.
Fluctuations in Operating Results
Our results of operations are susceptible to fluctuations for a number of reasons, including, without limitation, customer demand for our products and services, supplier costs, changes in vendor incentive programs, interest rate fluctuations, decision to sell financial assets, general economic conditions, and differences between estimated residual values and actual amounts realized related to the equipment we lease. Operating results could also fluctuate as a result of a sale prior to the expiration of the lease term to the lessee or to a third-party or from other post-term events.
We expect to continue to expand by opening new sales locations and hiring additional staff for specific targeted market areas whenever we can find both experienced personnel and desirable geographic areas over the longer term, which may reduce our results from operations. COVID-19 may negatively affect market demand, which will likely lower our financial results, and may adversely impact our ability to expand. We are uncertain as to the extent and duration of the impact to the IT market demand for our products and services.
CRITICAL ACCOUNTING ESTIMATES
As disclosed in Note 2, “Recent Accounting Pronouncements”, we adopted a new credit loss standard on April 1, 2020. Under this new standard, we estimate an allowance for credit losses related to accounts receivable for future expected credit losses by using relevant information such as historical information, current conditions, and reasonable and supportable forecasts. The allowance is measured on a collective basis when similar risk characteristics exist, and a loss-rate for each group with similar risk characteristics is determined using historical credit loss experience as the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current conditions, as well as changes in forecasted macroeconomic conditions. Our allowance reflects the forecasted credit deterioration due to the COVID-19 pandemic.
Our other critical accounting estimates have not changed from those reported in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2020 Annual Report.
SEGMENT RESULTS OF OPERATIONS
The three months ended June 30, 2020, compared to the three months ended June 30, 2019
Technology Segment
The results of operations for our technology segment for the three months ended June 30, 2020, and 2019 were as follows (dollars in thousands):
Net sales: Net sales for the three months ended June 30, 2020, were $341.2 million compared to $368.5 million during the three months ended June 30, 2019, a decrease of 7.4% or $27.3 million, due to decreases in net sales to customers in the technology, telecom, media and entertainment, SLED, financial services, and all the other customer categories, which was partially offset by a small increase in sales to customers in the healthcare category. Product sales decreased 9.1%, or $29.3 million, to $293.4 million due to a shift in mix to third-party maintenance, software assurance, subscriptions/SaaS licenses, and services where we recognize revenue on a net basis. Services revenues increased 4.4%, or $2.0 million, $47.8 million to due to an increase in staffing and professional and managed services.
Adjusted gross billings decreased 0.4%, or $2.0 million, to $546.4 million for the three months ended June 30, 2020, from $548.4 million for the same period in the prior fiscal year. A decrease in demand from our customers in the healthcare, telecom, media and entertainment, and all the other categories of customers, was almost entirely offset by increases in demand from SLED, financial services, and technology markets. For the three months ended June 30, 2020, there was an increase in adjusted gross billings of $25.3 million, to $205.2 million for products that we recognize revenue on a net basis, such as, third-party maintenance, software assurance, subscriptions/SaaS licenses, and services.
We rely on our vendors to fulfill a large majority of shipments to our customers. As of June 30, 2020, we had open orders of $426.8 million and deferred revenue of $71.8 million. As of June 30, 2019, we had open orders of $210.6 million and deferred revenues of $60.9 million.
We analyze net sales by customer end market and by vendor, as opposed to discrete product and service categories. The percentage of net sales by industry and vendor are summarized below:
Our revenues by customer end market have remained consistent over the year with over 80% of our revenues generated from customers within the five end markets identified above. During the trailing twelve-month period ended June 30, 2020, we had an increase in the percentage total revenues from customers in the telecom, media and entertainment industry, and decreases in the percentage of total revenues in the SLED, and financial services markets. These changes were driven by changes caused by the COVID-19 pandemic, changes in customer buying cycles, and the timing of specific IT related initiatives, rather than the acquisition or loss of a customer or set of customers.
