Scansource Inc (SCSC) 2003 Q1 法說會逐字稿

Good afternoon. My name is Ben and I will be your conference facilitator today. At this time I would like to welcome everyone to the ScanSource conference call.

All lines have been placed on mute to prevent background noise. After the speakers' remarks there will be a question-and-answer period. If you would like to ask a question during this time, simply press star and 1 on the telephone keypad.

I would now like to turn the call over to Mr. Jeff Bryson. You may begin your teleconference

Thank you. Welcome to the ScanSource conference call to discuss results for the quarter ended September 30, 2002. My name is Jeff Bryson, and I'm CFO of ScanSource. With me today is Michael Baur, President and CEO. We will present a few minutes of prepared material and then take your questions.

This conference call contains certain comments which are forward-looking statements that involve risks and uncertainties. These statements are subject to the Safe Harbor created by the Private Securities Litigation Reform Act of 1995. Any number of important factors could cause actual results to differ materially from anticipated results. For more information concerning factors that could cause such a difference, see the company's annual report on Form 10-K and quarterly reports on Form 10-Q filed with the Securities and Exchange Commission.

Our first comment will be on sales results by unit. The company recorded sales of 260.6 million for the quarter ended September 30, 2002, an increase of 38 percent over sales of 188.8 million for September 30, 2001. Our business consists of three reporting segments, North America distribution, international distribution, and ChannelMax. North America distribution sales throughout the US, Canada and Mexico, from a single centrally located distribution center in Memphis, supported by the headquarters staff in South Carolina. North American distribution includes sales by three sales units, the ScanSource sales team who sell automatic identification and data capture products, AIDC, and point-of-sale equipment.

The Catalyst telecom team sells voice, data and converge communications products from Avaya and the Paracon sales group sells converged products from Intel. September quarter end 2002 sales of 260.6 million include 244 million from North America distribution, a growth rate of 48 percent over last year and 13.3 million from international distribution which includes Latin America and Europe, all of which is incremental compared to last year. Sales also include 3.3 million from ChannelMax.

Measuring sales based upon our end markets shows year-over-year growth of 46 percent in bar code and point-of-sale and 30 percent for telephony for the quarter ended September 2002. That produced a 52 to 48 mix of bar code and point-of-sale versus telephony sales.

Our next discussion will center on operating results. Gross margin was 11.6 percent for the first quarter of 2003 versus 11.1 percent for last year. Gross margins were higher due to some opportunistic purchases from the June quarter that we earned as they sold through in the September quarter.

Operating expenses were 19.7 million and 7.6 percent of sales compared to 13 million and 6.9 percent of sales last year. Operating expenses were higher than expected for three reasons. SG&A included approximately 400,000 of direct expenses in Europe which was in line with our expectations. These costs are primarily employment-related expenses.

We funded a discretionary 401(k) plan profit sharing contribution for our employees for 1.4 million, and we were able to make charitable contributions of 700,000 which was our first substantial charity giving since the spring of 2001. Without these costs, operating expenses were within the range posted over the past three quarters. Operating income increased by 33 percent to 10.5 million, and 4.04 percent of sales, compared to 7.9 million and 4.2 percent of sales for the September 2001 quarter end.

Due to the reduction in interest rates, net interest expense was only $389,000 versus $554,000 for the same period last year, even though the use of the line of credit was slightly higher than last year. We are continuing to mitigate the P&L impact of a portion of our borrowings by recovering some of our interest costs from customers. As we told you on our last call, our overall effective tax rate for the next couple of quarters will be higher than our historical 38 percent rate since we cannot tax effect foreign country operating losses. As those country units begin to turn profitable, the overall effect of tax rate will then drop as net operating loss carry-forwards are used in those countries.

To help you forecast our results, we will try to predict our tax rate one period in advance. For the September quarter, the actual tax rate blended to 39.6 percent which was slightly lower than we expected. We expect our tax rate for the upcoming December quarter to range from 39.5 to 40 percent. September quarter end net income increased 32 percent to 6 million and 2.3 percent of sales compared to 4.5 million and 2.4 percent of sales for the quarter ended September 2001. Diluted earnings per share were 30 percent higher this year, at 95 cents per share, compared to 73 cents per share for the September period one year ago. Our return on invested capital this quarter was 27 percent which is slightly above our target range.

We will now take a moment to update you on each of our reporting segments. First, we'll cover North America distribution and the ScanSource sales unit. The North America distribution segment has three sales units, the first of which sells automatic data capture and retail store automation equipment for manufacturers such as Symbol, IBM, Sebra, Intermec, and NCR. Automatic data capture products include all types of mobile data collection computers, bar code scanners, wireless products and bar code label printers. Retail store automation equipment includes those computer-based systems that have replaced electronic cash registers in grocery retail and hospitality environments.

