Scansource Inc (SCSC) 2009 Q2 法說會逐字稿

Welcome and thank you for standing by. At this time all participants are in a listen-only mode. (Operator Instructions). Today's conference is being recorded. If you have any objections, you may disconnect at this time. I will now turn the meeting over to Mr. Richard Cleys. Thank you. You may begin.

Thank you Andrea and thank you for joining us for the ScanSource conference call to discuss financial results for the quarter ended December 31, 2008. My name is Rich Cleys and with me are Scott Benbenek, President of worldwide operations; and Mike Bower, CEO of ScanSource. We will review with you the quarter's operating results 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 including but not limited to macroeconomic circumstances that could impact our business such as currency fluctuations, continued adverse capital and credit market conditions, and a prolonged economic downturn. For more information concerning factors that could cause such a difference, see the Company's annual report on Form 10-K for the year ended June 30, 2008 filed with the Securities and Exchange Commission.

I will start our discussion by providing overall sales and operating results. For the quarter ended December 31, 2008 the Company generated $477 million in sales which represent a 14% decrease over the prior year comparative quarter sales of $553 million. As discussed previously in our quarterly sales release on January 8, 2009 the decrease in sales for the quarter reflects softness across all business units and geographies.

Geographically sales originating from our North American distribution segment decreased by a 14% in comparison to the prior year quarter while the international segment saw sales decrease by 11% over the same period. Measured in local currency, the international segment decreased by 4%.

Within our product lines, we experienced a 13% decrease in worldwide sales in our POS barcoding business and security products over the comparable prior year quarter. These product categories represent 65% of our total sales for the current quarter with the remaining 35% of our total sales originating from communications products which experienced a decrease of 15% in comparison to the prior year quarter. Mike will discuss sales result in greater detail later during this call.

Gross margin expressed as a percentage of sales increased to 11% for the December 2008 quarter compared to 10.7% for the prior period quarter. From a gross margin percentage perspective, the Company benefited from two unusual factors.

First, specific vendor program changes that resulted in accelerated recognition of vendor credits; and second, vendor price increases. A more normalized margin for the December quarter would have been 10.3% which is comparable to the September result of 10.28%.

Operating expenses in the current quarter were $33.9 million or 7.1% of sales compared to $33.7 million or 6.1% of sales for the comparable prior year period. Year-over-year bad debt expense increased $1.9 million.

Since September 2008 we have increased our bad debt reserve by $500,000. Also included in the current year SG&A expense is $720,000 for MTV Telecom which was not included in last year's SG&A.

Operating income for the December 2008 quarter decreased to $18.4 million, a 27.7% decrease for the comparable prior year quarter of $25.4 million. Expressed as a percentage of sales, operating income was 3.9% in the current quarter compared to 4.6% for the prior period.

Interest expense was $600,000 in the current quarter compared to $1.3 million for the prior year quarter. Interest expense decreased over the prior year quarter due to lower interest rates between the two quarters. At December 31, 2008 the outstanding balance on our revolving credit facility was $20 million.

As discussed in this afternoon's press release, during the current quarter the Company settled a legal claim with a former legal service provider that resulted in a $3.5 million recovery. This settlement was received in December and was recorded as other income in our consolidated income statement.

Tax effect of this settlement accounted for approximately $0.08 of our diluted earnings per share for the quarter. Somewhat offsetting this benefit is approximately $1 million of foreign exchange losses which were due to unprecedented currency volatility.

The effective tax rate for the December 2008 quarter decreased significantly to 34.8% compared to the prior year quarter of 37.7%. In the current quarter, the Company received a favorable tax ruling that was retroactive to fiscal 2008.

In applying the retroactive aspect of this tax ruling, the Company received a onetime tax benefit this quarter of approximately $400,000 or $0.02 of our diluted earnings per share. Excluding the impact of this discreet item in the quarter, we believe our effective tax rate for the year will be approximately 37.5%.

Our return on invested capital this quarter was 16% which is below our historical range of 20 to 25%. As discussed in our previous conference call for the September 2008 quarter, the Company has elected to maintain a minimum of $75 million in cash reserves on hand to ensure that we have access to sufficient working capital to meet the needs of our customers and vendors in the unlikely event that the credit markets and the related financial system would deteriorate further.