The majority of our revenues by vendor are derived from our top six suppliers, which, when combined is a fairly constant percentage of 63% and 64% of total revenues for the twelve-month periods ended June 30, 2020, and 2019, respectively. None of the vendors included within the “other” category exceeded 5% of total revenues.
Cost of sales: The 11.3% decrease in cost of sales was due to the decrease in service and product sales and a shift in product mix, as we sold a higher proportion of third-party software assurance, maintenance and services, which are recognized on a net basis resulting in an improvement in gross margin on product sales. Our gross margin increased 320 basis points to 25.4% for the three months ended June 30, 2020, compared to 22.2% in the same period in the prior year due to an increase in our services revenues and a shift in product mix. Vendor incentives earned as a percentage of sales increased 50 basis points for the three months ended June 30, 2020, resulting in a favorable impact on gross margin, as compared to same period in the prior year.
Selling, general, and administrative: Selling, general, and administrative expenses of $65.6 million for the three months ended June 30, 2020, increased by $2.9 million, or 4.6% from $62.7 million the prior year. Salaries and benefits increased $5.5 million, or 10.8% to $57.0 million, compared to $51.5 million during the prior year due to an increase due to higher variable compensation related to the increase in gross profit, and higher replacement costs from turnover. Our technology segment had 1,500 employees as of June 30, 2020, a decrease of 5 from 1,505 at June 30, 2019. General and administrative expenses decreased $2.6 million, or 23.7%, to $8.5 million during the three months ended June 30, 2020, compared to $11.2 million the prior year, due to a decrease in general office related expenses, acquisition related expenses, and travel and entertainment expenses resulting from restrictions on travel due to the COVID-19 pandemic.
Depreciation and amortization: Depreciation and amortization increased $0.1 million, or 2.4%, to $3.5 million during the three months ended June 30, 2020, as compared to $3.4 million in the prior year, due to the acquisition of ABS Technology in August 2019.
Interest and financing costs: Interest and financing costs of $0.3 million were incurred in the three months ended June 30, 2020, compared to none in the prior year. The increase is due to $35.0 million in borrowings under the accounts receivable component of our Technology segment credit facility.
Segment operating income: As a result of the foregoing, operating income was $17.5 million, an increase of $1.8 million, or 11.4%, for the three months ended June 30, 2020, as compared to $15.7 million in the prior year period. For the three months ended June 30, 2020, adjusted EBITDA was $23.2 million, an increase of $1.7 million, or 8.1%, compared to $21.4 million in the prior year period.
Financing Segment
The results of operations for our financing segment for the three months ended June 30, 2020, and 2019 were as follows (dollars in thousands):
Net sales: Net sales increased by $1.0 million, or 7.6%, to $13.8 million for the three months ended June 30, 2020, as compared to prior year results due to higher post contract earnings, and portfolio earnings, which partially were offset by lower transactional gains. During the quarters ended June 30, 2020, and 2019, we recognized net gains on sales of financial assets of $2.5 million and $3.3 million, respectively, and the fair value of assets received from these sales were $73.2 million and $69.9 million, respectively.
At June 30, 2020, we had $185.0 million in financing receivables and operating leases, compared to $169.5 million as of June 30, 2019, an increase of $15.5 million, or 9.1%.
Cost of sales: Cost of sales increased $0.1 million for the three months ended June 30, 2020, which consists of depreciation expense from operating leases. Gross profit increased by 8.2% to $11.7 million, for the three months ended June 30, 2020, as compared to $10.8 million in the prior year.
Selling, general and administrative: For the three months ended June 30, 2020, selling, general, and administrative expenses increased by $0.8 million or 25.4%, which was due primarily to an increase variable compensation due to higher gross profit and an increase in allowance for credit losses.
Interest and financing costs: Interest and financing costs decreased by 50.3% to $0.3 million for the three months ended June 30, 2020, compared to the prior year, due to a decrease in the average balance and interest rate on total notes payable outstanding. Total notes payable for the financing segment was $63.4 million as of June 30, 2020, a decrease of $9.5 million, or 13.0%, as compared to $72.9 million as of June 30, 2019. Our weighted average interest rate for non-recourse notes payable was 3.54% and 4.25%, as of June 30, 2020, and 2019, respectively.
