Scansource Inc (SCSC) 2011 Q3 法說會逐字稿

Welcome to the ScanSource Third Quarter Earning -- Announcement Call. All lines have been placed in a listen-only mode until the question-and-answer session. Today's call is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. Rich Cleys, CFO. Sir, you may begin.

Thank you, [Tamara], and thank you for joining us for the ScanSource conference call to discuss financial results for the quarter ended March 31st, 2011.

My name is Rich Cleys, and with me are Scott Benbenek, President of Worldwide Operations, and Mike Baur, our CEO. We will go over 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 events that occur or circumstances that exist after today's date.

Any number of important factors could cause actual results to differ materially from anticipated results, including results of purchase accounting for the recent CDC Brazil acquisition. 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, 2010, filed with the Securities and Exchange Commission.

This afternoon, the Company released results for our third quarter and year-to-date period ended March 31st, 2011. Mike will begin our discussion with some opening comments. After those comments, I will provide overall sales and operating results for the third quarter. Later in the call, Mike will comment specifically on the quarterly results and outlook for each of our business units. Mike will now begin our discussion.

Thanks, Rich, and good afternoon. Before we discuss the quarterly results, I wanted to welcome our new Board member, Steve Owings, back to the company. As most of you know, Steve provided the strategic vision in ScanSource's founding years and has continued to work for the Company in an advisory role with reduced responsibility since 2005. The ScanSource Board and our employees are delighted to have Steve rejoin the Board, and we look forward to his contributions.

Now, I'll turn it back over to Rich for his comments.

Thanks, Mike. For the quarter ended March 31st, 2011, the Company generated worldwide net sales of $613 million, which represents a 24% increase over the prior year quarter and a 10% decrease from the sequential quarter. We are pleased with our third quarter results, although we missed our expectation for revenue.

We saw very good demand across all geographies compared to last year. On a geographic basis, sales originating from our North American distribution segment increased 22% in comparison to the prior year quarter. Our international segment grew 28% from Q3 2010. When measured in local currency, net sales for the international segment grew 29% from the prior year same quarter. These results do not include our recent acquisition of CDC Brazil as the transaction closed April 15th, 2011.

Within our product lines, we experienced a 21% increase in worldwide sales of our POS bar coding and security product categories over the prior year quarter. These product categories represent 61% of our total sales for the quarter with the remaining 39% originating from the communications products business.

Our communication sales units experienced an increase of 28% in comparison with the prior year quarter. The Company's consolidated gross margin percentage decreased 23 basis points from the third quarter 2010 to pinpoint 7% for the quarter ended March 31st, 2011.

Sequentially, gross margin increased 40 basis points, driven by both favorable customer and product mix. Operating expenses in the current quarter increased to $40.3 million compared to $35.4 million in the prior year third quarter. As a percentage of net sales, operating expenses decreased 56 basis points to 6.6%. The change is mainly driven by increased volume.

Also this past quarter, we incurred a $2.4 million charge to fund a supplemental executive retirement plan for our Founder and former CEO Steve Owings, who recently retired and joined our Board of Directors. Excluding this one-time charge, our third quarter operating expense ratio was 6.2% as we have effectively managed our spending.

From the sequential quarter, operating expense increased $3.3 million from $37.1 million. If you recall last quarter, we had a one time recovery from a legal settlement in the amount of $3.1 million or $0.07 a share, which reduced last quarter's expense. Net of these one time events, operating expense actually decreased $2.2 million from the second quarter.

Operating income for the March 2011 quarter was $25.5 million, a 34% increase from operating income in the comparable prior year period of $19 million, but decreased $8.1 million from the sequential quarter. Expressed as a percentage of sales, operating income was 4.2% in the current quarter compared to 3.8% for the prior year quarter and 4.9% for the second quarter of 2011.

Interest expense was $429,000 for the quarter, up from $377,000 in the prior year quarter and $388,000 in the second quarter. This was driven by increased borrowings on the Company's revolving lines of credit.

The effective tax rate was 34% and 36.5% for the quarters ended March 31st, 2011 and 2010 respectively.

