Scansource Inc (SCSC) 2011 Q2 法說會逐字稿

I'd like to thank participants for holding, and welcome to the ScanSource Quarterly Earnings Announcement call. All lines have been placed in listen-only mode until the question-and-answer session. Today's call is being recorded. If you do have objections, you may disconnect at this time.

I would now like to turn the call over to Rich Cleys, CFO. Thank you, sir. You may begin.

Thank you, [Brian], and thank you for joining us for the ScanSource conference call to discuss financial results for the quarter ended December 31st, 2010.

My name is Rich Cleys, and with me are Scott Benbenek, President of Worldwide Operations, and Mike Baur, 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.

The statements made in this call are made as of today's date. We may subsequently make these statements available on ScanSource's Website or otherwise. ScanSource does not assume any obligation to update the forward-looking statements provided to reflect the events that occur or circumstances that exist after today's date.

Any number of important factors could cause actual results to differ materially from the anticipated results. For more information concerning factors that could cause such a difference, see the Company's annual report on Form 10k for the year ended June 30, 2010, filed with the Securities and Exchange Commission.

This afternoon, the Company released results for our second quarter and year-to-date period ended December 31st, 2010. I will start our discussion by providing overall sales and operating results for the second quarter. Later on the call, Mike will comment specifically on quarterly results and outlook for each of our business units.

For the quarter ended December 31st, the Company generated worldwide net sales of $684 million, which represents a 25% increase in sales over the comparative prior year quarter and an 8% increase over the sequential quarter ended September 30, 2010.

Included in the quarter sales results are revenues from ScanSource Communications Germany, formerly known as Algol Europe, which was acquired November 30th, 2009. Our net sales for the quarter hit the second consecutive sales record for the Company. These results well exceeded our expectations as we experienced strong demand in all geographies.

On a geographic basis, sales originating from our North American distribution segment increased 22% in comparison to the prior year quarter. The International segment grew 34% and, when measured in local currency, net sales for our International operations increased by 43% in comparison with the prior year quarter.

With our product lines, we experienced a 20% 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 the communications products business. Our communications businesses experienced an increase of 33% in the comparison to the prior year quarter.

Company's consolidated gross margin percentage was 10.3% for both quarters ended December 31st, 2010, and December 31st, 2009. Sequentially, gross margins increased from the previously-reported 10%, primarily due to the effects of higher sales volume on vendor programs.

The volume impact is both achievement of vendor incentive programs and the recognition timing of many of these programs. Operating expenses in the current quarter decreased to $37.1 million, compared to $38.2 million in the comparative prior year period and $38.6 million sequentially. This decrease is primarily the result of proceeds from a legal settlement against a former service provider for expenses incurred in prior years of $3.1 million.

Operating expenses of -- as a percent of net sales decreased to 5.4% in the current quarter, compared to 7% in the comparative prior year period and 6.1% in the first quarter of 2011. Without the benefit of the $3.1 million legal settlement, operating expenses as a percentage of net sales was 5.9%.

Operating income for the December 2010 quarter increased to $33.5 million, an 85% increase from the operating income in the comparative prior year period of $18.1 million and $24.8 million from the sequential quarter. Expressed as a percentage of sales, operating income was 4.9% in the current quarter, compared to 3.3% for the prior year quarter and 3.9% for the first quarter of 2011.

Interest expense was $388,000 for the quarter, up from $364,000 in the prior year quarter and $366,000 from the first quarter. This was driven by increased borrowings in the Company's revolving line of credit. The effective tax rate was 35.7% for the quarters ended December 31, 2010, and December 31, 2009.

Our return on invested capital was 25% for the quarter, compared to 16.1% for the prior year quarter. The increase in return on invested capital is driven by our strong operating results for the quarter.

In summary, the December, 2010 quarter had fully -- had reported fully diluted EPS of $0.80 versus a fully diluted EPS of $0.44 in the December 2009 quarter. This improvement was due to the increased operating income generated from higher gross profit dollars on higher sales, coupled with the benefit of the $3.1 million recovery, or $0.07 per share from a legal settlement against a service provider for expenses incurred in prior years.

