Scansource Inc (SCSC) 2011 Q1 法說會逐字稿

Welcome to the ScanSource quarterly earnings announcements call.

(Operator instructions)

Now, I would like to introduce your presenter, Mr. Rich Cleys, the CFO. Sir, you may begin.

Thank you, Bobbie, and thank you for joining us for the ScanSource conference call to discuss financial results for the quarter ended September 30, 2010. My name is Rich Cleys. With me are Scott Benbenek, President of the Worldwide Operations, and Mike Baur, CEO, 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 risk and uncertainties. These statements are subject to the Safe Harbor created by the Private Securities Litigation Reform Act of 1995. The statements made in this call are made as of the date hereof even if subsequently made available on ScanSource's Website or otherwise. ScanSource does not assume any obligation to update the forward-looking statements provided to reflect events that occur or circumstances that exist after the date on which they were made. 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 for the fiscal year ended June 30, 2010, filed with the Securities and Exchange Commission.

This afternoon, the Company released results for our first quarter period ended September 30, 2010. I will start our discussion by providing overall sales and operating results for the first quarter. Later in the call, Mike will comment specifically on the quarterly results and outlook for each of our business units.

For the quarter ended September 30, 2010, the Company generated worldwide net sales of $634.5 million, which represents a 30% increase in sales over the comparative prior year quarter and a 9% increase over the quarter ended June 30, 2010. Included in the quarter sales results are revenues from ScanSource Communications Germany, formerly known as Algol Europe, which was acquired November 30, 2009. Our net sales for the quarter hit another new record for the Company and well exceeded our expectations as we experienced good demand and gained market share in all geographies.

On a geographic basis, sales originating from our North American distribution segment increased 24% in comparison to the prior year quarter. Our international segment grew 54%, and when measured in local currency grew 67%. Within our product lines, we experienced a 27% increase in worldwide sales of our POS Bar Coding and Security Product categories over the prior year quarter. These product categories represent 60% of our total sales for the current quarter, with the remaining 40% of our total sales originating from our communications products. Our communications businesses experienced an increase of 35% in comparison to the prior year quarter.

The Company's consolidated gross margin percentage was 10% for the quarter ended September 30th, which was slower than the prior year quarter gross margin of 10.5%. The September 2010 gross margin reflects a higher mix of lower margin product lines. Sequentially, gross margin increased from the previously recorded 9.8% primarily due to timing of vendor incentive programs benefits.

Operating expenses in the current quarter increased to $38.6 million compared with $33.7 million in the comparative prior year period. The increase is primarily the result of higher head counts and the addition of ScanSource Communications Germany, which did not exist in the prior year's quarter. The September 2010 quarter bad-debt expense was as expected. However, it is lower than the September 2009 quarter, which was much higher than normal. Operating expenses, as a percent of net sales, decreased to 6.1% in the current quarter, compared to 6.9% in the comparative prior year period. Operating income for the September 2010 quarter increased to $24.8 million, a 40% increase from the operating income of the comparative prior quarter -- prior year of $17.7 million. Expressed as a percentage of sales, operating income was 3.9% in the current quarter compared to 3.6% for the prior year quarter and sequentially was up from the 3.6% reported for the fourth quarter 2010.

Interest expense was $366,000 for the quarter, which was flat for the prior year quarter. The effective tax rate for the September 2010 quarter decreased to 35.6% compared with the prior year quarter of 37.4%. The decrease in the effective rates in the prior year reflects the benefit of changes from our international capital structure executed during the fourth quarter of last fiscal year. Our return on investment capital was 19.5% for the quarter, which compares favorably to the 16% reported for the prior year quarter. In summary, the September 2010 quarter had reported fully diluted earnings per share of $0.58 versus a reported fully diluted earnings per share of $0.41 for the September 2009 quarter. This improvement was due to the increased operating income generated from higher gross profit dollars on higher sales.

Turning to the balance sheet, inventory turned 6.6 times during the quarter, which was higher than the 6.4 times inventory turns generated in the June 2010 quarter but lower than the 7.2 turns in the comparative quarter last year. As inventory balances leveled off during the current quarter, paid-for inventory days were a positive 7.7 days, compared to a positive 10.1 days for the June 2010 quarter and 4 days for the comparative prior year quarter.

As you may recall, the Company has maintained increased inventory levels while sales volumes continue to improve and lead times for our vendor products have lengthened. The magnitude of product shortages that we have been experiencing during the last several quarters has been reduced. Accordingly, inventory on hand of September 30, 2010, was $345.3 million versus $346.6 million for the -- at June 30th, and $269.7 million at September 30, 2009. There are $76.5 million in checks written but not cleared in the September 30, 2010 accounts payable balance. At June 30th, this amount was $62.7 million.

