Scansource Inc (SCSC) 2003 Q4 法說會逐字稿

Good afternoon. My name is Summer and I will be your conference facilitator today. At this time, I would like to welcome everyone to the ScanSource earnings conference call. All lines have been placed on mute to prevent any background noise. After the Speaker's remarks, there will be a question-and-answer period. (CALLER INSTRUCTIONS). Thank you. Mr. Bryson, you may begin your conference.

Thank you. Welcome to the ScanSource conference call to discuss results for the quarter ended June 30, 2003. My name is Jeff Bryson. And I'm Vice President of Administration and Investor Relations of ScanSource. With me today is Mike Baur, President and CEO; and Rich Cleys, Vice President and CFO.

We'll provide you some short remarks to recap the quarter's key market issues and our operating results. And we'll 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 Exchange Commission. I will now introduce Rich Cleys, CFO, to comment on overall sales and operating results.

Good afternoon. The company recorded sales of $253 million for the quarter ended June 30, 2003, an increase of 8% over sales of $233.7 million for June 30, 2002. Measuring sales based upon our product groups shows year-over-year growth of 11% in AIDC and point-of-sale and a 5% year-over-year increase in telephony for the quarter ended June 30, 2003. That produced a 58-42 mix of AIDC in point-of-sale versus telephony sales.

Our next discussion will focus on consolidated operating results. Gross margin was 11.6% for the fourth quarter of fiscal 2003 versus 11% for the last year and is somewhat higher than our most recent quarters. Gross margins were higher, due to some opportunistic purchase discounts from the March and June quarter that we earned as they sold through in the June quarter.

Geographic sales mix and the re-class that resulted from implementing EITF 0216 vendor consideration -- that implementation occurring in our third quarter of fiscal 2003.

Operating expenses were $18.4 million and 7.3% of sales, compared to $17.1 million and 7.3% of sales last year. In both the current and prior years, there were costs that do not occur every quarter.

In the current-year period, the company funded a discretionary profit-sharing contribution for our employees of $1.1 million and provided for charitable contributions of $200,000.

In the prior-year period, we had a significant customer account receivable for which we provided $1 million of additional bad debt expense. If each quarterly period is adjusted for these amounts, SG&A would have been 6.8% and 6.9% of sales for the periods ended June 30, 2003, and 2002, respectively.

Operating income increased by 29% to $11 million which is 4.3% of sales compared to $8.5 million and 3.6% of sales for the March 2002 quarter-end.

Due to the reduction in both average usage of our line of credit and interest rates, net interest expense was only $80,000 versus $336,000 for the same period last year. Our overall effective tax rate continues to be higher than our historical 38% rate since we haven't been able to tax effect foreign country operating losses.

If those as those country units begin to turn profitable, the overall effective tax rate will drop as net operating loss carry-forwards are used in those countries.

For the June quarter, the actual tax rate blended the 39.7%, which was below the 41% to 43% expected, because Europe's year-to-date operating loss was reduced.

We expect that our blended tax rate for the upcoming September quarter to be between 38% and 40%. June quarter-end net income increased 17% to $6.2 million and 2.5% of sales, compared to $5.3 million in June 2002.

As a reminder, on January 6, 2003, we declared a 2-for-1 stock split which was effective as a 100% stock dividend on your common stock paid on January 28 to shareholders of record of January 17, 2003. Giving effect to the stock split, diluted earnings per share were up 17% and 49 cents per diluted share, versus 42 cents for the same quarter last year.

Our return on invested capital this quarter was 28%, which is above our target range. We would now like to discuss balance sheet metrics and cash use. Inventory turns, without ChannelMax inventory, improved to 6.3 at the ended June, 2003, compared to 5.4 turns in the June 2002 quarter.

The number of outstanding accounts receivable days, without ChannelMax, was 46 at June 30, 2003, which was slightly higher than the June 2002 quarter at 42 days. Our line of credit can fluctuate, depending upon the role our vendors wish us to play in the distribution channel.

Cash of over $11 million was provided by operations this quarter, resulting from earnings and an increase in accounts payable. After cash use for capital expenditures, our line of credit balance dropped to $18.1 million at quarter-end. We ended the quarter at less than one day of paid-for ended inventory, meaning that a significant portion of our investment in inventory was offset by our interest-free trade payables to creditors.

In looking ahead to September quarter, I would expect our number of paid-for inventory days to be lower -- or higher -- I'm sorry. And our line of credit usage to be higher, due to some changes we made in our key vendor -- key accounts payable vendor programs.