Turning to the balance sheet, inventory turned 6.7 times during the quarter, which was slightly higher than the 6.6 times generated in the September 2010 quarter, but slightly lower than the 6.8 turns in comparison -- in the comparable prior year last quarter.

As inventory balances increased during the current quarter pay for inventory days were a positive 12.5 days compared to a positive 7.7 days for the September 2010 quarter and six days for the comparative prior year quarter. The Company has maintained inventory turn levels in order to maximize order fill rates as sales volumes continue to improve. Mike will have more expansive comments during this business discussion later on the call.

Accordingly, inventory on hand at December 31st, 2010, was $389.4 million versus $345.3 million at September 30th, 2010, and $309 million at December 31st, 2009. There are $53.2 million in checks written but not cleared in the December 2010 accounts payable balance. At June 2010, this amount was $62.7 million.

The number of days in receivable, DSO, was 55 at December 31st 2010, down from 59 days in the sequential and comparative prior year quarters. The sequential decline in DSO was due to the timing of sales during the quarter and, to a lesser extent, a more favorable mix of customer terms.

The Company had cash and cash equivalents on hand of $13 million at December 31, 2010, compared to $14.4 million at September 30, 2010, and $34.6 million on hand as of June 30, 2010. During the quarter, the Company had capital expenditures of $3.9 million, primarily relating to our investment in a new ERP system, which we discussed on our last conference call.

Total interest-bearing debt increased to $45.2 million for the December 31, 2010 balance sheet from $30.4 million at June 30, 2010, driven by borrowings on the Company's revolving line of credit. As we would expect, after two quarters of double-digit sales growth and the resulting increase in working capital, the Company had end of quarter borrowings on the revolving line of credit.

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

Thanks Rich. All ScanSource business units had excellent results with record demand in sales across all geographies. One key contributor to the surprising sales results was that certain vendor programs for resellers were scheduled to expire at the end of the year. This resulted in a rush by resellers to accelerate orders to maximize the financial benefits of these programs.

Our sales teams had an outsourcing quarter, taking market share from competitors by providing the right combination of value-added services and excellent operational execution. As we plan for 2011, we expect to see continued demand for our products and services throughout the year. We will watch carefully the changes in our vendor supply chain so that we don't have product shortages like last year. As a result, we anticipate maintaining higher levels of inventory throughout 2011.

ScanSource reseller community has prospered through 2010 after surviving the recession of 2009. We are seeing our customers' financial condition stabilize as they prepare for growth opportunities ahead. In summary, we are excited about the way 2010 ended and the potential for continued growth in 2011. Now, we'll comment on each of our reporting segments.

North American distribution, which includes sales into the United States and Canada, posted record sales of $522.9 million, an increase of 22% year-over-year and 6% sequentially.

Our North American discussion will start with our POS and Bar Code unit. The North America POS and Bar Code unit had record results for the December quarter. These excellent results were led by an increase in demand during the quarter and excellent execution on behalf of the sales and business development teams.

We believe that this unit gained market share this quarter, as record sales were achieved across most product categories. The sales growth was stronger with the Bar Code or AIDC vendors than our POS vendors and was led by Motorola, Intermec, Zebra and Honeywell. Our continued investment in strong inventory levels has results in high levels of customer satisfaction.

As we mentioned last quarter, we are investing in new programs to drive incremental sales for ScanSource, and an example is the launchings of payment processing services for our reseller channel. These services are designed to help our channel sell more terminals, from vendors like Verifone, into the retail marketplace.

We will be providing value-added services, like key injection program, to make it easier for our resellers to sell and install these products. We are seeing good results from our ISV partnerships that are being managed and marketed through our SUMO partnering tool. We now have over 170 ISVs and 900 bars signed up with SUMO and looking for partners to develop opportunities.

We've also launched AppSource as a Web storefront for resellers needing easy-to-use mobility applications. AppSource will allow developers to access the ScanSource reseller base of over 20,000 companies and lower the cost for resellers to provide mobility solutions to their small to medium end user customers.

Next, I'll update you on our ScanSource Security sales unit. ScanSource Security sales unit also had excellent results for the December quarter and saw record sales with many vendors. Key vendor results were led by Panasonic and Axis in the video surveillance category, followed by Ruckus and Tropos in networking.