Segment operating income: As a result of the foregoing, operating income and adjusted EBITDA both increased $0.4 million or 6.3% and 5.7%, to $7.5 million and $7.6 million, respectively, for the three months ended June 30, 2020, over the prior year period.
Consolidated
Other income: Other income increased to $0.1 million due to favorable foreign exchange rate during the three months ended June 30, 2020, compared to unfavorable foreign exchange rate in the prior year period of $0.1 million, partially offset by interest income.
Income taxes: Our provision for income tax expense was $7.7 million for the three months ended June 30, 2020, as compared to $6.5 million for the same period in the prior year. Our effective income tax rates for the three months ended June 30, 2020, and 2019 were 30.8% and 28.7%, respectively. The change in our effective income tax rate was primarily due to an adjustment to the federal benefit from state taxes.
Net earnings: The foregoing resulted in net earnings of $17.4 million for the three months ended June 30, 2020, an increase of 7.2%, as compared to $16.2 million during the three months ended June 30, 2019.
Basic and fully diluted earnings per common share was $1.30, for the three months ended June 30, 2020, an increase of 7.4% and 8.3% as compared to $1.21 and $1.20, respectively, for the three months ended June 30, 2019. Non-GAAP diluted earnings per share increased 4.9% to $1.51 for the three months ended June 30, 2020, as compared to $1.44 for the three months ended June 30, 2019.
Weighted average common shares outstanding used in the calculation of basic and diluted earnings per common share for the three months ended June 30, 2020, was 13.3 million and 13.4 million, respectively. Weighted average common shares outstanding used in the calculation of the basic and diluted earnings per common share for the three months ended June 30, 2019, was 13.4 million and 13.5 million, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity Overview
Our primary source of funding is cash from operations and borrowings which are accounted for as non-recourse and recourse notes payable. We use those funds to meet our capital requirements, which have historically consisted primarily of working capital for operational needs, capital expenditures, purchases of equipment for lease, payments of principal and interest on indebtedness outstanding, acquisitions and the repurchase of shares of our common stock.
ePlus Technology, inc. and certain of its subsidiaries, which are part of our technology segment, finance their operations with funds generated from operations, and with a credit facility with Wells Fargo Commercial Distribution Finance, LLC (“WFCDF”). This facility provides short-term capital for our technology segment. There are two components of the WFCDF credit facility: (1) a floor plan component, and (2) an accounts receivable component.
We believe that cash on hand and funds generated from operations, together with available credit under our credit facility, will be enough to finance our working capital, capital expenditures, and other requirements for at least the next year.
Our ability to continue to expand, both organically and through acquisitions, is dependent upon our ability to generate enough cash flow from operations or from borrowing or other sources of financing as may be required. While at this time we do not anticipate requiring any additional sources of financing to fund operations, if demand for IT products declines, or if our supply of products is delayed or interrupted, our cash flows from operations may be substantially affected.
The extent of the impact of COVID-19 is uncertain and may impact our liquidity position over the longer term. As credit markets have tightened as a result of COVID-19, we may have difficulty funding our financing transactions with lenders, which may result in the use of our cash or a decrease in financing originations.
Cash Flows
The following table summarizes our sources and uses of cash over the periods indicated (in thousands):
Cash flows from operating activities. We had $6.4 million provided by operating activities during the three months ended June 30, 2020, compared to $87.4 million used in operating activities for the three months ended June 30, 2019. See below for a breakdown of operating cash flows by segment (in thousands):
Technology Segment: In the three months ended June 30, 2020, our technology segment provided $11.2 million from operating activities primarily due to cash generated from earnings. Additionally, we had net borrowing on the floor plan component of our credit facility of $48.3 million. The net borrowing is primarily the result of extended payment terms from Cisco that deferred $34.2 million in payments. We use this facility to manage working capital needs. We present changes in this balance as financing activity in our consolidated statement of cash flows.