Our return on invested capital was 18.2% for the quarter compared to 16.8% for the prior year quarter. This increase in return on invested capital is driven by our strong operating results for the quarter.

In summary, the March 2011 quarter had reported fully diluted EPS of $0.60 versus a reported fully diluted EPS of $0.45 for the March 2010 quarter. This improvement was driven by increased volumes in the top line and effective management of the Company's operating expenses.

Turning to the balance sheet, inventory turned 5.5 times during the quarter compared to 5.7 times and 6.7 times in the prior year and sequential quarters respectively. As inventory balances increased during the current quarter, the Company had 18.1 paid for inventory days on hand at March 31st compared to 17.7 days at the end of the prior year third quarter and 12.5 days at the end of the second quarter of 2011.

The Company had strategically increased inventory levels for some products in response to market conditions and to take advantage of vendor programs earlier in the quarter, resulting in higher inventory levels at quarter-end. These factors have lowered our inventory turns from the sequential quarter. Accordingly, inventory on hand as of March 31st, 2011, was $401.2 million versus $389.4 million at the end of the second quarter and $312.5 million at March 31st, 2010.

There were $45 million in checks written but not cleared in the March 2011 accounts payable balance. At June 2010, this amount was $62.7 million. The number of days in receivables, DSO, was 56 days at March 31st, 2011, from 55 and 59 days in the sequential and comparable prior year quarters respectively.

The Company had cash and cash equivalence on hand of $31.2 million at March 31st, 2011, compared to $13 million at December 31st, 2010, and $34.6 million on hand as of the prior year-end. During the quarter, the Company had capital expenditures of $4.5 million, primarily related to our investment in a new ERP system, which has been discussed in previous conference calls and filings.

The Company held $34.5 million of interest bearing debt at March 31st, 2011, up from $30.4 million at our prior year-end, but down sequentially from December's $45.2 million. During the quarter, cash provided from operations totaled $31.5 million. We expect that the impact of higher sales and the CDC purchase will increase our average debt in the June quarter by approximately $50 million from the March 31st end of quarter balance.

Mike will now provide an update on our business.

We are pleased to have 24% year-over-year sales growth. However, we missed on our expectations due to fewer big deals and aggressive pricing by some of our competitors in the Americas. In addition, some of the big deals we expected to close in the quarter were delayed and some were lost to competition.

As a result of the aggressive pricing actions by some of our competitors, we lost market share in some business units. Our strategy in valuated distribution has always been to balance our investments in programs and services with our gross margin and return on invested capital achievement. Our customers and vendors continue to tell us that this type of distribution is important to the markets we serve. However, we also expect to deliver revenue growth and increase our market share, so expect us to reinforce this message to our sales teams this quarter.

Overall, our inventory positions are in excellent shape as we enter our fourth quarter. And so far, we haven't experienced any supply chain disruptions from the crisis in Japan. As demand has continued to improve each quarter from a year ago, we are encouraged to see our customers and vendors excited about the opportunities for the rest of 2011.

Now I will comment on each of our reporting segments. North American distribution, which includes sales into the United States and Canada, posted sales of $462 million, an increase of 22% year-over-year and a decrease of 12% sequentially. Our North American discussion will start with our POS and bar code unit. This team had good results but missed our expectations. The results showed good profitability and strong year-over-year sales growth, but we saw a reduced level of big deals, especially in our retail systems business.

For ScanSource, almost all POS and bar code vendors had sales results lower than our record quarter in December and against our expectations. The focus for this business unit is recruiting net new customers and developing new channels for our vendors. However, we will also take retake market share in specific opportunities.

Next, I'll update you on our ScanSource security sales unit. This business unit had very good results for the March quarter, achieving strong sale gains compared to last year, although flat with last quarter. ScanSource Security continues to take market share and recruit new customers for our vendors. The March quarter is seasonally weaker for our security vendors and customers due to the slowdown in purchasing by schools, prisons and other government institutions. As we begin to achieve critical mass, we are starting to realize this seasonality, as well.