We had an outstanding quarter in this unit especially in AIDC, where all product categories performed well, where as POS product sales were mostly flat. In Catalyst we saw significant sales growth from our existing resellers, a portion of which was from channel shift. Growth also came from the fact that the September quarter is Avaya's fiscal year end, which coincides with buying incentives that they make available to resellers. Recently Avaya has split their voice products into two business units relevant to Catalyst Telecom. The first is the Converged Systems and Applications Group, CSAG, which markets the Definty PBXs which require more value-added services and are continuing to be sold under a closed distribution model. The second group is called the Small and Medium Business Systems, SMBS Unit, and it markets the Magix, Partner and IP office solutions which are targeted to a broader market place. The SMBS group will go to market under an open sourcing program effective October 1, 2002, where dealers will no longer be tied to only one distributor.

We believe that Avaya's intent it to expand the total number of dealers buying these products. We'll keep you updated on how this affects our business.

Our second reporting segment is international distribution. This segment consists of ScanSource Latin America, based in Miami, and ScanSource Europe, headquartered in Belgium. Our international business segment is focused on the AIDC and POS markets and operates as standalone businesses with their own sales and management teams, distribution centers and MIS systems. The UK portion of the European unit had good year-over-year sales growth, as that veteran sales team as had more available inventory and more capital to extend credit to customers.

During the quarter, we have spent a significant amount of time with manufacturers working out the details of our authorization to sell all of our product lines across Europe. Our European incremental direct expenses this quarter worked out to 6.5 cents per share, which was within our planned range of 5 to 7 cents per share. Our investment there was spent filling out key positions to be ready for growth and in marketing activities to build the market.

The Latin America unit had good year-over-year sales growth, especially since they have continued to make no sales to Argentina. During this quarter we expect to reorganize our Mexico operations and assign management of our Mexico City sales office to our ScanSource Latin America leadership.

We would now like to discuss balance sheet metrics and cash use. Inventory turns without ChannelMax inventory improved to 6.3 at the end of September 2002, compared to 5.4 turns in the June 2002 quarter. The number of outstanding accounts receivable days without ChannelMax was 44 days at September 30, which is slightly higher than the June 30 quarter at 42 days.

Our line of credit can fluctuate depending upon the role our vendors wish for to us play in the distribution channel. Cash of 1.1 million was used in operations this quarter, primarily from increases in receivables and inventory -- and a reduction of inventory, net of the reduction in inventory. After cash use for capital expenditures, our line of credit balance was 49.4 million at quarter end. We ended the quarter at zero days of paid-for inventory, meaning that our investment in inventory was completely offset by our interest-free trade payables to creditors.

We will conclude this part of the call with our expectations for the December 31, 2002, quarter. Looking ahead to the December quarter, we think total revenues could range from 235 to 255 million, which would give us a growth rate of between 13 percent and 23 percent compared to the prior year. Earnings per share could range from 85 cents to 95 cents per share for the quarter ended December 31, which would be after a 4-6 cent per share investment in Europe. At this time, we will attempt to answer your questions.

At this time, I would like to remind everyone, in order to ask a question, simply press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q & A roster. Your first question comes from Jeff Rosenberg.

Uhm, let's see. First, I wanted to ask, you talked about 2.1 million in the purely discretionary issues in SG&A. If you back those out, you still had a pretty significant uptick in SG&A during the quarter. Is that something that could fluctuate depending on whether gross margins stay as high as they did this quarter and I guess I should ask the logical other question there, which is what is -- was it in the mix or whatever that caused growth margins to be as healthy as they were?

Well, in your first question, I think the overall SG&A after factoring out the Europe investments and so forth, we were fairly pleased with the SG&A other than the two discretionary items you referred to. I think certainly a lot of our costs are variable so when sales go up, some of those costs are variable and go up with sales. But the other question, Jeff, i'm sorry, I caught the first part, not the second.

Just gross margins were higher than they have been for the past several quarters. I assume that's likely mix. But just what's the reason there that that ticked up?

Right. We did have some opportunistic buying opportunities there in June that flowed through as the products were sold here in September.

And how much of that had to do with the fact that inventories on an absolute basis went down as much as they did, if you can talk a little bit about that?

Well, I think the opportunistic buying probably was reflected in a little bit higher inventory at the end of June. And then I think what we have seen in the management of inventory here at the end of September is some of the things we have been putting in place over the last several months or beginning to, to kick in. Certainly, too, having the stronger-than-expected sales in September helped pull some of that inventory through as -- and helped keep inventory turns in a better -- in better shape.

Okay. And then, uhm, just on Europe, uhm, you mentioned year-over-year growth in the UK, and if you would talk a little bit about how things are trending sequentially as it relates to -- I think you were hoping by the end of the calendar year that a goal of reaching 10 million per quarter in Europe and break-even, you know, how was that progress there?