If we have not drawn the $75 million cash reserve, our return on invested capital would have been 18%. Please note that we have excluded income from the legal settlement from these calculations.

Balance sheet metrics and cash management were as follows. Inventory turned 6.2 times during the quarter which was lower than the 6.9 inventory turns generated in the September 2008 quarter and 6.3 turns in the comparable prior year quarter. Paid-for inventory days was a positive 4.8 days compared to a positive one day for the September 2008 quarter and negative 1.7 days for the comparable prior year quarter.

We're satisfied with the 4.8 days as we managed inventory levels down during the quarter in response to lower sales volume. There are over $91 million of checks written but not cleared included in accounts payable at December 31, 2008.

The number of days in receivables, DSO, decreased to 54 days at December 31, 2008 compared to 57 days both the sequential and comparative quarters. Although collections have improved versus the prior quarter and prior year, half of the improvement is due to mix and the increase in the bad debt reserve.

The Company has over $85 million of cash and cash equivalents on hand at December 31, 2008 compared to just $15 million at June 30, 2008. As mentioned previously, $75 million of the December cash balance is the cash reserve as a liquidity reserve. As of today, we continue to believe that maintaining these reserves is warranted until the credit environment becomes more certain.

For the year-to-date fiscal period ended December 31, 2008 the Company has generated over $79 million of cash flow from operations. Our total interest-earning debt was $55 million at December 31, 2008 compared to $64 million at June 30, 2008. And at December 31, 2008 there were $230 million of available funds for borrowing on our credit facility.

Mike will now give you an update on our business.

Thanks Rich. During our last conference call in October, we discussed the economic uncertainty that was affecting our business and the possibility for future impact in 2009. The global economic slowdown coupled with tighter credit markets (technical difficulty) customers and vendors across all of our business units.

As a consequence, our revenue was impacted more than we planned. After comparing our results with our vendors' overall business, we don't believe we lost market share during the quarter.

However, we believe that our combination of excellent execution and logistics and our unique value added services allow us to retain our customers' business during a more competitive environment. Now I will comment on each of our reporting segments.

North American distribution include sales into the United States and Canada and posted sales of $380.6 million, a decrease of 14% for the December quarter on a year-over-year basis. Our North American discussion will start with Catalyst Telecom.

The Avaya sales results for Catalyst were disappointing. We missed our expectations and plans for Avaya once again. The problems associated with pricing and selling Avaya's enterprise products continue.

Although additional changes were announced by Avaya in November, the reseller community was very slow in getting new proposals out to their customers. This delay resulted in lower closed sales than we projected. However, our Avaya resellers have continued to be loyal to Avaya and Catalyst during this challenging time.

Meanwhile Catalyst and Avaya have been focused on recruiting selected Nortel resellers as Nortel has continued to struggle and is in bankruptcy. On a positive note, we achieved strong sales gains year-over-year and quarter over quarter with Juniper and Aruba.

Our Avaya customers have begun selling these products and we have recruited new resellers to Catalyst. Additionally we've seen significant growth in our sales of vendor provided services. These services include hardware maintenance and software support contracts. Most of these programs are fee based and have helped our gross profit margin as a result.

Next up his ScanSource Communications. This sales unit also struggled yet (technical difficulty) Polycom videoconferencing business grow year-over-year albeit at a much slower rate. We also saw strong growth from our AudioCodes gateway business.

Next I will discuss North American POS and bar code. The December quarter turned out to be extremely volatile for this sales unit. Unlike in previous years, we saw a significant drop in orders in the month of November after a good October, yet December rebounded nicely. As a result, the POS and bar code unit in North American missed our plan.

We had fewer large deals which helped us maintain good profitability. All product areas were affected and we believe we maintained market share. We also were challenged by significant currency volatility in Canada during the quarter.

And now our third technology area is ScanSource security. This unit has continued to grow and take market share although we expected more from security going into the quarter. We saw much more competitive price pressure as we tried to take market share.

We had some strong results however in our outdoor wireless networks and in our IP camera business. And one of the highlights was our Zebra card business where new channel programs (inaudible) Zebra are driving incremental business for ScanSource.

Our second reporting segment is international distribution. Our international business which includes Europe, Latin America and Mexico, posted sales of $96.5 million, a decrease of 11%. When measured on a local currency basis, our international business decreased by 4%.