The sales team increased our market share by aggressively recruiting and quoting solutions to large customers. We also invested in market development activities to recruit, educate and train resellers through our IP workshops held in three locations last quarter, and we exhibited and marketed at several key trade shows, including ASIS, ICE West -- I mean, East, and the ScanSource Communications Partner Conference.

We continue to believe the growth opportunity is available to our team, so we're adding more headcount in sales, business development and tech support.

And now, we'll update you on Catalyst Telecom. Catalyst Telecom team had record sales results in the December quarter, following a record September quarter. Traditionally, the December quarter is down from the September quarter. However, this team exceeded our plan, due to strong end of year sales from our Avaya resellers.

Some of this demand was driven by end of year vendor programs that rewarded revenues in calendar year 2010. Without these program incentives, the quarter would still have been very strong. We believe our sales and business development teams took market share on the quarter while delivering strong value to our customers. We were also very pleased by increasing sales of Avaya Data products, formerly Nortel Data, and strong sales of Polycom wireless and voice products and Aruba networking products.

We're excited about the new products and programs Avaya and our other vendors are bringing to the channel, so we continue to make strategic investments in our Catalyst business unit. We have added significant numbers of people across all functional areas to ensure our ability to execute flawlessly as we recruit new customers and grow our existing base of business.

Next up, I'll update you on ScanSource Communications. This sales team once again delivered record results, led by our strategic vendor, Polycom. This team achieved record sales results for all Polycom products, including video, wireless, voice and service offerings. We exceeded our plans for the December quarter and saw strong demand across almost all ScanSource Communications vendors.

For example, AudioCodes and NET also had record sales in the December quarter. In addition, we saw continued growth in new customers and market share gains. We continue to see strong growth with the traditional audio/visual resellers, voice and data telephony bars, direct marketing bars and also service providers.

ScanSource Communications hosted a partner conference during the quarter to present our plans and strategies for 2011. This conference allowed our key resellers and vendors to meet and discuss sales and marketing opportunities. The conference agenda focused on the tremendous growth and opportunities in unified communications. ScanSource Communications has assembled some of the strongest companies in this area, including Polycom, Plantronics, AudioCodes, Dialogic and NET.

We have recognized the need to add certain strategic products to help fill out our UC offerings. As a result, we announced last week an expanded strategic relationship with ShoreTel after working with ShoreTel for the last year in our UK communications business.

And in the US, with our ShoreTel bundled solution, we are very pleased to begin offering the full ShoreTel product line to resellers. Effective immediately, we will be supporting ShoreTel resellers with value-added services, excellent logistics, credit terms, technical support and highly-skilled sales teams.

ScanSource Communications will be adding additional resources to support these new opportunities with ShoreTel. We will be working closely with ShoreTel executives to map out our joint efforts at recruitment of new resellers and support of existing resellers. The plan is to improve the customer experience for all resellers as they transition to this new two-tier distribution model. This transition, for the first group of existing ShoreTel partners, will happen over the next six months.

Our second reporting segment is International Distribution. Our International business, which includes Europe, Latin America and Mexico, posted record sales of $160.8 million, an increase of 34% from last year and, when measured in local currency, grew 43% over last year.

Once again, Europe POS and Bar Code has a record growth quarter year-over-year in almost every country and region and with almost all vendors. We saw especially strong year-over-year growth in the Nordics, Spain, Italy, Germany, Netherlands and Eastern Europe. This growth was highlighted by the recruitment of new customers, by our partner development team and incremental sales from our strong base of resellers.

Our strategic vendors all had excellent sales results with ScanSource, including Motorola, Intermec, Datalogic, Zebra and Honeywell. Our fastest-growing vendor has become LXD, as they have started to embrace two-step distribution in Europe, and their resellers have begun to utilize the ScanSource value-added distribution model.

In the December quarter, ScanSource POS and Bar Code Europe hosted its annual partner conference and met many partners through the highly successful partner tours, which were held across Europe.

In order to support the growth initiatives for this year, we are adding headcount in all functional areas.

Now, let's turn to ScanSource Europe Communications. As a reminder, ScanSource Communications Europe includes two acquisitions -- MTV Telecom, located near London, England, and Algol Europe, based in Cologne, Germany. Both of these teams are now working together to grow our base of business and expand our opportunities beyond the UK and the Germanic region.