The number of days in receivables, DSO, was 59 at September 30, 2010, up from 55 days in the sequential quarter and 58 days outstanding for the comparative quarter last year. The DSO in September 2010 quarter, which is within our expected result, increased due to a higher mix of international sales and a higher mix of sales in the communications business within North America, both of which have longer terms of sales. As discussed during previous calls, we continue to be cautious about the impact that the economic environment has on our customers, and we believe that our underwriting policy is appropriate under the current conditions.

The Company has cash and cash equivalents on hand of $14.4 million as of September 30, 2010, compared to $34.6 million at June 30, 2010. The decrease from the prior quarter is largely attributable to the growth in our receivable balance over the last quarter. Total interest-bearing debt remains unchanged at $30.4 million for September 30, 2010, and June 30, 2010. Our cash flow includes capital expenditures of $1.9 million this quarter, of which the majority is for a new enterprise computer system. This ERP system will enable our continued growth and provide a worldwide information platform for the Company.

Mike will now give you an update on our overall business.

Thanks, Rich. The strong performance by our company this quarter reflects a combination of large deals and better customer demand. In general, our sales teams took market share by having the right products available at competitive prices and executing logistics, service, and support, and high levels of customer satisfaction. Our strong balance sheet has allowed us to invest in higher levels of inventory and provide appropriate levels of trade credit to our resellers.

As Rich mentioned, we are investing in the future growth of the Company by implementing a new computer system across all of our business and all geographies. This new ERP system will allow us to ensure best practices are being followed across our company. In addition, we expect to receive productivity gains and financial benefits once the system is rolled out in fiscal of 2012. We've listened to many companies' stories about how to ensure success with a project like this and believe we are in an excellent position to achieve our goals. We have selected some of our most experienced and best people to lead this project, combined with industry experts with many years of ERP experience.

Now, I will comment on each of our reporting segments starting with North America distribution, which includes sales into the United States and Canada, posted record sales of $494.3 million, an increase of 25% year-over-year and 7% sequentially.

Our North American discussion will start with our POS and Barcode unit. This sales team delivered strong results again as large deals continued this quarter, especially in the retail sector. Inventory levels continued to rise and fill rates improved as most of the shortages and supply chain issues were significantly reduced. All product categories showed growth again this quarter as our sales and business development efforts performed at high levels. The POS and Barcode team hosted a partner conference in Savannah, Georgia, that had record attendance by hundreds of customers and vendors. Education and networking are key components of this event and a new partner tool called AppSource was launched to the POS and Barcode community. AppSource is a Web storefront for mobile application developers to sell their apps to the ScanSource reseller community. We believe AppSource will enable our resellers to service the SMB end users more efficiently and profitably.

Another announcement at the partner conference was the availability of a new portfolio of tools to assist resellers with their sale of payment processing services. In partnership with Mustang Microsystems and First Data Corporation, ScanSource resellers can provide credit and debit card terminals and merchant processing services in a more cost effective and profitable manner. These new offerings will expand our reach and open new markets within the AIDC and POS industry.

Now, we'll update you on our ScanSource Security Sales unit. The Security team had another record sales quarter as they have added hundreds of new customers and saw strong demand across the board. In video surveillance, Panasonic continues to have strong results and Axis and Cisco had record sales. In card printers, Zebra, Fargo, HID, and Datacard all experienced excellent results in the September quarter. Our marketing efforts continue to drive demand for security products and help educate resellers on new security technologies. ScanSource Security is hosting regional IP workshops during the quarter to help educate the channel. In addition, the Security team is targeting certain Catalyst and ScanSource POS resellers for cross-selling opportunities. We expect our run rate business, without the help of large deals, to continue to grow as we aggressively take market share.

Next, I'll update you on ScanSource Communications. ScanSource Communications had a record sales quarter led by Polycom, Plantronics, and AudioCodes, and had strong sales from large federal deals. Recruiting new resellers continues to be a strong focus for the sales team. In addition to the impressive federal wins, the focus on developing business with service providers has driven significant growth. Overall, the growth in the number of customers has led to incremental market share gains for ScanSource Communications.