In Europe our bar code and (technical difficulty) plan. We believe that they're also (technical difficulty)

(Operator Instructions)

Thank you. Sorry about that. It looks like we had some technical difficulties. We will go back to Europe.

In Europe our bar code and POS business actually beat our plan. We believe that they're also gaining market share and expect that trend to continue into 2009. To wrap 2008, this region was struggling with currency volatility. However, we achieved record number of orders and number of customers during the quarter and won back some large accounts that we had lost earlier in the year due to currency and pricing issues.

The areas of Germany, France, Nordics and Italy all did very well. In addition, we have substantially increased our business in Eastern Europe by adding additional sales people that are focused on this area.

Certain manufacturers are working closer with us now in transitioning some of their direct resellers to distribution. This is always a longer process than we like but it will result in incremental business in 2009.

Our European communication business struggled this quarter and did not meet our expectations. The growth in existing vendors and new vendors is moving too slow and we're anxious to move that forward faster. The UK has experienced significant economic upheavals and that has affected our business as well.

However, we believe our combination of services and our strong team of people there coupled with our ScanSource Europe organization will begin to make an impact in 2009. This week we announced that the former owner of MTV Telecom and the Managing Director have left the company. We have appointed Clay Sorensen as acting Managing Director.

Clay brings 25 years of communications experience with ScanSource and many years of experience with Avaya to this business. Clay will work with Xavier Cartiaux, the ScanSource Europe Managing Director, to grow our UK business.

Now turning to Latin America and Mexico, we had a good sales quarter especially in Mexico. One very positive opportunity is with Intermec as they are embracing the two-tier distribution model in Mexico and Latin America for the first time.

We expect this opportunity to develop throughout 2009. We also had a strong quarter in Miami at almost record sales levels. This result is due to new growth from our security product lines and help from Intermec. Now, I will conclude this part of our call with closing comments.

As we expected, the December quarter was challenging. We were disappointed with the sales results yet pleased with our margins and profits. We recognize that we can be more aggressive and take share under any market conditions and will do so in a strategic manner.

Our strong balance sheet, profitability and cash flow will allow us to take maximum advantage of the opportunities ahead of us. We're excited about our markets and we believe our resellers and vendors provide compelling solutions with strong ROI. These are significant advantages during an uncertain economic time.

As we have experienced unprecedented volatility in our business, we're challenged to provide financial guidance looking out even one quarter. As you know, ScanSource operates with no backlog as we take orders and ship products the same day and our resellers are not required to provide forecasts. As a result, our visibility into future orders is always limited.

We consider the value of our financial guidance to our investors under these conditions and have elected to continue our history of providing quarterly guidance. We believe total revenues for the March quarter could range from $450 million to $470 million and our earnings per share could range from $0.30 to $0.34 per share.

Thank you and at this time we would be glad to answer your questions.

(Operator Instructions) Reik Read.

Mike, in your comments you just said basically everything is weak. I get that we're hearing a lot of project delays.

Do you have any sense at all that that might be changing or there's some verticals that are maybe starting to look a little better than others? And then two, can you talk a little bit about your ability to offset some of that with indirect business shifting from direct to indirect or anything else that may be out there?

Yes, you bet. So looking at verticals, certainly everybody knows the weak ones. We just hit the national retail show last week in New York. It seemed like there was actually more enthusiasm than you would expect being such a challenging time for retail.

So even within retail, there are some niches where there are opportunities. However if you look at broad-based opportunities, I would say the verticals that still have interest from end-user demand and where our customers seem to be doing well is health care, health care and government. Those are probably the two that would stand out.

Those are primarily North American statements. When it comes to opportunities from ship business, we have already discussed during this call that Intermec is doing that on an international basis. They had already started it in the US earlier this year but I would say 2009 is the year where we will see that continue and accelerate its space.

Also I met recently with MCR and they have hired additional talent to expand their channel focus and they have made the statement just recently that they have to grow through the indirect channel. So we see a renewed commitment and investment in resources on their side to focus significantly on the indirect channel.

And so that is one way there may be some direct end-user business that might be available to the channel but more importantly they have got new programs and new strategies around building a strong indirect channel. So we see that as good.