For the December quarter, this group achieved record sales led by our success with Avaya ECG products and the recruitment of new customers in the UK, as Avaya terminated one of their distributors. The group also achieved record results with Extreme Networks, Juniper, ShoreTel and APC.

In Europe, the team has found great success at attracting new resellers by increasing marketing programs and attending the partner tours road shows that were held in Germany and France. Another key value-added program that provides professional services for hire was launched in the UK to support partners needing third-party installation services.

In Germany, ScanSource University expanded our offerings to include Avaya certification training for our partners. During the quarter, we announced the signing of Polycom for ScanSource Europe. We are getting ready to roll out programs and plans for a successful launch in the March quarter. Polycom and ScanSource expect to be very successful together, as we have a blueprint from the USA that we will customize for Europe. ScanSource will be supporting the existing Polycom channel partners and recruiting new resellers in 2011.

In our Latin America and Mexico business unit, the sales team achieved record results in the POS and Bar Code business and with many of our newer vendors. Seasonally, the December quarter is our best of the year in this region. And this year was no exception, as we realized strong results with our top customers and in all major countries.

Our strategic vendors, including Motorola, Zebra, Honeywell and Intermec had record sales results for the December quarter, and we exceeded our plans. We assigned new vendors in the Communications and Infrastructure areas that contributed to our record results in Latin America.

The team achieved excellent results with Polycom, Alvarion and Extreme. We are investing in additional resources to better support these new products and vendors.

Now, I will conclude this part of our call with closing comments. We believe total revenues for the March 2011 quarter will range from $630 million to $650 million, and our earnings per share could range from $0.57 to $0.61 per diluted share.

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

(Operator instructions.) Our first question comes from Andrew Abrams with Avian Securities. Your line is open.

Hi. I was wondering -- congratulations on a great quarter, by the way.

Thank you.

Thank you.

Just a little color, if you could, on the AIDC side. You mentioned vendor programs that were ending, and that's a very understandable part of the end of the year, but your numbers for the March quarter seem like that strength may be in AIDC. Looks like it's continuing.

Is there some characteristic here that you can kind of look and say -- okay, AIDC has sort of recovered? Or is this very specific to particular products or regions?

Well, Andrew, this is Mike. It's -- we didn't specifically say the programs were related to AIDC. They were more related to communications, to be clear.

Okay.

But, our AIDC business was strong, and we do see continued demand, frankly for the last four quarters. If you recall, back in March of last year, when we had product shortages, it kind of colored where the real demand was. And as we went through the June quarter and September quarter, we weren't sure if it would continue. But, that part of our business, the AIDC business, did continue to perform well in December, even as we got through almost all product shortages.

And so, we feel, right now, like there's still a strong demand underlying our business, and that's why we feel good about our forecast.

Got it. And the difficulty -- or I'm not sure if you would consider it a difficulty, but the fact that you guys have been outperforming your own guidance for the last couple of quarters -- is it a function of the way business comes in during the quarter? Meaning the -- you know, the order rates kind of pile toward the back end of the quarter? Or is this just better strength than you're willing to commit to early in the quarter?

Well, we did miss our numbers back in March.

That was a while ago.

And so, that tends to color your thinking. But, to be honest, it was the shortages of inventory as we look back through last year that made it difficult beyond normal to forecast.

And as a reminder -- to your question around where our business -- and when it comes in, we don't really have forecasts from our customers that are -- that they have to commit to. So, every day, all of our orders come in, and they out unless they're waiting for a particular product.

So, we don't have what would be call backlog by traditional companies. We typically do see, in most every quarter, some surge in activity near the end. In this case, there was some because there were some programs that were expiring. Vendors were going to change them for 2011.

But, I would say what's, again, coloring our forecast, other than the normal, that we really don't have a backlog, is that we weren't sure -- were we getting market share because we were the only place we had product, which truly was our concern in June, less so in September. And now, in December, we believe that we did bring in some new customers who tried us in all of our regions during the shortages last year and stayed with us.

And so, we've seen some of those customers that are new to ScanSource still stay with us, even during the December quarter. But, frankly, they had other choices.