Now, we'll discuss Catalyst Telecom's results. Catalyst delivered a record sales quarter as demand for Avaya products increased from the previous year and the previous quarter. Although the Avaya demand was driven by increased sales to Avaya resellers, we need to meet annual sales target to qualify for 2011 programs. In addition, Catalyst grew the sales of Nortel, now Avaya Data Products, significantly. Avaya's product roadmap is rewarding partners who are certified to sell the full portfolio of voice, data, and video. Catalyst's certification training classes have been well received and are being held across the country on a frequent basis. Catalyst's sales team also continued to achieve strong sales of Juniper and Aruba.

Our second reporting segment is International Distribution. Our International business, which includes Europe, Latin America, and Mexico, posted record sales of $140.2 million, an increase of 54% from last year, and when measured in local currency, grew 67% over last year. In Europe, the AIDC/PO listing had a record quarter, with almost all countries and all products showing strong growth year-over-year. The sales demand was higher due to better availability of inventory at ScanSource despite continued supply chain issues. We also saw a return of large deals and a lack of a slowdown in business in August as in past years. Our number of active resellers continues to grow larger as well. During the September quarter, we added head count in the sales area and continued our aggressive recruitment of resellers. The ScanSource Europe sales and marketing teams conducted partner tours in Germany, France, and Italy that were very well attended.

Turning now to our Europe Communications business, the ScanSource Europe Communications team achieved another record sales quarter. Our strong results were led by record sales of Avaya ECG and SMB products as we recruited new resellers and took market share from competition.

In Latin America, we achieved a record sales quarter in September by having higher inventory levels and working closely with our vendors on supply chain issues. This team saw an increase in big deals, especially in Mexico. ScanSource Latin America gained market share due to inventory and aggressive marketing and sales campaigns. All countries in Latin America showed sales growth over last quarter except for Chile and Brazil. The September quarter is seasonally our best sales quarter of the year, and we are investing in recruiting and education events like our ScanTeach event held in Costa Rica.

So, now we'll conclude this part of our call with closing comments. We believe total revenues for the December 2010 quarter will range from $625 million to $645 million, and our earnings per share could range from $0.55 to $0.58 per diluted share. In addition, we anticipate receiving a settlement from a former service provider of $0.07 a share, resulting in combined total earnings per share for the quarter of $0.62 to $0.65 per diluted share.

At this time, we'll be glad to answer your questions.

(Operator Instructions)

All right, and our first question comes from Mr. Pai from Stifel Nicolaus. Your line is open.

Yeah. Good afternoon and congratulations on a solid quarter.

Thank you, Ajit.

Thank you, Ajit.

A couple of quick questions. I think the first is your comments -- I missed part of it -- on Chile and Brazil. Why did you see some weakness over there?

Oh, we didn't have -- this is Mike, Ajit. We just recognized that those two countries in general didn't have any significant business. That's why I called them out. Brazil is not a surprise, because today we don't have an operation in that country, and it's always been a challenge for us to export business from Miami into Brazil, because they have such high tariffs. So, Brazil is always going to be a very small opportunity from us operating the way we do today, and Chile just didn't have big deals like they had in previous quarters.

Got it. The second question is just to get an idea of your gross margins going into the next quarter. The mix of businesses that you're guiding to for $625 million to $645 million for the December quarter, can you give us some color as to whether that mix will be similar to this quarter? Will there be greater big deals than your expectations or fewer big deals?

Yeah, Ajit, this is Rich. So, if I look at the midpoint of our guidance at $635 million, I would expect some EPS without that settlement gain of about $0.57. As far as the mix of the business, we'd expect a similar mix in terms of the big deals, and an operating profit coming in in the $3.9 million area.

Got it. And then, when you look at the sort of seasonality that you saw, you typically said that you saw a slowdown in summer, and this year it's being seasonally stronger. What do you attribute that increased strength to?

You know, we were asking that question. We didn't get a lot of great answers from our teams other than it appeared that even in July we had a much stronger month going into that quarter than was historical in Europe. And so, in one case, we still had some business that we didn't accomplish in June because of some of the shortages. So, July was better because of shortages in June that weren't able to be fulfilled. And then, I would say August was again a big surprise, because we thought we would have the normal holiday slowdown, and we just didn't see it. So, we don't know if more people were not taking holidays or what, but our business saw continued strength, even in August.

And you're talking about both your businesses, the AIDC security, as well as your telecom business?

Yeah. We're only talking Europe specifically.

Yeah. In Europe, but -- okay.

Yeah.

Okay. Thanks so much.

Thanks.

All right. Our next question comes from Tony Kure from KeyBanc. Your line is open.

You guys, can you hear me okay?

Yeah.

Yeah.