This is Mike, Jeff. I -- I think the key is that number one, we haven't broken out the specifics on the sales we are trying to keep that together with Latin America, so the total Latin America and Europe was 13.3 for the quarter versus 10.4 million in the June quarter okay? And, uhm, without separating that out, I can tell you we are still making good progress in Europe. We're able to see some of the investment go down this quarter because we had better sales growth. But certainly our challenge is to make that work in this quarter and we are still working with some of the vendors who really -- a lot of our sales have still been restricted to the UK marketplace as we work in these pan-European agreements. So we are hoping that will start kicking in this quarter.

Right now we're still anticipating for the December quarter that we'll still have an investment of I guess between 4 and 6 cents. And we would hope that by next quarter, we would be in a position of where that's not the case. We'll be covering our direct expenses. But right now, that's the best we can do.

So is that somewhat behind plan or are you upping your -- your level of discretionary investment as you have strong results elsewhere? How would you characterize that?

I think it's definitely, uhm, the sales are growing slower than I would like. And I think the vendors, too. I think we have had a challenge with trying to explain our business model to a lot of the manufacturers, field sales teams. We're coming into a market where we're trying to create a pan-European strategy where no one has done that before in this industry. So they are used to having regional distributors, so there is a lot of communication that's still having to be had with most of our vendors. As you recall, we only started this really with the support of one or two key vendors. And so we have been trying throughout the year to get more of our vendors on board and that's taken longer than we would have liked.

Okay. Thanks a lot.

Thanks, Jeff.

Your next question comes from Reich Reed.

Good afternoon. Mike, can you maybe talk a little more about the SMB side of Avaya going to an open source distribution structure? How much of that is pertains to your business? And what do you think that will ultimately mean for you?

Well, we certainly have spent a lot of time talking to Avaya about this issue. They signed up another distributor, as you guys recall Tech Data, earlier this year to sell only the SMBS products as they're called now, and the plan was to get them to go out there and find their own channel. Then in October, open it up so that if a reseller buying from ScanSource or from our competitors, whether it was Tech Data or one of the other small distributors, if any of those guys had customers who wanted to buy from another distributor, they wouldn't be prohibited from doing that. What Avaya has tried to communicate, though, is they really want all the distributors to grow the total pie by going out and finding more customers. So they with this reorganization and this SMBS business unit, Avaya has committed more resources to help the distributors find new resellers. And to help the existing resellers sell more product.

So we certainly expect in the short term that there's going to be certainly margin pressure and we are going to be watching that very closely. But frankly, Avaya like still an added value model in the SMBS space, they know it's a different type of value add. But we certainly are cautiously optimistic that we'll continue to retain our share of the market.

Can you also talk about the converged voice data products and, you know, what might be new there for you guys?

Well, Avaya -- I'm not really -- the technology guy. John Black, who heads that up for us, is more specifically informed on which products in that group are selling for us. But I would tell you this that Avaya has a strong offering. They have continued to show leadership in taking IP-enabled products and showing that you can attach them to your existing Legacy equipment. I think that's a unique value proposition that some of their competitors don't have. So we believe they are showing to us the right kind of technology, they are make the right investments so that we think that long term Avaya still has a very strong business proposition for us and our Catalyst business unit.

I guess I should have been more careful in asking that but I mean is that -- are you starting to see that trend more from your viewpoint?

I think -- I think it's still slow. I mean, I think the whole idea of moving into some of the IP-enabled stuff, which is where everybody's talking about the industry going, I think it takes a long time. I think just back in the computer business, we saw that the year of the networking took about a decade. And so we'll see how long the IP-enabled transition takes, too. But we're pleased with the investments that Avaya is making to make the product line and their channel a value-added strategy that will include Catalyst.

Can you also, Mike, give us a quick update on NCR? That shift has also been pretty slow to progress. They continue to struggle in their retail business. Is that struggle helping you gain some momentum?

Well, I would say they're still having a -- I think all of the -- all the retail point-of-sale companies are having a difficult year. You know, we've continued to not see as we had in years past a lot of larger opportunities through our channel, and I think NCR and IBM and all of our point of sale manufacturers are trying to figure out what's the best business model going forward. And I think NCR has gone through a lot of that study this year. They have made some structural changes in organization. And really, very little of that has impacted the channel so far this year. I would say they just put some new management in place. We have had recent meetings with them and they are committed that the channel has to become a bigger part of their overall business for them to really succeed financially. So I would say we haven't seen as much of that channel shift as we had hoped during this year.

Is there a lot of culture to overcome there? Is that kind of the issue.

You bet. It's a company where 90 percent was sell direct just two years ago.

Thanks a lot, Mike.

Yup.

Your next question comes from Chris Quilty.

Let me start with a silly question. Just when I run the net income against the number of shares on a fully diluted basis I come out with 97 instead of 95.