Great. Thank you very much.

You bet.

Okay, our next question comes from Tony Kure with KeyBanc. Your line is open.

Good evening, guys. How are you?

Hey, Tony.

Hi, Tony.

Just a couple quick questions. The vendor programs that came through -- it sounds, obviously, that -- a lot of folks hustling to take advantage of in December quarter. What have those established? And, like, do you have visibility into the relative attractiveness of those types of programs now into the calendar year, 2011? Or is that something you don't have visibility into?

Well, there's two kind of vendor programs that we talked about on the call, Tony. This is Mike. And so, the ones that we talked about, where some revenue probably got moved into this quarter from the March quarter -- those are programs that are driven by certain vendors who want to have reseller incentives. So, these are reseller programs, and they generally are announced on an annual basis.

And in this case, they -- some of our vendors made some late changes to their programs that would change the financial incentives in March versus December. So, that's a reseller type program. And typically, we've not seen that impact our business. That has been rare.

Let me let Rich talk about the vendor programs that we receive and how that impacted us in the quarter, if that helps, Tony.

Sure. That'd be great.

So, this is a -- basically an across the board comment with regard to vendor programs that we receive. There are two factors that helped us recognize significantly more than we had planned for in the vendor programs. One is our achievement. So, the goals that were set for us -- many of them are volume related, but there are other goals, we significantly exceeded.

And then, the second factor is, the way that you account for some of these programs is that you amortize them into income over your sales or over your inventory turn. So, when you have a strong sales quarter like we did, we got -- we have the benefit of exceeding achievement as well as the timing on the accounting. So, it's a -- kind of the perfect storm for the vendor programs for us.

From a positive perspective.

Right, right.

Sure, sure. So, I guess my next question is related to gross margins, and that would probably be the driving factor on the gross margin line, too. Is that a fair assumption or --?

Yes. The gross margins -- it's the vendor programs -- and we're talking about percentage right now, right?

Yes.

So, the gross margin percentage -- it's the vendor program, both the timing and the achievement. And then, if we look at the sales mix that we had this quarter, where we look at large deals versus prior periods, the big deals -- we did have big deals this quarter, but we had such a top line achievement that the big deals did not have an adverse impact or really didn't have an impact on our overall gross margin percentage.

Okay. That makes sense. And then, if you could remind me or maybe walk through what sequential trends, historically, are. Maybe not so much for the March quarter -- well, actually -- yes, for the March quarter, and then into the June quarter, what has historically been the trend?

Yes. And the historical trend, over the last couple of years, has been significantly impacted by the economy and then the production -- the shortage issue that Mike talked about. But, over the years, the toughest quarter and usually the -- probably the weakest quarter is that March quarter that we're just about to go into.

So, if I go back and I analyze achievement over many, many, many years, this quarter tends to be about 6% less than the December quarter. Then, we go into the June quarter. The June quarter tends to be a stronger quarter for us. That's our fiscal year-end, and it tends to be a good quarter for us.

And you mean the -- by that, you mean sequentially rebounding from the third quarter, right?

Yes, yes. It tends to be a stronger quarter than the March quarter, historically.

Okay. And then -- actually, one more question just in relation to -- there was a quick comment on the Avaya/, you know, Nortel sales. Seems to be gaining speed here. Is that -- was that a bigger piece? Are you seeing that accelerate at a faster rate than your other, I would say, broad-based sales trends?

Well, what we are trying to say there, Tony, is that we are doing two things since the Nortel acquisition of, now, a year ago. Two things -- one is trying to make sure that our existing Avaya resellers are starting to sell successfully the Nortel products that they didn't have available before, so that's working.

And number two, we've been out recruiting former Nortel resellers to get them to buy their Nortel products from us and teach them how to sell Avaya products. So, we are seeing both of those dynamics happen, which is why we mention it -- is that we're seeing incremental business, if you will, in the Catalyst business unit from our success with the former Nortel products, yes.

Okay. Thanks so much.

Appreciate it.

(Operator Instructions.) And our next question comes from Chris Quilty with Raymond James. Your line is open, sir.

Good evening, guys, and congratulations --.

Well, thanks, Chris.

