Scansource Inc (SCSC) 2013 Q4 法說會逐字稿

Welcome to the ScanSource Quarterly and Year End Earnings Conference Call. All lines have been placed in listen-only mode until the question-and-answer session.

Today's call is being recorded. If anyone has any objections, you may disconnect at this time.

I would now like to turn the call over to Mary Gentry, Treasurer and Director of Investor Relations. Ma'am, you may begin.

Thank you, and welcome to ScanSource's earnings conference call for the quarter and year ended June 30, 2013. With me today are Charlie Mathis, our CFO, and Mike Baur, our CEO. We will review operating results for the quarter, and then take your questions. A slide presentation that accompanies our comments and webcast is posted in the Investor Relations section of our website.

Certain statements made on this call will be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from such statements. These risks and uncertainties include, but are not limited to, those factors identified in the release and in ScanSource's SEC filings. Any forward-looking statements represent our views only as of today, and should not be relied upon as representing our views as of any subsequent date. ScanSource undertakes no duty to update any forward-looking statements to actual results or changes in expectations. We will be discussing both GAAP and non-GAAP results during our call, and have provided reconciliations between these amounts in our Press Release, which can be found on our website and has also been filed with our Form 8-K.

Mike Baur will now begin our discussion with an overview of the quarterly results.

Thanks Mary, and thank you for joining us today.

For the fourth quarter of 2013, we reported net sales of $713 million, which was below our expected range. We had a diluted EPS loss of $0.48, including impairment charges for our ERP project and for goodwill in Brazil and Europe communications, which we will discuss later in this call. Excluding these non-cash impairment charges, our adjusted diluted EPS totaled $0.71 per share, higher than our expected range. Charlie will go into more detail on the numbers in a minute.

The overall story for our weaker revenue versus our expectation was a lack of big deals in our Barcode and POS business, and weaker than planned sales from our Catalyst business. We had lower big deals due to delays in purchasing decisions from end users, and larger projects being broken into smaller ones. In Catalyst, we had good sequential growth from the March quarter. However, our expectations for stronger growth from our Avaya Enterprise business fell short. While our overall sales missed our plan, we had record sales quarters for ScanSource Communications in North America, our Security business unit, and our Barcode and POS business in Mexico. And it was our second best sales quarter in Brazil, as measured in local currency, since our April 2011 acquisition of CDC Brazil.

As we discussed last quarter, our vendor incentive programs are very dependent on revenue growth. With the weaker demand for products, we have experienced vendor program targets that are difficult to reach. We anticipate these targets continuing to stay above our ability to maximize our incentives. Because we've always managed our business to ROIC targets, and knowing that our gross margins are under pressure from the lack of consistent vendor programs, we have begun pulling the other levers available to us that affect ROIC.

So during this quarter and last quarter, we made decisions to reduce our inventory levels with certain product lines where we have reduced profitability. These efforts by our merchandising teams resulted in faster inventory turns for almost every business unit, without sacrificing fill rates to our customers. This was our best quarter all year for inventory turns. In addition, we have focused on managing our headcount to match the value-added services we are being paid for by our customers.

We ended our fiscal year with a fourth quarter return on invested capital of 17.2%, excluding the impairment charges. This represents a sequential increase from 13.3% for the third quarter, and reflects higher margins, better working capital management, and our focus on value added growth.

We announced a new management structure that became effective July 1st to enhance our worldwide technology markets focus and our growth strategy. With this structure, which you can see on slide 4, we changed from a geography focus to a technology focus to leverage our leadership in specific technology markets. We believe this change in structure will also provide more resources and experience to our international markets, as we believe the growth opportunities are still there.

Buck Baker was promoted to President for our Worldwide Barcode and Security Segment, which includes our POS and barcode, and our Security business units. Buck is an 18-year veteran of the Company, and has recently returned from a six-month assignment in Europe where he did a great job coaching our Barcode-POS and our Communications management teams. Buck spent time previously in our North America Communications, and our Barcode-POS business units.

Mike Ferney was promoted to President for our Worldwide Communications and Services Segment, which includes our Communications business units, ScanSource Catalyst, and ScanSource Services Group. Mike has been with the Company for 15 years, and has recently been leading the Catalyst Team with John Gaillard. Before that, he was a key executive in the North American Communications unit.