By September, we would probably have to stair-step upward in our line of credit balance, without regard to cash if any needed to fund our growth. This will be a one-quarter event as we move to the new program and will not signal a new level of ongoing cash use. In the quarters following September 30th, we would expect domestic cash use and changes in the line of credit to be similar to our past experience. I will now turn the call over to Jeff Bryson to comment on each of our reporting segments.

Our business consists of three reporting segments, North America distribution, international distribution, and ChannelMax. North America distribution sells throughout the U.S. and Canada, from a single centrally located distribution center in Memphis, supported by the headquarters staff in South Carolina.

North America distributions include sale -- about three sales units. The ScanSource sale team -- who sell automatic identification and data capture products, AIDC, and point-of-sale equipment. The Catalyst Telecom team, who sell voice data and converge communications products from Avaya and Aparacon sales group who sell converge communications products from Intel.

Now we'll provide sales results and update you on each reporting unit. First we'll cover North America distribution and the ScanSource sales units. North America distribution sales were $232 million, a growth rate of 8% over last year.

The North America distribution segment has three sales units, the first of which sells AIDC and point-of-sale equipment from manufacturers such as Zebra, Intermec, MCR, Symbol and IBM. AIDC products include mobile data collection computers, barcode scanners, wireless products, and barcode label printers. The point-of-sale equipment includes those computer-based systems that have replaced electronic cash registers in grocery, retail, and hospitality environments. We were pleased to see good growth this quarter from the point-of-sale product group.

As you know, if you follow the AIDC marketplace, Symbol and Intermec initiated new business partner programs in the quarter that just ended. And Zebra is in the process of launching one as well. In general, these VAR programs are designed to grow the market by rewarding demand creators and have reaffirmed the importance of the value-added distribution model, going forward.

We're beginning to see some benefit from these programs and believe they will help us grow in the coming months. Another development in this space last quarter, was the announcement by Tech Data they have begun a point-of-sale/data capture unit. This unit has signed a few vendors. But we have seen little impact from their presence so far. Our concern with the potential margin pressure that we might face, particularly if our current competitors overreacted to Tech Data, and lower prices unnecessarily.

We have also added a new VP of Sales for our North America AIDC and point-of-sale unit, Mark Morgan. Mark brings more than 17 years of experience in consultative sales, technology, and product distribution to this position. He will help us develop and strengthen current and prospective customer relationships.

Mark has served as a sales and marketing consultant for local and international companies, where he managed business development planning, vertical sales strategies, sales force automation, product positioning, and pricing strategy among other strategic sales efforts.

The Catalyst Telecom sales unit is led by Avaya. Avaya has two voice product units, relative to Catalyst Telecom. The first of the newly renamed Enterprise Communications Group, ECG, which markets Definity PBXs and the Avaya multi-vanish IP telephony solution for larger enterprises.

ECG products generally require more value-added services and are continuing to be sold under a closed distribution model. Approximately three-fourths of Catalyst-Avaya voice sales are for ECG products. The second Avaya group is called the Small and Medium Business Systems unit, SMBS. And it markets the Magics, Partner, and IP Office Solutions which are targeted to a broader marketplace. SMBS products account for around one-fourth of Catalyst-Avaya voice sales.

Generally sales were stronger for Catalyst, due to more sales through our existing reseller group, particularly those emphasizing ECG products. There has been no fundamental change in Avaya strategy in using the indirect channel. The channel will continue to be an important to Avaya because it helps them reach new markets at lower cost than a direct sales force would. The Paracon sales team achieves strong growth this quarter, in sales of Intel-based communications products. Paracon is still looking at potential new vendor opportunities in the telephony space.

Our second reporting segments is international distribution. International distribution, which includes Latin America and Europe, posted sales of 19 million which is higher than last year's quarter of 12 million. When compared to last year, approximately $2.4 million of the change in international sales was the result of favorable foreign currency changes. O

ur international business segment is focused on the AIDC and electronic point-of-sale, or EPOS, as it is known in Europe, products at this time. ScanSource Latin America sales recovered nicely from the March quarter, which is seasonally slower. And they have added their first in-country business development representative in Brazil.

In Europe, we continue to see good sales growth which, when combined with the savings generated by our cost reduction efforts, allowed this unit to cover its incremental direct expenses for the first time. This impacted earnings in two ways. It reversed the drag on earnings that we had experienced over the past five quarters and provided some relief in our overall tax rate.

We will continue to make investments in Europe, as the expected sales growth permits. Now that Europe has achieved an initial goal of covering direct expenses, we'll no longer report its financial results separately. But we'll focus instead on the international reporting segment as a whole.