Okay. Sorry about that. A question about the -- a couple things -- the inventory balances, I think the comment was they leveled off during the year, and then combining that with the fact that it sounds like the inventory availability was an advantage for you guys. So, I guess my question is do you think that your competition is sort of caught up now with your inventory advantage, and is that something that you don't expect to be as significant as an advantage going forward?

Well, Tony, it's Mike. I don't know where they stand. I know that we had experienced maybe better than we expected allocations in the June quarter. I think I made a comment on the call that we were somewhat cautious about September's results because of a possibility that we would not get the same allocations we got in June in September. It turns out we got excellent allocations, which I assume means the other guys got enough, too. So, I believe that we've been able to maintain -- this is our -- I guess our view right now is that we've been able to maintain some of these customers that we may have brought back in the business, and the evidence of that is that we're selling to more customers now than we did before. But, we believe that there may be some drop off, but that's not what we're forecasting at this stage, not for December.

Okay. And then, I guess, maybe how would that have materialized, or what's sort of come to light with pricing? I mean, did pricing change materially as you were benefiting from these, or -- and are you calculating that same advantage into this current quarter? Just maybe talk about how pricing trends.

I would say it this way is that, even when we had product and no one else did, we didn't charge more for that, and I think our customers appreciated it, and I think our vendors did, too. So, we were able to maintain margins, and I think, if you look at our gross margins, they're still in the similar range once you take out any runoff items that we called attention to over the last four or five quarters. We've been able to maintain margins, but we didn't use inventory to improve margins, and I think our customers appreciate it, and I believe that's why they'll stay with us.

Okay. And then, since the question on the shortages, it sounds like that's been sort of alleviated, or it sort of dropped off over the last couple quarters now, and given that, I mean, you're looking at sort of a same type of elevated levels of sales into the second quarter here. So, there's no assumption of pull through, additional pull through from shortages? Is that fair to assume?

Well, I think the performance we achieved in September was so much higher than we had expected that, as we looked at our forecast for December, looked at what were the underlying results of that, clearly Europe saw more gains from product shortages, I would say, in the September quarter. We saw most of those gains and most of the shortages gone by the beginning of the September quarter in North America. So, I would say Europe specifically was somewhat out of phase by a quarter from availability, so and Europe and Latin America together account for 20% or so of our business, as you know. So, we believe we've already gone through that time where everyone else has inventory now, and we should see a steady, stayed business. So, that's why we feel comfortable with our forecast.

Okay. And I'm sorry, just one last question on gross margins. I know you had some vendor program benefits in the first quarter. I guess with the 10% -- and maybe, Rich, you said this when you talked about the expectations for the second quarter, but I mean, is it fair to extrapolate that sort of gross margin improvement from the -- from how you ended, say the fourth quarter or ended -- how you ended last year?

Well, I think the overall operating margin should come in similar to how we ended it in this last September quarter.

Okay. I see what you're saying. So, if [FTNA]is flat, then the gross margin should be about the same, too, is what you're kind of saying?

Yeah

Yeah.

Okay. Thanks, guys, good quarter.

Thanks, Tony.

Thank you.

All right. And our next question comes from Mr. Brian Drab from William Blair. Your line is open.

Hi, Rich.

Hi, Brian.

Hi, Mike. First question just on Algol. What was the contribution of Algol? I guess we're calling it ScanSource Communications Germany?

Yeah. ScanSource Communications Europe is a combined business unit. We're not going to disclose the exact sales figure for it, but what I could do is say that, in terms of -- if we give you -- remember, we said there was a foreign exchange adjusted growth of about 67%. If we adjusted out the Algol from the prior year, that would be in the mid-40s.

Okay. Thanks. And then, is Avaya still on a September year-end, and with -- is that something that still is a seasonal influence on your revenue?

Well, they are still on September 30, and our comments in the call so far were that we felt like more of the help there was not what had been in prior years just an end of the year push. It was more of the resellers had some certification levels that they needed to achieve to set their program benefits for 2011, and those program benefits and those levels are determined by volume. So, there was some reasons for resellers to do more business in September than October, but it wasn't like we saw, say three years ago, where we would see a September 30 huge rush of business at the very end. I think it was more stable throughout the quarter, and frankly, throughout the year.

Okay. Great. And then, could you elaborate a little bit on the progress and impact you're seeing from rolling out the Nortel products?

Well, we're basically two quarters in actually selling Nortel products, and we feel very good about our progress. A big part of our efforts had been to discuss and solicit business from some of the existing Nortel partners, also to get our Avaya partners trained to resell Avaya products. So, I would say we're very pleased with the business we've gotten so far through September.

Okay. Thanks very much.

Yeah.