Right. That's kind of an oddity. It's actually been in our numbers for a while. What happens is in a fully diluted earnings per share calculation, we have to give effect to one of our subsidiaries which we majority own that subsidiary today. We own 90 percent of it but we have to consider that it has some options outstanding if all of its options were exercised we would only be 80 percent owners of that subsidiary instead of 90. So the fully diluted calculation makes you take out that additional 10 percent of their earnings that would be, you know, deemed to be going to those other owners and because of that the earnings per share goes from 96.6 cents per share down to 95.4. So with rounding we're at 95 rather than 97.

That's what I thought. Just kidding. So that's obviously net point?

No, it isn't. Actually, that's our ChannelMax unit.

Speaking of ChannelMax, boy, the trend looks like it's going away. What are the expectations there?

Well, I think you have to remember that the reason it looks that way is because of the change in the [INAUDIBLE] contract. We talked about it so much this year, we took it out of the language for this call but we still had this last quarter where we still have revenue based comparison a year ago. That's why it looks so different still, Chris. But in the December quarter, that will go away. Or at least mostly.

Yeah. Okay. Do you have the comparison available?

Yes. Just one second. Okay. Had EXPANET been denominated as sales in this year's September quarter end amounts, the overall sales growth rate would have been 47 percent. And ChannelMax's sales would have been 19.8 million compared to 24.4 million last year.

Okay. Got it. Uhm, and there was a little bit larger bubble in the other line... than normal?

Yes. Again, that is reflective of the same thing you and I were just chatting about, that in all cases that other line includes the minority share of net income that you apportion out below the line. So that's reflective -- it's slightly higher and that's reflective in the earnings per share calculation, as well.

Okay. And on the European side of the business, you have had some higher-than-expected costs perhaps in the last couple of quarters here. How close do you think you're done you are towards the end of the hiring cycle in terms of setting up those satellite offices in country and sort of getting a baseline level at least in personnel?

We think we're pretty close. I mean, what we're trying to do is not to, uhm, not to, uhm, suggest that we aren't ready for growth. We want to show the manufacturers that we are making the right structural investments so whether that's opening the office in Germany and France with one person each, you know, we have done that. The key is that we have had to invest in some merchandising people. We call them product managers, as well. That manage the vendor relationship so as we brought on all of the vendors and their selling efforts across Europe, we have had to have more merchandising people ahead of the game.

So I would say, you know, we feel good about where we are. We think that we just got get our revenue up at the right point. Because a lot of these costs are those fixed costs. These aren't salespeople that are variable. These are fixed costs that once our revenue gets to where we want it to be, we'll be able to see the appropriate contribution margin coming.

Okay. And switching back over to the Avaya side, the guidance that they -- you've obviously incorporated the guidance that they gave out last night on a go-forward basis and your expectations, I presume, for the December quarter?

You know, we really -- we don't always know whether their guidance -- how much that will affect us. I mean, obviously, we have been constantly aware that they've got to figure out how to restructure their business and do the right thing, but they have -- they have been very close with us about here's what we want, the channel to do. And where we're going to go as a company. So we certainly agree with their strategy. It certainly makes a lot of sense.

Okay. Great. Congratulations, guys.

Well, thanks.

Your next question comes from Gregory Makosko.

Hi. Could you talk about the average orders for Avaya and how that's trending?

Uhm, for Avaya, we will in general we talk about average order size but we don't break it out by manufacturer. I would just say in general our telephony business, and Avaya being the biggest part of that, we have always had larger order sizes in our bar code business, Gregory. I don't know if that helps.

You but I mean, are the -- is the average order in telephony trending up? Average order size?

I wouldn't say that. No. Not necessarily. We don't have a metric that says that has changed, no.

What about self checkouts? Is there any activity there?

Well, a lot of the self checkout has been sold direct by the manufacturer because there's significant infrastructure and investment in software that has to be made both at the host application for the retailer or supermarket and at the self checkout, so my suggestion would be that the self checkout products have not been channel-ready yet. But they're -- there are indications that they should be very soon. So it's really a software integration challenge for the manufacturers today to make them work through the channel.

So you might see that in the next quarter or two?

I'd say sometime next year.

Okay. And then with regard to your, uhm, IT system, I know that you had talked in the past about direct connection with your vendors. How is that doing?

Uhm, it's one of those that we still have a lot of hopes there and expectations, not a lot of progress. I think our intent is to try to pilot that with a couple of key manufacturers. So that we can prove the concept and come up with hopefully some industry standards communication parameters so we are still working on that earnestly.

Okay, good. Thank you.

Thanks. The.

At this time there are no further questions. Mr. Bryson, are there any further remarks?

Thank you for attending our call.

This concludes today's ScanSource conference call. You may now disconnect.