In the three months ended June 30, 2019, our technology segment used $42.1 million from operating activities due to changes in working capital exceeding cash generated from earnings. Partially offsetting the cash used in operations were changes in the accounts payable - floor plan balance of $19.9 million, which is presented as financing activity in our consolidated statement of cash flows.
To manage our working capital, we monitor our cash conversion cycle for our technology segment, which is defined as days sales outstanding (“DSO”) in accounts receivable plus days of supply in inventory (“DIO”) minus days of purchases outstanding in accounts payable (“DPO”). The following table presents the components of the cash conversion cycle for our Technology segment:
Our cash conversion cycle increased to 30 days at June 30, 2020, compared to 24 days at June 30, 2019. Our standard payment term for customers is between 30-60 days; however, certain customer orders may be approved for extended payment terms. Our DSO increased due to an increase in sales during the quarter ended June 30, 2020, to customers with terms greater than or equal to net 60 days. Our DPO increased 5 days. Invoices processed through our credit facility, or the A/P-floor plan balance, are typically paid within 45-60 days from the invoice date, while A/P trade invoices are typically paid within 30 days from the invoice date; however, certain of our suppliers temporarily increased our terms to 90 days. The 3 day increase in DIO was due to an increase in average inventory balances of 28.1%, or $15.8 million, due to pending projects for our customers and some delays in receiving by our customers whose offices were closed due to COVID-19.
Financing Segment: In the three months ended June 30, 2020, our financing segment used $4.8 million from operating activities, primarily due to changes in financing receivables net of $24.7 million. In the three months ended June 30, 2019, our financing segment used $45.3 million from operating activities, primarily due to changes in financing receivables- net of $58.2 million. We recognize the change in financing receivables, including the issuance of financing receivables offset by repayments of financing receivables and the proceeds from the transfer of financing receivables, when we account for the transfer as a sale, as part of operating activities.
Cash flows related to investing activities. In the three months ended June 30, 2020, we used $2.2 million from investing activities, consisting of $2.3 million for purchases of property, equipment and operating lease equipment offset by $0.1 million of proceeds from the sale of property, equipment, and operating lease equipment. In the three months ended June 30, 2019, we used $1.2 million from investing activities, consisting of $1.5 million for purchases of property, equipment and operating lease equipment offset by $0.3 million of proceeds from the sale of property, equipment, and operating lease equipment.
Cash flows from financing activities. In the three months ended June 30, 2020, cash provided by financing activities was $54.0 million consisting of net borrowings of non-recourse and recourse notes payable of $8.5 million, net borrowings on floor plan facility of $48.3 million, and offset by $2.7 million in repurchase of common stock.
In the three months ended June 30, 2019, cash provided by financing activities was $44.3 million consisting of net borrowings of non-recourse and recourse notes payable of $38.0 million, net borrowings on floor plan facility of $19.9 million, and offset by $13.3 million in repurchase of common stock and $0.3 million paid to sellers of SLAIT Consulting, LLC as part of a working capital adjustment.
Our borrowing of non-recourse and recourse notes payable primarily arises from our financing segment when we transfer contractual payments due to us under lease and financing agreements to third-party financial institutions. When the transfers do not meet the requirements for a sale, the proceeds paid to us represent borrowings of non-recourse or recourse notes payable.
Non-Cash Activities. We transfer contractual payments due to us under lease and financing agreements to third-party financial institutions. As a condition of these agreements, certain financial institutions may request that the customer remit their contractual payments to a trust, rather than to us, and the trust pays the financial institution. Alternatively, the customer will make payments to us, and we will remit the payment to the financial institution. The economic impact to us under either structure is similar, in that the assigned contractual payments are paid by the customer and remitted to the lender. However, when our customer makes payments through a trust, such payments represent non-cash transactions. Also, in certain assignment agreements, we may direct the third-party financial institution to pay some of the proceeds from the assignment directly to the vendor or vendors that have supplied the assets being leased and or financed. In these situations, the portion of the proceeds paid directly to our vendors are non-cash transactions.