All of our key vendors and customers are very familiar with Buck and Mike, and we expect both of them to provide strategic vision, establish consistent operational metrics, and provide leadership to our teams. This new structure provides great opportunities to share best practices among our technology teams, and leverage our size and experience to deliver more value to our vendor and reseller partners in our existing markets. We expect to grow our top line revenue, and gain operational efficiencies with this new structure.

Now let me comment on the $28.2 million non-cash impairment charge that we took for our ERP project. Since fiscal year 2009, we've been working on the development of a standardized ERP system using the Microsoft Dynamics AX-based ERP software. We have not implemented this ERP software. In January 2013, we filed a lawsuit against our former ERP software systems integrator, Avanade. The lawsuit alleges, among other things, fraud, misrepresentations, and breach of contract, and we are seeking recovery of damages. We engaged Tata Consultancy Services, TCS, to replace Avanade. In March, TCS presented a plan and had the costs to complete the project approaching the $72 million upper end of our previously disclosed total project cost with no assurance that the system would be successful.

In April, we moved significant number of ScanSource team members who were working on the project, the ERP project, back into our business roles while we evaluated our next steps. In the current quarter, the ERP team has been focused on working with Microsoft on alternative options to facilitate completion of the project. In addition, the ERP team met with other software vendors for an understanding of how their software could meet the needs of the Company. In connection with the preparation and review of the financial statements for the year ended June 30, 2013, we reviewed the project and decided not to move forward with Microsoft Dynamics AX. While we have impaired our Dynamics ERP software, we remain committed to the implementation of a new ERP system. We are currently evaluating our alternatives for next steps. Meanwhile, our legacy ERP systems continue to run our business successfully.

With that, I'll now turn the call over to Charlie to discuss our fourth-quarter financial results in more detail.

Thanks Mike, and good afternoon everyone.

As you heard Mike talk about the changes in the organization structure, let me add that I will be discussing the financials related to these organization changes through our two new reporting segments, Barcode and Security, and Communications and Services, rather than the geographic segments previously used. The information can also be found in our Press Release and the accompanying slide presentation starting on slide 8, as well as in the annual 10-K, which we will file next week.

Barcode and Security combines our most mature business unit, POS and Barcode, with our fastest-growing unit, Security. Also, you can see from the slides that Communication and Services has consistently delivered higher operating margins, and understand why we continued our investment in Europe, changed our organization structure in order to expand communications business in other geographies, so as they can perform very well if executed effectively. Also, I will be covering a lot of the financial information for the quarter and full-year related to these new segments, and again this information can be found starting on slide 8 through 11 in the presentation.

We generated worldwide sales of $713 million in the fourth quarter 2013, a decrease of 6% from the prior year, and an increase of 4% over the March quarter. For the full year, worldwide sales declined 4.6% to $2.9 billion in fiscal year 2013 from $3 billion in fiscal year 2012. In the fourth quarter 2013, sales for our Barcode and Security segment were $445 million, or a 2% decrease from the prior-year quarter. Year-over-year, Worldwide Barcode and Security sales were basically flat, and increased 1.4% excluding the impact of foreign exchange.

Turning to our new Communications and Services segment, sales decreased 11% from the prior-year quarter to $268 million. As a reminder, our distribution agreement with Juniper Networks ended in September 2012, and Juniper sales represented approximately $32 million in net sales in the fourth quarter 2012. Year-over-year, worldwide sales of the Communications and Services segment decreased $129 million, largely as a result of the Juniper vendor termination.

Turning to the gross margin. In the fourth quarter 2013, the overall gross margin increased to 10.62% or an 83 basis point improvement from the June 2012 quarter, and 54 basis points sequentially. The fourth quarter 2013 gross profit margin was better than expected, largely due to our European operations. Although we do not expect to maintain this gross margin going forward, as you know, we have put a lot of resources and focus on Europe over the last couple of quarters. We had higher gross profit margins for our European business units from the favorable resolution of several inventory aging issues, and certain adjustments related to timing and vendor programs. In addition, we had a favorable product mix and better attainment of vendor programs that contributed to a higher gross profit margin in ScanSource Catalyst versus the prior year's margin. Although we were pleased with the results, again, let me emphasize the gross margins are higher than we would expect going forward.