Hello?

Yes, Chris --.

Oh, okay. A question for you. Even if I back in the $3.1 million legal settlement that I assume hit in the SG&A line?

Right.

Okay, it still looks like your -- you know, your sales and marketing expenses were lower than I would have expected. Is there view -- in some way accrue for that and those -- the sales compensation gets picked up later in the year? Or was the full impact here in this quarter? And if so, why -- or am I wrong, that the number shouldn't have been higher?

Well, if we back out the $3.1 million, our SG&A is going to be -- or our operating expense -- SG&A is going to be about 5.9% of sales. So, with the higher volumes, we did get some leverage on that SG&A. So, with -- if you look at our guidance, we'd be looking slightly higher, as a percentage. But, to your detailed question on compensation, the SG&A does include the compensation for commissions. So, we've got that included in our numbers, but the leverage is there.

Okay. And, you know, again, your guidance for Q3 seems to imply anywhere from, say, 3.8% up to 4.2% operating margin, given the range of revenues, which is still towards the higher end of where you've historically done. Does that reflect a change in mix with the business? Or is there some other factor?

I think it's reflective of -- the margins are there -- the revenues -- at the mid-point, we'd have $640 million in revenues, so we're continuing to see good, strong revenue results, albeit, this is our March quarter. And this implies, at a mid-point about 4% on the operating profit line.

So, if we continue to see strong operating results, that'll be an indication to even further reinvest in growth opportunities for the Company.

Okay. Europe doesn't seem like you had any issues coming out of there. No debt crisis spillover?

No, it -- are you -- you're probably referring to both sales opportunity as well as credit. Yes, we've navigated through that fairly well.

Okay. And again, with Latin America, I think you've had -- some of your distribution competitors have picked up vendors in the region. You haven't seen any kind of an impact from that?

Nothing specific that we felt like we would talk about. What we've done in Latin America is really expand our center portfolio as well. So, Polycom is a pickup for us over the last couple quarters, Alvarion, Axis. So, in Latin America, we're selling now -- in addition to the POS and Bar Code stuff, we're also selling security and our communications products, which is the only place where we're selling all three technologies.

And it's because the opportunities are smaller there, and we need to maximize the investment in SG&A. So, we're picking up maybe some vendors in these other parts of our business, but not necessarily in the POS and Bar Code.

And I think I'd add, on the European side, Chris, that I think our strong inventory position has allowed us to gain some share there and some customers. And we seem to be sustaining that.

Okay. And final question. Security. I mean, that whole business got off to, you know, a slower start some years ago when you got into it. You know, where do you think you are in that process? Are you about where you thought you'd be now? Have you caught up? And in addition to that, when look at your line card, are you there or do you still see 20% or 50% room for expansion over time?

Well, Chris, I think what we learned is that we did not want to carry all of the vendors that every distributor traditionally carried. So, from the -- after the first couple years, we decided to bow out, if you will, of the burglar alarm kind of business, which is -- the way that model works -- very low dollar transactions, and it's a will-call or a local warehouse pick up kind of business.

So, we weren't clear, when we first got started, whether we would be in that business. And so, that represented some opportunity we essentially have walked away from. And then, what we've learned is, since then, the video surveillance business, which is going through a technology shift from analog to digital -- and we're only about halfway through that shift, if you will, we believe that is the business that fits our model more anyway.

So, we like the video surveillance part of the business we're in. We like the card printer business. It's steady and has good growth still ahead of us. And we like this -- what we call the networking infrastructure to support video surveillance. And that's the Cisco products along with their cameras, that's the Tropos, the Alvarion, all the back-hall kind of wireless infrastructure to support high performance megapixel video surveillance.

So, yes, I think we're with the right vendors to answer that question. We're not looking for any significant new vendors at this time unless they are new and adding value into the video surveillance or card printer area.

Okay, great. Keep up the good work, guys.

Appreciate it.

Thank you.

At this time, I show no further questions.

Okay. Well, great. Thanks for joining us. Our next conference call to discuss the March 31st call to discuss the March 31st quarterly earnings call is expected to be on April 28th, 2011.

Okay, thank you. That does conclude the conference for today. You may disconnect your phone lines at this time.