We are excited about our new vendor, March Networks, who has decided to use ScanSource Security as its first two tier distributor in North America. March Networks has a strong network of security integrators with an impressive video surveillance product portfolio.

Another exciting development is the decision by Sony Electronics to reducer their distribution network and work with only three two tier distributors in the United States, including ScanSource Security. This significant change announced recently will enable Sony Security resellers to receive more value added services and focus, and it will enable ScanSource security to grow our Sony market share quickly.

Now, turning to Catalyst Telecom, Catalyst team had a very good March quarter following record results in December. Seasonally, this has always been a weaker quarter for our Avaya Enterprise Business. Our Avaya ECG Enterprise SME business was down from December but showed strong growth on a year-over-year basis. Especially strong was the sales results from our Avaya data portfolio, the former Nortel products, that showed strong growth year-over-year and sequentially.

Catalyst is adding substantially to its sales team to recruit and develop new customers. As the Catalyst opportunities for growth continue to improve, we have decided to invest in our sales team to drive incremental revenue.

Next, I will update you on ScanSource Communications. This sales team delivered very good results with strong year-over-year growth and continued to take market share in recruiting customers. Polycom named ScanSource Communications the 2010 Global and North American Distributor of the Year for overall revenue and recognizing our value added services. The overall Polycom business was, again, very strong year-over-year, although down slightly from the record results in December.

As announced last quarter, ShoreTel is expanding the opportunities with ScanSource Communications by starting a program to share the responsibility for recruiting and supporting their reseller channel with two tier distribution. This strategic shift by ShoreTel will result in incremental growth for ScanSource and ShoreTel. For the March quarter, we exceeded our goal with ShoreTel for recruiting new partners and are excited about the opportunity ahead.

Our second reporting segment is international distribution. Our international business, which includes Europe, Latin America and Mexico, posted strong sales of $151.4 million, an increase of 28% from last year. The Europe POS and bar code team had an excellent quarter and exceeded our expectations. We had strong growth in all of the major countries in Europe, led by the UK, Germany, Denmark and Belgium.

As in North America, we saw fewer big deals, which led to a higher gross margin for this business unit. In addition, we continued to sell more service contracts, which also improved our gross margins, as we recognized some of these contracts as fee revenue.

Most of our AIDC vendors showed excellent growth year-over-year. Sequentially, we took market share due to our inventory availability, excellent customer service and dedicated account managers. We continue to benefit from the advantages of volume and scale as we operate centrally from Belgium with the multinational, multilingual sales and support teams. In addition, we benefit from our local in country sales offices throughout Europe.

Now, let's turn to ScanSource Europe Communications. This team had a challenging quarter as certain big deals in our German sales office were delayed or lost. In the UK, the sales growth was very good as this team continues to recruit new customers and grow the Avaya portfolio nicely, especially the Avaya data formerly Nortel products.

As we announced last quarter, we have begun our relationship with Polycom in Germany first, and we expect the team there to build our business incrementally and take market share. In Latin America and Mexico, we achieved very good results and exceeded our expectations. Seasonally, this region is sequentially weaker. However, we saw quarter over quarter growth in certain countries like Venezuela and the Dominican Republic, and also with our exporters based in Miami.

Our gross margin deterioration in certain product lines will be difficult to improve unless our vendors reduce the number of distributors in some of these markets. As a result, we're taking actions to focus on fewer vendors, focusing on those who need the value added services that we provide our resellers.

Our most recent news in Latin America is the acquisition of CDC Brazil that we announced in early April. We are excited that Alexander Conde and his team of 200 employees are now part of the ScanSource family. The CDC Brazil strategy of value added distribution is almost identical to ScanSource and will be complementary for our vendors and our customers.

We will now be able to participate in the exciting growth opportunities for POS and bar code in the largest IT market in Latin America. The CDC Brazil team has experienced rapid and sustained growth for eight years, and they've become the largest and most value added AIDC and POS distributor in Brazil.