And then clearly if we can get through the Avaya problems that are product and pricing related, they clearly have also stated that they need to use the channel more going forward. So those are kind of our opportunities.

When you go back and you look at the last time we went through a cycle like this, it seemed like a lot of the vendor community was looking to use the channel more. Is that what you mean when you talk about these opportunities maybe accelerating? Is that the case?

Yes, absolutely. I think two things. One is there is a normal cost advantage using distribution in the channel to go after the SMB business. But as the large customer opportunities are less and the larger projects are less, they can move some of those resources to support the channel rather than supporting direct sales.

Okay and then are you guys seeing within your [VAR] customer base -- is there ability to get access to reasonable credit impaired at this point and to what extent is that an opportunity for you guys?

I think in some selective customers, we're seeing some inability to get credit. But by and large, our customers are performing well. We are -- you know that this is the value that we have. We've got a strong team both here and internationally in terms of finding ways to grant credit to the customers and we are looking at this time -- our underwriting policies are very effective and we think that the policies and procedures that we follow, the relationships that we've got are going to do us well. But there are a few customers that have some limits in terms of the banking. But by and large we're in pretty good shape.

And then Rich, just one last question for you. You talked us through the gross margin, why that was a little bit higher. Was there anything from a mix perspective that also might have made that higher? I guess I'm wondering because you had a pretty good sequential drop in revenue but not a real big sequential drop in terms of operating expenses. So can you talk about what is maybe holding that operating expense up on a sequential basis?

Well I think you have asked two questions here. One is about the gross margin and the gross margin, the primary factors are the ones that we cited. Vendor programs which included acceleration of recognition due to a change in the vendor program and then also some price changes that we have experienced where the vendors have increased prices and because of the inventory levels we carry, those have helped us.

As far as the overall cost goes, I mentioned that we increased our bad debt reserve during the quarter and that I don't anticipate that that increase will be a required increase on an ongoing basis. Overall though, we did bring our expenses down albeit not dollar per dollar with the kind of margin decrease we had. Does that help?

Yes, thank you guys.

Ajit Pai.

A couple of quick questions. I think the first one is just looking at your cash flows. So since the top line has begun decelerating, you have been generating a lot of cash and have a pretty solid net cash position. Despite what you're seeing in end markets right now, is there any reason why that net cash position shouldn't continue to increase over the next two to three-quarters just given how sluggish growth is?

I think our model does generate cash flow. I think we have had some unusually strong cash flow. I mentioned that our accounts payable that had not cleared was $91 million. That is a bit higher than what we normally have. So the $79 million worth of year-to-date cash flow we have is augmented by that accounts payable.

But generally speaking this model is working. It generates cash flow when sales are slower. In a case where sales are down like this, we should generate cash flow. So going forward we would expect -- we don't necessarily model for increases in cash flow when we do our interest forecast, but the model overall should be positive.

Got it. Just looking at the net cash position that you have and the fact that you have been acquisitive in the past and a number of your competitives and smaller competitors particularly in many markets where you don't anticipate are probably going through challenges. Is the potential acquisition pipeline looking richer than it has in the past couple of years?

This is Mike. I would say that we have over the last year continued to review acquisition opportunities. I think strategically we are looking in two areas. One is in Europe.

We've said that we want to expand our communication business beyond just the UK and that might require an acquisition. Then also we've continued to look at the security business as does an acquisition makes sense. I think we are prepared from a balance sheet perspective to take advantage of that and do an acquisition.

As you know, our acquisitions typically are fairly small companies and they are businesses that we are finding that have upside opportunity because of the distribution and knowledge we can bring to that company or frankly our strong balance sheet to help them grow.

Got it and then the last question would be on the security business that you talked about. I think in the past you have included in the AIDC and point-of-sale segment and those businesses (inaudible) have actually been quite week while security just based on commentary that you've provided has been quite strong. So at what point do you think that it starts exceeding 10% of your revenue and we start getting some better visibility into it as an independent segment?

We primarily don't like to segment it for competitive reasons because there is still an emerging opportunity to do some things that are unique in the security channel. We don't have any companies that look exactly like us that we're competing with so we're trying not to give too many ideas out there.

But clearly as this grows, we will talk about it more and give more detail. But our preference right now is to take it to the next level before we have to do that.