Our third reporting segment is ChannelMax. ChannelMax revenue was $1.7 million in sales this quarter, much lower than last year as we've seen and discussed with you, over the past few quarters. As a result, we've decided to restructure this unit.

By October 1, 2003, we expect to reassign the ChannelMax service team to become a part of our partner services group. We will consolidate the information services staff into the MIS department at ScanSource and will have the operational management team in Memphis report to our corporate group. In conjunction with this change, this reporting segments, identified by its separate legal entity and minority shareholders will cease by October first and a onetime charge will be taken against September 30 earnings of between 9 and 11 cents per share.

We will conclude this part of a call with our expectations for September 30, 2003 quarter. Looking ahead to the September 2003 quarter, we think total revenues could range from $240 to $260 million. Earnings per share could range from 30 cents to 38 cents per share for the quarter ended September 30, which would be after our one-time charge for the reorganization of ChannelMax of approximately 11 cents per share. At this time, we will attempt to answer your questions.

At this time, I would like to remind everyone in order to ask the question (CALLER INSTRUCTIONS). The first question comes from Jeff Rosenberg.

Hi. How are you? Let's see. Let me start with sort of -- I know you say you're not going to break out Europe going forward. But, can you remind us what the expected dilution was, in terms of -- or just subtraction from earnings this quarter? And what you actually achieved?

I believe we gave guidance -- this is Rich Cleys, Jeff. I believe we gave guidance that it would be 3 cents on the quarter dilution.

That was before any sort of tax effect, right?

Yes. Obviously, we covered our expenses. And we were able to, by covering our expenses, not have the tax drag that we had before.

When you say cover your expenses, you were basically break-even in Europe for the quarter?

As denominated by that 3 cents. On a comparative basis, I think we would say that 3 cents did not occur as expected.

Okay. Is that something that occurred -- well I guess it occurred for the quarter. Any reason the tax rate wasn't 38% for the quarter and wouldn't be 38%, unless you sort of took a step backwards? Is that sort of what you are hedging, in terms of your expected tax rate for the current quarter?

Can you ask that question again Jeff?

I'm sorry, I asked two at once. One was, if you covered your direct expenses and you didn't have any dilution, why wasn't the tax rate 38% for the quarter?

Of course, we are in some countries where the statutory rate is higher than 38%. We also have state taxes to consider. So 38% -- I believe is a going-forward blended-rate, which would reflect some benefits in the future. Whereas right now, we've got to provide for those state and some of those higher statutory geographies.

So the 38% to 40% range is not suggesting that, perhaps, you're still kind of fluctuating around? You expect to stay around break even in Europe?

I think we have turned the page there. And we should be break even.

Great. That's fantastic. And then on the gross margin -- a couple of questions there. You're saying you had some opportunistic buys. And that benefited you, yet you had high inventory turns. I would have expected you to have more inventory, if you were able -- if you were benefiting from that.

Is that just a timing effect there? And you actually brought inventories down to low levels? But you were still, at the same time, benefiting from purchases at low prices?

Right, we actually sold through those purchases. We were able to take those opportunistic buys. And much of that was reflected in our margin.

Okay. So I guess the key question is -- going forward, it sounds like what you're saying, in terms of what you expect to have on your line of credit -- you're going to see an increase in inventory. Is that right? Is that what we should expect in the current quarter?

I think what we are talking about is the net inventory. So it would probably be more in area of payables.

Okay,

Jeff, it's just different terms with some of our vendors.

It's not a function of them asking you to hold more inventory?

: No.

So it's different payable terms. So, what would be sort of our sequential expectation? Maybe not down to the basis point, but sort of directionally? And a little bit of magnitude, in terms of what you can sustain, in terms of gross margin?

I think gross margin has always fluctuated. If you look back over the last four or five quarters, it has ranged from 10.7 or 10.8, up to the 11.6 we posted last time. So I think you're going to have some mix issues, as you go forward. And I think you have to find out what your opportunities are, in terms of your buying leverage.

Okay, so -- okay. That's fine. Then the last thing and I'll let other people go. The AITF 0216 -- I wasn't familiar with that. Can you give a little bit of elaboration on what kind of effect that had? And whether that sort of permanently affects you positively or negatively, going forward?

The 0216 is the vendor cash consideration. And, essentially, what has happened is, there are some reimbursements that we've received, that -- in the past we've been reducing our SG&A, because those were reimbursements for costs that are in SG&A.