For the full year, gross margins for 2013 were 10.2% compared to 10% for 2012. We are also pleased about attaining this double digit gross margin on a full-year basis.

Turning to slides 8 and 9, our Worldwide Barcode and Security segment reported gross margin for the fourth quarter 2013 of 9.7% compared to 9.4% for the prior-year quarter. For the full year, our Worldwide Barcode and Security segment reported gross margins of 9.2% for both 2013 and 2012. Our Worldwide Communications and Services segment, which you can see on slides 10 and 11, reported gross margins of 12.1% for the quarter compared to 10.4% for the prior quarter 2012. For the full year, our Worldwide Communications and Services segment reported gross margins of 11.9% for 2013 compared to 11.3% for the fiscal year 2012.

Now moving to SG&A expense. For the fourth quarter, and excluding the impairment charges, SG&A expenses in the current quarter totaled $46.8 million compared to $46.6 million in the prior year, and $47.9 million in the sequential quarter. The decline from the sequential quarter was driven by lower ERP expenses as expected, lower executive compensation, as well as a reduction in bad debt expense. This bad debt expense reduction was important, because at the same time we were able to reduce our exposure in Venezuela to approximately $500,000. Expenses for the fourth quarter included a charge for ERP impairment of $28.2 million as Mike discussed previously.

In addition, we performed our goodwill impairment testing as of June 30, 2013. In two of our reporting units, it was determined that the book value exceeded the fair value, primarily as a result of lower projected earnings and cash flow forecast. Accordingly, we recorded a non-cash charge for goodwill impairment of $5.4 million for our European Communications reporting unit, and $15.1 million for our Brazil POS and Barcode reporting unit. After the goodwill impairment, our European Communication reporting unit had no remaining goodwill, and our Brazil POS and Barcode reporting unit had approximately $3 million in goodwill at June 30, 2013.

As a reminder, our Brazil acquisition was structured as an upfront cash payment, with five annual earn out payments through 2015. The goodwill we recorded at the time of the acquisition was partially based on estimated future earn out payments. The actual earn out payments we made are significantly lower than those forecast at the time of the acquisition. The amount of expense that has been recorded on the fair value contingency consideration line in our P&L over the last nine quarters is also significantly lower than would have been otherwise.

As a case in point in the fourth quarter 2012, we recorded a fair value adjustment gain of $1.1 million. For the fourth quarter 2013, the fair value adjustment was a loss of $447,000. Now going forward assuming no changes to the current forecast, we would expect a fair value adjustment each quarter of approximately $700,000, though this can fluctuate based on the assumed discount rate, foreign exchange changes, and other factors. Despite the non-cash impairment goodwill for the quarter, we still maintain that we made an excellent investment in Brazil, with an excellent management team, and with an earn out structure that has done what it was intended to do.

For the full year, SG&A expense year-over-year were 6.6% of sales in 2013 compared to 6.2% of sales in 2012. The increase in SG&A expenses were largely the result of higher bad debt expense and one-time charges related to our European operations, offset somewhat by lower overall headcount.

Turning now to the operating income for the fourth quarter. With the non-cash impairment charges, we had an operating loss in the current quarter of $20.4 million, down from operating income at $28.3 million in the prior-year quarter, and $20.8 million in the sequential quarter. Excluding the impact of impairment charges for ERP and goodwill mentioned previously, non-GAAP operating income was $28.4 million or 4% operating income margin, compared to 3.8% in the prior year and 3% in the March quarter. Excluding the impact of non-cash impairment and one-time Belgian compliance charges for the full year 2013, non-GAAP operating income was $101.9 million compared to $113.5 million in the prior year of 2012.

Next let me turn to the reporting segments operating margins for the fourth quarter. Excluding the impact of Brazil POS and Barcode's goodwill impairment of $15.1 million, adjusted operating income for the Barcode/Security segment for the 2013 June quarter was $13.5 million or 3% operating income, down from $17.2 million and 3.8% operating income margin in the prior quarter of 2012. The decrease in operating income for Barcode/Security for the quarter is primarily due to an increase in bad debt expense, and the fair value adjustment for contingent consideration in Brazil.