We have high expectations for their continued success as part of the ScanSource Latin America team. As the results for this acquisition will become part of our international segment, we will not provide separate financial details in the future. However, as we disclosed previously, the 12 month revenues for CDC Brazil as of December 31st, 2010, were approximately BRL246 million. As CDC Brazil has already achieved significant scale and invested appropriately in value added distribution services, the CDC operating margins are very good and at typical ScanSource levels.

In closing, I would like to thank the ScanSource Corporate Development Team and the CDC Brazil team for their hard work and long hours in completing this successful acquisition.

Now, I will conclude this part of our call with closing comments. We believe total revenues for the June 2011 quarter could range from $700 million to $720 million, and our earnings per share could range from $0.60 per share to $0.62 per diluted share. Included in our guidance is two and a half months revenue for CDC Brazil. As you recall, the 12 months ended December 2010 revenues were BRL246 million or approximately $155 million at forecasted exchange rates. Based upon our assumptions, the fourth quarter impact of two and a half months for Brazil should be net income break even.

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

Thank you.

(Operator Instructions.)

Our first question comes from Tony Kure from KeyBanc. Your line is open.

Good afternoon, gentlemen. How are you today?

Afternoon, Tony. Good. Thank you.

Hey, Tony.

Good. I just wanted to touch on the aggressive pricing actions from competitors during the quarter. Why would this happen during this particular quarter? Why is this sort of a relatively new phenomenon or called out as a new phenomenon? And then, what's sort of the expectation going forward as far as how -- what your reaction is going to be to -- sounds like some more -- increasing aggressiveness?

This is Mike, Tony. I think -- we always have competitive pressures. I think in this quarter, for whatever reason, our competitors decided to get more aggressive. Frankly, we had a strong December quarter, if you recall, and we took market share the last two or three quarters, as we've indicated. And so, it could be their reaction to that.

But, nonetheless, what we did in the quarter, I was frankly not totally in agreement with, was we walked away from some business. And we had a discussion with our team and we made the decision that in some cases, we should not have walked away from some of that business, even though it was at lower margins than we would like.

And so, we recognize that for some business that we've always been willing to take because our vendors expect us to grow, expect us to show revenue growth with them. And we don't want to give a smaller competitor a chance to create additional scale and critical mass. So, we're going to go back to our teams and change some of those decisions that we made last quarter. And that's reflected in our forecast.

Okay. So, that's what I was actually going to get to next. The fourth quarter, does that revenue guidance suggest maybe more of these bigger deals being a bigger mix again going forward, and then maybe some of the push outs that happened in the third pushing over to the fourth, is that sort of what's implied by the revenue?

Yes, Tony, this is Rich. If I look at the third quarter and analyze our EPS components, between the customer and the product mix, that's over $0.08 a share that contributed to the quarter. So, it more than made up for the volume decrease from our overall guidance. So, I -- the way we're guiding right now, I wouldn't anticipate that favorable customer and product mix that we just experienced.

Okay. But, more on the revenue side, the expectation for the increase in revenue is -- that's where I was -- the angle I was going after. Is that your expectation for winning more of these deals or more availability of these deals push -- spilling over, or just more along the revenue side?

Yes, we'd anticipate winning more of these deals. And of course, remember, we've got two and a half months of CDC in the numbers, too.

Right, right.

So, if you do the math there based on what Mike said with the $155 million, pure math would be about 32ish, $32 million or so of contribution from Brazil. So, that would be incremental to what we've reported in the past.

Sure. Okay. And then, as far as purchase accounting goes for CDC, is that expense factored into the -- well, is there a, sort of a material impact into the fourth quarter numbers? And if so, how long would that persist into 2012?

Yes, we do have the purchase accounting assumed in there. Of course, we're in the process of doing that purchase accounting. CDC, we told in this fourth quarter forecast, we're anticipating that it's net income neutral. Now, another thing about CDC is it's a larger, more mature business. So, they have mature EBITDA margins. So, as you can tell, we've got some significant purchase accounting then in these estimates of break even.

And then, would that persist past the June quarter?

Yeah, the purchase accounting -- and again, I don't have all the numbers in, but you're -- we would have intangibles that we'd be amortizing over five to ten years probably on average.