This new pronouncement requires you to very specifically identify those costs and match those reimbursements. If it doesn't meet that specific matching, it gets reclassified to cost of goods sold. And in-turn, if it's in cost of goods sold, it's considered more of a price variance. And we would amortize those price variances over the next inventory turn.

So we should think of those as having no net effect on operating margin? And to a certain extent as sort of -- as we think about the historical range of gross margin -- it pushed it up a little bit? And maybe caused you to not offset SG&A as much as you would have historically?

Right. I would say that from a gross -- from a net income point of view, it's little or no impact for us. What it does is it nudges up our SG&A and it nudges up our margin.

Okay. Great. Thanks.

Our next question comes from Rick Reed.

Good afternoon. I just want to follow-up on Jeff's question on the tax rate. I mean, just a little clarification. You guys historically have said that your tax rate for the core business is 38%. Now you're seeing these NOLs -- that you'll be in a position to be able to use those. Why wouldn't it get pushed down below 38%? What has changed between what you historically have had as a 38% tax rate and now?

Like I said, there is at least one geography where we have a higher statutory tax rate, which probably is in the past. And we also have the state taxes to consider.

Wouldn't the state taxes -- I'm sorry. Wouldn't the state taxes have been there before?

Yes, but what I'm saying is, for us to get below the 38% now with that statutory, we have to be generating profit in those geographies where we have those net operating loss carry-forwards.

So, it's a country-by-country issue?

: Right. You know, it depends upon which countries we're forecasting the profit in, as to where we would see the tax rate. If we forecasted a lot of profit in those countries with the NOLs, we of course, would be below 38%.

That's perfect. That's helpful. Then, just in terms of -- Mike, if you can just give us an update on what is Avaya communicating to you -- with -- in terms of what they expect channel to be doing these days? I think in the last couple of calls you've mentioned that Avaya has been more of the mind that they want the channel to create value, rather than just giving them business. And what impact are you seeing on pricing, as a result of that?

: Well, I think there's been really no impact on the pricing, based on that. I think it's more a reflection of Avaya's new management team, when they came in last year at the beginning of the fiscal year in October.

They were wanting to make sure that they understand the efficiency gains they have, by using the channel more, now and in the future. I think they have done a lot of analysis and they're comfortable with -- they're comfortable with the fact that the channel, combination of distribution and resellers, does deliver a lower operating cost for Avaya, especially when they try to reach specific markets where they don't have any coverage.

So, the questions in the past have been, are there some accounts that Avaya services direct today, that they are not covering well enough with their direct sales force? And are there any of those accounts that they'll turnover to the channel to, frankly, cover better. And have Avaya's sales force focus on even larger opportunities.

So, I think that is still the conversation. And I think they haven't made any specific pronouncements. Some of our vendors will say we want to have X amount of business through the channel by this date. Avaya has not stated that this year. Of course, their new fiscal year comes October 1st. So we'll see over the next few months what they expect our role will be next year. So on our next call, we should be able to update you on that.

Just go back to margin question, quickly. On a sequential basis, if my math is right. You guys were up about 50 basis points, from an operating margin view-point. Can you characterize for us, how much of that came from the European improvement, how much of that came from the opportunistic purchases, and then what is the other component of that?

: I don't think we're going to break it out. But I would tell you that we -- whenever we see this happen, we then have to talk about how should we be building additional value-added programs. You know, we certainly had hoped that Europe would come in the way did. But we weren't -- were careful not to start some of our other investments in North America that, frankly, I've been waiting to do for about three quarters.

I would say after seeing this, it will certainly give me more confidence to start making investments this quarter in new value-added opportunities. So that's why we are not saying go model this particular operating rate. We think that -- we've always said that's the signal to us to invest in more programs. And, frankly, we couldn't do those last year, because I had such an investment in Europe.

Can you give us a sense, Mike, for the quality of programs that you would be investing in, in the coming quarters or how that would unfold?

I would just say that the -- you know, if you look at -- there's going to be a lot of things that we'll do, that we won't necessarily talk about, because we have new competitors now in this space.

I think for us, we go back and look at what is our traditional operating margin? And I think that's what you should continue to look for. This particular margin, this particular quarter. If everything fell together and it was a great quarter, we would not plan for that every quarter going forward. That's for sure.

The next question comes from Chris Wilsey (ph).

Good afternoon, gentlemen. Just for reference sake, if I remember correctly. On last year's September quarter, as Avaya hit their end of the year, all the salesman went out and really plugged for the sales goals. And you had a big run-up in the September quarter, followed by a fall-off in the December.