Excluding the impact of European Communication's goodwill impairment charge of $5.4 million, for the current quarter the Communications/Services segment had non-GAAP operating income of $14.9 million, and adjusted operating income margin of 5.6%, compared to $11.1 million operating income and 3.7% operating margin in the prior-year quarter. The increase in this segment is due to higher gross margins, as previously discussed, lower bad debt expenses, and lower inventory reserves.

For the full year, excluding the impact of $15.1 million related to Brazil POS and Barcode goodwill impairment, non-GAAP operating income for the Barcode and Security segment for fiscal year 2013 was $49.8 million or 2.7% operating income margin, compared to $56.7 million or a 3.1% operating margin in fiscal year 2012. The change in operating income is primarily due to costs associated with the Belgian tax compliance issues and higher bad debt expenses, particularly in Latin America.

Excluding the impact of $5.4 million related to European Communications goodwill impairment, non-GAAP operating income for the Communications segment for fiscal year 2013 was $50 million or 4.8% operating margin, compared to $56.8 million and 4.8% operating margin in fiscal year 2012. The decrease in operating income dollars is primarily the result of lower gross margin dollars resulting from lower sales in fiscal year 2013, and the effect of ScanSource Europe restructuring costs.

Interest expense was $419,000 for the quarter, and interest income was $590,000. For the full year 2013, interest expense was $775,000 compared to $1.6 million in 2012, due to higher cash balances and lower borrowings. The effective tax rate was 32.3% this quarter, compared to 30.9% in the prior-year quarter, and 34.6% for fiscal 2013 compared to 33.2% in fiscal 2012. We expect the fiscal year 2014 effective tax rate to range from 34% to 35%.

Excluding the impairment charges of $48.7 million, our return on invested capital totaled 17.2% for the quarter, compared to 18.1%, and 13.3% in the prior-year and sequential quarters respectively. Full the full year, our ROIC for 2013 was 16%, compared to 17.2% in 2012. Diluted earnings per share was a loss of $0.48 for the fourth quarter, excluding ERP goodwill impairment charges during the quarter of $18 million and $15.2 million net of taxes respectively, non-GAAP diluted earnings per share was $0.71, compared to $0.71 and $0.50 for the prior-year and sequential quarters respectively. On a full-year basis, diluted earnings per share were $1.24 in 2013. Excluding the impairment charges and one-time charges associated with Belgian tax compliance, adjusted net income on a non-GAAP basis was $2.47, compared to $2.68 in full year 2012.

Moving to the balance sheet, and you can see this on slide 12 of the presentation. Cash and cash equivalents on hand totaled $148.2 million at the end of the quarter, compared to $29.2 million at June 30, 2012. Our day sales outstanding, DSO, was consistent with the prior year and sequential quarter at 55 days. Inventory turned 6.2 times during the quarter, compared to 5.4 times in the prior year and sequential quarters. We had 5.7 paid for inventory days at the end of June 2013, versus 9 and 13.5 days for the prior year and sequential quarters respectively. Paid for inventory days are down from prior periods, primarily due to lower inventory levels. We reduced inventory levels by $15 million during the quarter, and $85 million for the full year.

The Company held $5.4 million of interest-bearing debt as of June 30, 2013, compared to $9.7 million at June 30, 2012. Average debt for June 2013 quarter decreased to $5.4 million, from $41.3 million in the June 2012 quarter. Our balance sheet is exceptionally strong, and we generated $53 million in cash from operations during the fourth quarter of 2013, and approximately $129 million for the full year. The Company will continue to focus on ROIC and its variables as our key performance metric going forward.

With that, I'll turn it back over to Mike.

Thanks Charlie.