And the color that you provided on growth for that business, I think you said in Miami it was strong and many other geographies it was strong. Is there an increased focus on security out of end market spending because of rising crime or a slowing economy or is it just progress that you're making on a regular basis and end markets are not really accelerating there?

I would say the latter that the end markets aren't accelerating from what we hear. We are a new entrant into these markets and we are able to bring some unique value adds and frankly take some market share.

The vendors like our strategy and we're getting vendors signing up and saying this is the kind of model we want to support long-term. And I believe as they are struggling with their end markets, there's going to be more pressure on a more efficient supply chain and I think that is one of the things we bring to the security market they don't have today.

Got it. Thank you so much.

Chris Quilty.

I know we're only three weeks into the third quarter but you talked about some unusual monthly seasonality in Q2. Can you just give us a sense of whether you're seeing a return to normalcy here -- the March quarter or what your expectations are on a go-forward basis here?

I think our guidance is reflecting our caution still about the future. In this quarter it's always turned out to be our most challenging quarter to forecast if you go back years and years. March always is a big month in this quarter. So January is not a great indicator for what is going to happen in the quarter.

But has January followed the normal seasonal trend or is it still showing signs of being impacted by the financial contagion?

Well it's kind of hard because I don't have a blanket answer because some things that didn't happen in December did happen in January for us and I don't want to take necessarily credit for that yet. So there's some things that aren't happening in January that I expected to happen. So it is too early, too early to call.

Gotcha. And when you talked about the better-than-expected performance in Europe, that was across both communications and bar code or just the bar code?

No, that was really a bar code/POS statement. Yes, we are struggling in communications. A lot of it is still trying to train our team over there, bring them up under some new ideas and kind of the ScanSource way of doing business. And we have been slow to integrate that business into the rest of how ScanSource goes to market and we will start moving that faster going forward. So yes, our bar code/POS business we think especially on a local currency basis made significant improvements over prior quarters.

Okay and Rich, I just have been too busy writing to run the numbers but that 70 basis points includes of improved margin in the second quarter or -- how does that work out down to the bottom line?

The 70 basis points in the --

You mentioned that 10.3% would be more normalized versus the 11% you reported. How much of that EPS benefit was there?

There's about $0.08 benefit for the improvements in the gross margin that we don't necessarily see going forward.

Fair enough. And final question here. Again, I think it's probably too soon to tell but can you at least say you're optimistic that your Avaya product line will see a benefit in the next six months to a year from what is happening to Nortel or do you think most end-users kind of look through the bankruptcy because it's such a common occurrence nowadays?

Well on that front, I do feel optimistic. We have got some recent indicators that there are some existing Nortel partners that are very close to making an Avaya decision if not already. And so yes, I think that is optimistic.

We think the concerns that those partners would have about Nortel trump any concerns our existing Avaya partners have about Avaya's communication manager issues. But we have had a significant amount of interest from Nortel resellers.

Okay, and with that if you had more Nortel resellers come on, would there be some kind of an upfront cost to bring them on board either in terms of training or support? I guess more broadly, whether that particular opportunity or if you look across your business, do you foresee any areas where it might make sense to buckle down, spend some money where you have strength relative to competitors, not necessarily acquisitions, but in other areas to make investments in a difficult time here that may have a near-term negative impact or positive long-term ramifications?

That's a fair question. I think we don't anticipate that regarding the recruitment of new Nortel customers. We don't anticipate any significant investments. We're going to redirect some of our existing efforts that require either our dollars or Avaya dollars towards the Nortel resellers.

So I think that is a shifting of existing expenditures. I think the only incremental expenditures would still be in our security business and in our communication business in Europe. Those would still be businesses that are not at operating margins that we would like but we recognize that as long as we can still see the opportunity, we're going to continue to invest there frankly even in uncertain times like. We're going to be careful but we're going to make sure we don't miss the opportunity.

Good, well thank you very much and keep up the good work.

Tony Kure.

Good evening gentlemen. Just wanted to get a little color on the gross margin benefit again. Sorry to beat a dead horse here.

On the pricing side, I understand but I'm trying to reconcile the rebates and the vendor rebate's accelerating. What is the motivation for the vendors to do that? If you could maybe educate me on that?