And you've got steep comparables here. Should we expect the same sort of thing to happen? Or is something changed in the way Avaya is rewarding and paying its salespeople that maybe we see little bit of moderation this year?

Chris, this is Mike. I think what I'm suggesting in our guidance is that we could see not as much this quarter, only because Avaya has been pushing harder throughout this year. I think the fact that we had a good quarter ending June is reflective of that.

They clearly told their shareholders that they were going to get to a profitable state. And they did last quarter, as everybody saw. So I think they have, frankly, started earlier than they did historically. And they're looking at trying to make every quarter stand on its own, rather than just a year-end push. So I guess what I'm saying is there could be that year-end push. I'm not planning for a huge push like we would have traditionally.

And you're right. The fact is we've got a tough comp over this quarter. And that's why we're still sticking with some guidance that may appear kind of wide to some people.

Circling back to ChannelMax. It looks like the pre-tax charge you're going to take is somewhere in the order of -- in excess of $2 million. Can you give us a breakdown of how much of that is cash and how it is distributed -- are these all just severance or are there other elements in there?

It'll be-- the pre-tax -- you're about right on the pre-tax. And all else being equal, it will be fairly close between cash and what you see in the P&L.

And the cash element is severance? Are you losing people?

There is some severance going on. And some other contractual cash adjustments that have to be made.

And as Symbol begins to take some of their direct sales piece and move it through the indirect channel, would we expect that to show up in the ChannelMax piece? As a fee-based business?

No. No. I think what -- you know, the Symbol programs that have been rolled out in the last few months, I think, indicate that Symbol, frankly, is going to have fewer customers direct. There still may be some larger ones. But there will be more customers buying through distribution. That was part of their initiative in this new program that we've rolled out in the last quarter.

But, as I understand it, even the direct piece -- they would handle a lot of the -- just logistical fulfillment through the indirect channel. But they're obviously not going to pay you the same margin on that business, because they did all the lead generation. Does that business get pushed through with just a tighter margin? Or does it turned into a fee-based business?

Yeah, Chris, I think I know what you're saying -- this is Jeff. I think what you're hearing -- they use a phrase occasionally. They call it a fulfillment neutral strategy. Maybe, Mike, you can elaborate. But even though they might use that phrase, really, that's full-blown distribution selling, in the world in which we live.

I will just tell you, they are looking to reduce the amount of business that they're using through that program. So the ChannelMax program has not been growing. And that's evidenced by the results. We don't see that -- Symbol changing. We see that they would be a declining user of that.

Okay. Final question on Europe. You mentioned that it was breakeven. Was that breakeven as you exited the quarter? Or over the course of the quarter?

I'd think -- I'd hope that we were able to cover our expenses for the entire quarter.

So that's actually better than you were projecting?

Yes it is.

But you did say you were projecting a 3-cent loss. Never mind -- (laughter) (multiple speakers)

Well, we got a burned on Europe a little bit. So we want to be real cautious.

Now, how much of that -- I mean, a lot of the industry has seen some pretty significant gains from the 4X impact. Do you feel on the ground, where you've been struggling to find the right business model -- are you gaining traction, gaining share -- mind share with the European customers? Because you're bringing in somewhat of a different model than they're used to dealing with.

Yeah. And you know what’s interesting is, it's less the customers that have to be educated. But it's the vendors. And the vendors' field sales force. Because they're so used to working with -- you know, in the one country, three or four small local distributors, who sell to end-users, typically, and resellers. So our model is new to the vendors' sales force. So, getting them to, frankly, recommend us as another choice for their local VARs has been our challenge.

The VARs, once they start doing business with us -- or once we find them, which is our challenge early-on, they love it. We have more inventory availability than anybody else in Europe. We give excellent service over there, like we have here in the states. They -- there is a question about, do they need to have a personal call before they place an order? So we do have people out there, who can make a visit and make sure that we visit with the vendor sales team. So, the model, on the face of it, is actually very appealing to most resellers.

Okay. And did you comment at all on the Latin American piece? Trends in that market?

Yeah. We did. We had a good quarter. I think Latin America was strong. We'd like to think that this quarter coming up will also have a good Latin America quarter as well. They, typically, seasonally, the December quarter is their strongest.

Okay. Thanks a lot guys. Congratulations.

(CALLER INSTRUCTIONS) At this time, there are no further questions.

Okay. Thank you for attending the ScanSource call.

This concludes today's conference. You may now disconnect. (CONFERENCE CALL CONCLUDED)