Secured borrowings – Financing segment
We may finance all or most of the cost of the assets that we finance for customers by transferring all or part of the contractual payments due to us to third-party financing institutions. When we account for the transfer as a secured borrowing, we recognize the proceeds as either recourse or non-recourse notes payable. Our customers are responsible for repaying the debt from a secured borrowing. The lender typically secures a lien on the financed assets at the time the financial assets are transferred and releases it upon collecting all the transferred payments. We are not liable for the repayment of non-recourse loans unless we breach our representations and warranties in the loan agreements. The lender assumes the credit risk and their only recourse, upon default by the customer, is against the customer and the specific equipment under lease. While we expect that the credit quality of our financing arrangements and our residual return history will continue to allow us to obtain such financing, such financing may not be available on acceptable terms, or at all. As a result of COVID-19, credit markets have tightened. We may no longer be able to transfer receivables from certain customers with lower credit quality to financial institutions.
Credit facility — Technology segment
Our subsidiary, ePlus Technology, inc., and certain of its subsidiaries have a financing facility from WFCDF to finance their working capital requirements for inventories and accounts receivable. There are two components of this facility: (1) a floor plan component; and (2) an accounts receivable component.
On May 15, 2020, we executed an amendment to the WFCDF credit facility that increased the aggregate limit of the two components, except during a temporary uplift, to $275.0 million. Additionally, we have an election to temporarily increase the aggregate limit to $350.0 million for a period of not less than 30 days, provided that all such periods shall not exceed 150 days in the aggregate in any calendar year. Further, the amendment increased the limit on the accounts receivable component of the WFCDF credit facility to $100.0 million, changed the interest rate to two percent (2.00%) plus the greater of one month LIBOR or seventy-five hundredths of one percent (0.75%), and modified certain restrictions on ePlus Technology, inc.’s ability to pay dividends to ePlus inc.
As of June 30, 2020, the limit of the two components of the credit facility was $275 million, and the accounts receivable component had a sub-limit of $100 million.
The WFCDF credit facility is secured by the assets of ePlus Technology, inc. and certain of its subsidiaries, and varies available borrowing based upon the value of their receivables and inventory. Additionally, the credit facility requires a guaranty of $10.5 million by ePlus inc.
The credit facility restricts the ability of ePlus Technology, inc. and certain of its subsidiaries to pay dividends to ePlus inc. unless their available borrowing meets certain thresholds. As of June 30, 2020, their available borrowing met the threshold such that there were no restricted net assets of ePlus Technology, inc.
The credit facility requires that financial statements of ePlus Technology, inc. and certain of its subsidiaries be provided within 45 days of each quarter and 90 days of each fiscal year end, and also requires that other operational reports be provided on a regular basis. Either party may terminate with 90 days’ advance notice.
The loss of the WFCDF credit facility, including during circumstances related to COVID-19, could have a material adverse effect on our future results as we currently rely on this facility and its components for daily working capital and liquidity for our technology segment and as an operational function of our accounts payable process.
Floor Plan Component. After a customer places a purchase order with us and after we have completed our credit review of the customer, we place an order for the equipment with one of our vendors. Generally, most purchase orders from us to our vendors are first financed under the floor plan component and reflected in “accounts payable—floor plan” in our consolidated balance sheets. Payments on the floor plan component are due on three specified dates each month, generally 30-60 days from the invoice date. In addition, certain suppliers have temporarily extended their repayment terms to us due to COVID-19. Most customer payments in our technology segment are remitted to our lockboxes. Once payments are cleared, the monies in the lockbox accounts are automatically and daily transferred to our operating account. On the due dates of the floor plan component, we make cash payments to WFCDF. Our borrowings and repayments under the floor plan component are included in “net borrowings (repayments) on floor plan facility” within cash flows from the financing activities in our consolidated statements of cash flows.