Sometimes vendors give us programs that they don't really know how it affects our financials. So they are not even plugged into how we are treating that rebate or those program credits.

So there was a change in accounting treatment years ago that made all distributors and all vendors think through to those reductions of SG&A or the reduction of cost of goods sold. So our vendors don't think about it from an accounting perspective and in this particular case there was no thought to it. It was they came out with a new program replacing an older program and we had to change the treatment of it based on that.

Said Tony what we are doing is just based on [gaps]. Because the way the program is put together, we accelerated the recognition of the income. There's not really a change in the cash flow. It's an acceleration of the income under this program.

That wasn't our choice or really their choice. Is just happened. That's why it wasn't forecasted.

That's fair, thanks. And then the pricing side, just given that it happened in the quarter, in the calendar-ending quarter, is this something that is common in the December quarter or is this more of just an anomaly this year?

It's more of an anomaly. We had actually a couple of different lines and had price increases that we benefited in the quarter.

A couple more questions. Intermec has already been touched on. I think the last quarter you talked about how they were trying to make it or were looking to make it a requirement to introduce more attractive incentives for direct customers. Any progress on that other than the geographical color you provided as far as making it more of a formal thing?

I think in general obviously Intermec is trying to reduce their cost, right? And so they are trying to find ways to reduce their cost of sales to support a certain group of customers and it doesn't mean that they won't always have some direct resellers. But clearly from what we are hearing, they want to move this process maybe quicker than they did last year. So we're going to see we think an acceleration of this effort and this'll be across all the geographies.

Last question is I don't know if you provided this or not, but did you provide a CapEx number for the quarter, what you spent?

We don't normally provide a CapEx, Tony. Our capital expenditures tend to be not very significant for the year and unless we have got something really unusual, we don't provide anything or talk about it and we have got nothing significant or unusual going on in CapEx right now.

But we can get you the number if you need it, yes. Answer my own question. Rich can call you back and get that number for you.

Brian Drab.

Sorry to ask more questions about gross margin, but looking at the two issues that gave you the extra 70 basis points in the quarter, which was the more significant or could you provide some breakdown between the two issues?

We will talk about it in the 10-Q but we don't have it that fine-tuned.

And the second issue you mentioned, the vendor price increases. Can you talk at all about what product lines those price increases came through and then whether you think those are -- first of all, are you surprised that we were able to pass through those types of price increases given the environment and could they stick going forward and see some margin benefit in the coming quarters?

No, there weren't forecasted. They weren't predicted. They were situations that the manufacturers frankly were looking at a way to improve their profitability. And from our standpoint, we don't expect them to happen in the future.

Those are anomalies. Those aren't routine. It is rare for us to benefit from a price increase.

Okay, thanks. And one more question for you regarding Avaya. It appears that Avaya has continued to struggle a little longer than you would have hoped and I'm wondering if you're starting to see some loss of market share in that business.

I know you talked about loyalty among the resellers and that sounds good. But are you worried that you might start to the some market share there, can't figure things out at Avaya?

No, I think it's a fair question. We challenge ourselves and Avaya with that all the time. The interesting part for resellers who are committed and are really invested in this business, especially in the enterprise class products, these are very technical products, very solution-oriented requiring significant investment.

And frankly whether you're selling enterprise class products from Avaya, Nortel or any other vendor, it is not easy to change to another vendor. There's a significant investment to bring on a new vendor and very few resellers that we talk to -- and this is including the Avaya resellers or frankly the Nortel ones we're talking to now -- it is not normal for them to carry two product lines at the same time.

They've got to decide this is the horse I'm going to run with and I can't afford the investment in two of them. There's just not the scale to justify the investment. So I would say there's a chance they're going to lose market share but there aren't many other telecom companies frankly doing better than Avaya especially when you take out the fact that this issue of Avaya does affect them but they are still selling product.

They are still finding ways to close business, not at the level they would like to. But it cannot continue a lot longer. There is no doubt about that. But everyone at Avaya, all the resellers, everyone is focused on this and they do believe they're going to get it resolved.

I show no further questions.

Thank you. Thank you for joining us. Our next conference call to discuss the March 31 quarterly earnings is expected to be on April 23.

Thank you very much.

Thank you, this concludes today's conference. You may disconnect at this time.