Okay, but not purchase accounting, right?

Well, in the purchase accounting, you do a valuation of the assets of the business.

Okay.

That valuation, whatever those things come up with, say customers lists or non-competes or even the goodwill, there are different lots that are assigned to it. This is all done by an independent appraiser. And then, we amortize those depreciable items into expense over the life of those depreciable items. And what I'm saying is, in this guidance, I've made an assumption as to what the overall premium is for the entire earn out, and I've assumed how much is amortized in the income statement so that with all of those things, we're saying we're going to be break even for the fourth quarter.

Okay. And then, your press release, when -- I think you said it should be accretive to 2012.

Yes, we did.

Okay.

And we feel the same now.

Okay. And then, just last question on CDC - you talk how it's a rapidly growing company, only eight years old. So, that would make sense, obviously, given their revenue run rate. Can you just maybe give us an idea of how fast they grew the last -- their most recent year?

The -- I don't have the numbers in front of me, but I believe it was probably in the neighborhood of 35%.

Okay. Thanks so much.

Appreciate it.

Next question comes from Chris Quilty from Raymond James. Your line is open.

Thank you. Good evening, gentlemen. Just a clarification if I can on the price competition - was that kind of across the board in the bar code point of sale business on the products, or was it specifically in the large deal activity?

Yes, Chris, Mike here. It was big deal oriented. It was primarily bar coded POS North America.

Okay.

You got it.

So, just to follow up on the acquisition, are there any other sort of one time costs we should see in the third quarter?

In our fourth quarter or the third quarter?

Sorry - in your fourth quarter.

We -- whatever one time costs we have are baked into that break even forecast.

Okay. And the -- if we look at the acquired revenue contribution, you gave the--last year's run rate, and it looks like the company's been growing 35 percent in the last year. Presumably, your full year forecast on a go forward basis in terms of contribution for the quarter is assuming that they're growing at some kind of a like growth rate, or there are reasons to believe that it might slow down for any reason in the year ahead.

Well, I think, Chris -- this is Mike -- I'm not sure we have enough visibility yet in the years ago. But, we believe that the combination of CDC and ScanSource will do a couple of things for us. One, if some of the vendors that have already been working with CDC that we also share, whether it's in North America or Europe, were excited to see that ScanSource and CDC got together, they believe -- these vendors believe that now, there's more opportunity available for CDC ScanSource in Brazil. So, we expect the vendors, because of their support of this transaction, to actually help us grow at similar rates going forward.

What we don't know yet is some of the other vendors, what their trajectories are. There's a couple of new vendors for us down there. And so, we have to get more comfortable with their strategies for that marketplace. But, as everybody knows, Brazil's a fast growing market in itself. There's a lot of opportunity ahead, and we expect to participate in that and remain the dominant player in that marketplace.

Okay. And in terms of the margin structure of CDC, is it similar margins or higher margin business in general?

Well, in our international businesses, we have traditionally had higher margins. We've traditionally had higher gross margins and higher SG&A to reflect the difference in the approach in those markets versus the US and North America. So, I would say it's following the similar trajectories that we had in Europe, and I think it'll be very similar.

Okay.

The difference being they're already at mature operating profits.

And are there any natural synergies that you can bring to the table in terms of your buying power relative to what they had been able to garner that you can naturally flow through the business to get even higher margins?

We haven't forecasted that. I believe the strategy that we'll take will be to make sure this unit has the right value added services for that market. But, as Rich said, they already know that market pretty well. So, I don't -- I'm not forecasting any synergies of any significance at this point. I think it's more the financial balance sheet that we're bringing to that marketplace, which is something they didn't have, frankly. So, I believe our financial strength will reassure any vendors that might have been somewhat hesitant to allow them to continue to grow as a typical privately funded distribution company where you need a lot of cash to grow. They were getting to that point where they needed to have someone to assist them to make the vendors -- help the vendors become comfortable with their growth trajectory. And I think we will do that. So, I think that's where the synergy is is their ability to leverage the ScanSource balance sheet.