All right. Again, as a reminder, if you'd like to ask a question, please press star-one. And our next question comes from Reik Read from Robert Baird. Your line is open, sir.

Hey, guys, how are you?

Good.

Maybe just going back to that last question, Mike, I think as you've talked in the past, the Avaya resellers selling the Nortel data products has been a pretty positive experience for you guys thus far, but the laggard was the Nortel guys selling the Avaya voice. Can you talk a little -- one, is that correct? And two, what's the update on those kind of cross opportunities?

Well, you're right, Reik. The bigger challenge is getting Avaya products sold by the Nortel guys, and we're talking Enterprise class products clearly, because Avaya does business, frankly, differently than Nortel did. So, there's this whole getting used to the Avaya processes, which means how do you buy and sell service, for example, and how do you deploy. But, our teams were prepared for that, and they've done a really good job. I think the issue that we have to remember, and a reminder to our investors is the Nortel resellers were all buying from another distributor. So, we're coming into this having to recruit these guys to buy their Avaya products from us rather than the distributor that sold them Nortel in the past. And so, it's more work for us. So, we've got a lot more effort to engage a Nortel partner, because Avaya is a different sale form, and number one -- and number two, they have to learn how to do business with Catalyst. So, I would say we feel good about our progress, but it is a longer cycle for us in getting our Avaya guys to sell data products. You're absolutely right there.

And that sounds like, what you're saying is it's still fairly early in the process -- in -- I guess the question is how long does it take to get that up and running where you start to see a little bit more regularity, and of the total opportunity, how much is that a piece of?

Well, I think -- so, you're right. It does take longer, and the challenge for us, as I say, is they now have more and different distributors. So, the landscape changed after the Nortel acquisition, Reik, and so now, in North America, that's what we're talking about the big change and impact on us is the addition of tech data to the portfolio, in addition to the existing distributor Westcon and Jenny. So, now we've got one more distributor to compete with on Avaya than we had nine months ago.

And is--?

--So, the partners have to -- so, the Nortel partners have to get to know what everyone's offer is, and clearly, we've got a lot of people focused on that, but it does take some time. And then, they've got to learn what they have to do to start selling product. But, I would say this is that there's a huge amount of emphasis within the Avaya community on growth. We just got back from their North America -- actually, their Americas conference, and the whole thing was growth. And so, there's a lot of focus on getting partners revved up to sell more products right now.

And does that business, the Avaya voice business with the Nortel resellers of similar size as the data business?

It's larger.

Okay. And then, maybe just going over to the barcoding side, you again saw a number of large deals. Were those heavily skewed towards retail as we've been seeing, or are we starting to see those pop into the [TNL] and manufacturing area?

Yeah. We called out retail as the main source for those. Yep.

Are you starting to see transportation logistics and manufacturing pick up? Those have been clear laggards in that business, and is that starting to move forward?

We didn't call them out, because they didn't pop out of the pack. And so, they may be improving, but it wasn't significant enough, Reik, for me to call them out. Yeah.

Okay. And then, just going back to the expediting, the -- you don't have the advantage anymore, but does that mean you're done expediting, or do you still have to expedite because that is an issue out there?

Help me with what you mean by expedite.

Is -- are there certain instances when the vendors have to expedite simply because there's shortages that exist generally, i.e., you brought in a bunch of inventory as a competitive advantage, but that doesn't necessarily mean -- if that competitive advantage is gone, it doesn't necessarily mean that the product shortages are gone?

Yeah. So, let me say it this way, because we don't really talk about expedites in the time as much from the vendors, but what I have said and will say, reaffirm is that the lead times for our products have lengthened. And what I think we've done very well is we have put our orders into the factories much sooner than our competitors and with more what we call scheduled orders to give them visibility. We've given our vendors much more visibility and continue to do today, because even though they have recovered, they still need more visibility means that we don't have to face a last-minute expedite. So, I think we're on a more traditional business relationship from a logistics with our vendors, but we are living with longer lead times, which is why we still believe a higher inventory level makes sense. It gives us that ability, as business continues to grow, to take advantage of the fact that we have the product, and the recovery time is still long. So, again, just a quick answer, we probably had vendors three years ago that can provide us product in a week. We have very few vendors today who can do that. It typically is today more like four to 10 weeks.

Okay. Great. Thank you very much.

Yeah.

All right. And I show no further questions at this time.

Okay. Well, thank you, Bobbie, and thank you for joining us. Our next conference call to discuss the December 31st quarterly results will be -- is expected to be January 27, 2011. Thank you.

All right. Thank you for everyone's participation today. You may disconnect at this time.