The respective floor plan component credit limits and actual outstanding balance payables for the dates indicated were as follows (in thousands):
On July 23, 2020, we elected to exercise the temporary increase in the aggregate limit of the WFCDF credit facility to $350.0 million for a period of not less than 30 days.
Accounts Receivable Component. ePlus Technology, inc. and certain of its subsidiaries have an accounts receivable component included within the WFCDF credit facility, which has a revolving line of credit. The outstanding balance under the accounts receivable component is recorded as recourse notes payable on our consolidated balance sheets. Our borrowings and repayments under the accounts component are included in “borrowings of non-recourse and recourse notes payable” and “repayments of non-recourse and recourse notes payable”, respectively, within cash flows from the financing activities in our consolidated statements of cash flows.
As of June 30, 2020, and March 31, 2020, there was an outstanding balance for the accounts receivable component of $35.0 million. As of June 30, 2020, and March 31, 2020, the maximum credit limit was $100.0 million and $50.0 million, respectively. We may maintain a balance on the accounts receivable component to assist in mitigating risk arising from COVID-19.
Performance Guarantees
In the normal course of business, we may provide certain customers with performance guarantees, which are generally backed by surety bonds. In general, we would only be liable for the amount of these guarantees in the event of default in the performance of our obligations. We are in compliance with the performance obligations under all service contracts for which there is a performance guarantee, and we believe that any liability incurred in connection with these guarantees would not have a material adverse effect on our consolidated statements of operations.
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K, or other contractually narrow or limited purposes. As of June 30, 2020, we were not involved in any unconsolidated special purpose entity transactions.
Adequacy of Capital Resources
The continued implementation of our business strategy will require a significant investment in both resources and managerial focus. In addition, we may selectively acquire other companies that have attractive customer relationships and skilled sales and/or engineering forces. We may also open offices in new geographic areas, which may require a significant investment of cash. We may also acquire technology companies to expand and enhance the platform of bundled solutions to provide additional functionality and value-added services. We may continue to use our internally generated funds to finance investments in leased assets or investments in notes receivables due from our customers. These actions may result in increased working capital needs as the business expands. As a result, we may require additional financing to fund our strategy, implementation, potential future acquisitions, and working capital needs, which may include additional debt and equity financing. The impacts of COVID-19 may limit or eliminate our access to capital. While the future is uncertain, we do not believe our credit facility will be terminated by the lender or us. Our lending partners in our financial segment have tightened credit availability and are more discerning in their approval process. However, currently we have funding resources available for our transactions.
Inflation
For the periods presented herein, inflation has been relatively low, and we believe that inflation has not had a material effect on our results of operations.
Potential Fluctuations in Quarterly Operating Results
Our future quarterly operating results and the market price of our common stock may fluctuate. In the event our revenues or earnings for any quarter are less than the level expected by securities analysts or the market in general, such shortfall could have an immediate and significant adverse impact on the market price of our common stock. Any such adverse impact could be greater if any such shortfall occurs near the time of any material decrease in any widely followed stock index or in the market price of the stock of one or more public equipment leasing and financing companies, IT resellers, software competitors, or our major customers or vendors.
Our quarterly results of operations are susceptible to fluctuations for a number of reasons, including, but not limited to the worldwide impacts from COVID-19, currency fluctuations, reduction in IT spending, any reduction of expected residual values related to the equipment under our leases, the timing and mix of specific transactions, the reduction of manufacturer incentive programs, and other factors. Quarterly operating results could also fluctuate as a result of our sale of equipment in our lease portfolio to a lessee or third-party at the expiration of a lease term or prior to such expiration, and the transfer of financial assets. Sales of equipment and transfers of financial assets may have the effect of increasing revenues and net income during the quarter in which the sale occurs and reducing revenues and net income otherwise expected in subsequent quarters. See Part I, Item 1A, “Risk Factors,” in our 2020 Annual Report.
We believe that comparisons of quarterly results of our operations are not necessarily meaningful and that results for one quarter should not be relied upon as an indication of future performance.