Okay. And I think you mentioned that you did not experience any problems or product shortages due to the Japanese earthquake and tsunami. Have any of your vendors indicated that they might experience some problems on a go forward basis, or do you think it's just a non-event for you?

Well, I think, right now, we're at this point where, so far, no impact. But, we have heard -- as we went through our quarterly business reviews, we heard in some cases vendors seen taking actions ahead of any problems. So, it'll be interesting to see if they're able to do that. So, clearly, some of our vendors have sourced products traditionally in Japan, and they're lining up alternative suppliers today, is what I would say, Chris. But, right now, we're not forecasting any problems in the June quarter.

Okay. And you mentioned Sony Security products that they narrowed down to three two tier distributors. Do you know how many they had previously?

About 23.

Oh, wow. So, that's a big change.

Yes, that's why I called it out. This was -- this is one of those times that we saw in our other businesses as we entered them that have been slower coming in our security businesses, the maturity of the vendors and their programs and the recognition that if you're going to use two tier distribution, you don't need a lot of them. And so, we're excited about this. This is recognition of the value of two tier to the vendor and the commitment to ScanSource.

I'd say it's a testament to you guys, given that you haven't necessarily been in the business, I'm sure, as long as many of those competitors. Do you think this might set off any kind of a broader trend within the industry that our vendors might look at?

Well, we're hoping so, for sure. Panasonic did something similar about maybe three years ago now. And so, they were probably our first vendor. The other one that has used -- that's been visible with using fewer distributors is [Axis]. So, essentially now, these companies are some of the faster growing vendors. And so, I think they're able to digest some of these pretty dramatic changes when they're growing, and they can kind of afford to rock the boat somewhat. So, we really give them a lot of credit for doing that, and we certainly hope other vendors will take note.

Great. All right. Thanks, guys. Great results.

Thank you, Chris. Appreciate it.

Our last question comes from Keith Housum from Northcoast Research. Your line is open.

Thanks. Thanks, gentlemen, for taking my call. A few questions for you - with the rising gas prices around the world, is there any expectation that that may affect gross margins at all in terms of your shipping costs?

Well, one of the things that we have always looked at, and we had to do this back in 2008 when we saw fuel surcharges coming to us, is look to see how much of that we can absorb in our normal model. Traditionally, distributors pass on the cost of freight to our resellers.

In some of our business units, in some of our markets, we subsidize some of the freight. So, we're certainly watching it right now to see if there's a point to where we will be asking our customers to participate. But, right now, our stance is that we're not doing that. And so, there is some slight degradation in our profitability because of that, for sure, but not at the point where we're stopping to assess -- to make a determination today that we're going to pass this onto our customers. So, we feel fine with it today, but that certainly could change.

Okay, thanks. And then, in terms of the tax rate, I noticed this quarter came in at about 34%, which appears a little bit lower than your most quarters. How should we think about your tax rate going forward?

Yes, if -- when I would look at modeling the next quarter, I'd be looking at more of the 35.5% tax rate for that -- the fourth quarter.

Okay. Okay, that's helpful. And then, finally, I think you guys have said in the past that most of your -- like 80%, 85% of your sales come from your top 20 vendors. Do you see a trend at all toward the next tier, I guess your 20 through 40 vendors, are those picking up at all, or is it still along the same trajectory of most your sales from the top 20 guys?

Well, I think what we saw in this past quarter was there was a better mix, if you will, better meaning that some of the smaller guys who don't participate in some of the big deals probably had better performance for us. And that's kind of the way it's always happened. So, our top 10 or 15 vendors typically are the vendors that you drive these big deals we referenced earlier through, and it's their products that these are around, whereas the smaller vendors, in a lot of cases, they have traditional what we would call run rate business. And that business was very good for us in the quarter. So, we felt good about that.

Okay, great. Thank you very much.

Appreciate it.

We show no further questions at this time.

Thank you, [Tamara]. Thank you for joining us. Our next conference call to discuss the June 30th year-end results is expected to be on August 18th, 2011. Thank you very much.

That concludes today's call. Thank you for participating. You may disconnect at this time.