I'll start with our Worldwide Barcode and Security segment summarized on slide 13, which represents 62% of overall sales for the quarter. Worldwide Barcode and Security sales of $445 million increased 2% sequentially, and decreased 2% year-over-year. Net sales for our POS and Barcode business units in North America and Europe declined year over year, principally from lower big deals. But the number and the average size of the big deals decreased, as end users rolled out projects more slowly, and vendors took some larger deals direct. In addition, we saw softness in the mobility market as end users delayed purchasing decisions given heightened uncertainty surrounding macro economic conditions, new operating systems, and the availability of new devices.

Our POS and Barcode units also faced a more aggressive competitive landscape, including pricing and credit terms. Despite this, in North America, the number of active customers increased, and we had good year-over-year growth with our small and midsize vendors. We recently added two new vendors, Code and J2.

Brazil outperformed the market this quarter, with double-digit, year-over -year, and quarter-over-quarter sales growth in local currency, despite an uncertain economic climate. This quarter was the second highest since the acquisition of CDC in 2011. Brazil continues to be profitable, with good gross margins, even with lower growth rates than previously forecasted. Our management team has done a very good job of managing operating expenses to our current run rate of business. We remain positive on our business there, and expect to continue to get strong support for our value-added model from the market.

While results in Latin America varied country by country during the quarter, in Mexico, we had a record sales quarter where we benefited from a stronger economy, and good vendor support. Struggles related to the economic and political climate in Venezuela continued, including the scarcity of US dollars to make payments.

We have assigned one of our Senior Executives, Yvette McKenzie, to work with our LA team in Miami. She has been implementing best practices and sharing resources from our North America operations to better streamline our Business, and manage the Latin American business for growth.

Our Security business in the US and Canada had a record sales quarter, with double-digit growth driven by the Cisco Physical Security business and a record networking quarter. We had record quarters with Cisco, Ruckus, Panasonic, Sony, Exact, Samsung, and March Network. Panasonic continues to see value in the ScanSource Security business model, and recently reduced the number of distributors.

The June quarter is a seasonally strong quarter for our Security business, and we had another record big deal quarter with lots of school projects. Our customer count continues to expand, and we are starting to win deals with the large national security integrators. Security continues to be a growth initiative for us, and market trends point to continued growth opportunities. In July, we added Pivot3 as a new vendor, and recently signed Speco, a leader in analog cameras, as well as cameras as a new national contract with Bosch for its Advantage line. We are adding salespeople to this business unit to continue our momentum, and gain market share.

Now turning to our Worldwide Communications and Services segment on slide 14, which is 38% of overall sales this quarter, Worldwide Communications and Services net sales of $268 million increased 9% sequentially, but declined $32 million year-over-year or 11%. ScanSource Communications in North America had record sales quarter, led by record quarters with Polycom Voice, ShoreTel, Sonus, and Chief. Big deals were up both year-over-year and quarter-over-quarter. We also achieved our ShoreTel new reseller launch goal, including good revenue growth from our new resellers that we've recruited over the past year.

ScanSource Catalyst sales declined year-over-year, but they grew on a sequential basis over 10%. We missed our sales plan for this unit, as Avaya enterprise sales did not grow as much as we had expected. However, we had good growth with Avaya IP Office, and Avaya Data Networking. Over the last two quarters, we've been seeing more big deals, though they are still lower than a year ago. It is still a cautious spending environment, particularly for enterprise big deals. We had another quarter of double-digit growth with our wireless vendors, including a record Aruba quarter.

In June, we successfully launched the Cisco collaboration products, formerly the TANDBERG products, providing value-added distribution for the existing channel and recruiting new resellers to the Cisco story. We would expect our Cisco collaboration sales to build at a measured pace throughout the year, as customers become aware of our offers and experience, and experience the Catalyst value-added advantages in this space. We believe our growth opportunity with Cisco is great, and we want to make sure we are winning customers due to our value-added services. We have introduced a Catalyst collaboration tool to help our customers with their Cisco configurations. Our services group has rolled out a suite of Cisco network readiness services, and we have an added enablement specialist to assist in the onboarding of new Cisco collaboration resellers.

ScanSource Communications in Europe had its lowest sale quarter this year, principally from lower big deal volume in Germany. We had a good sales quarter in the UK, our second best quarter ever, driven primarily by small and midsize business growth. In April, as you may recall, we took steps to better align the cost structure of this business unit at the appropriate scale. Following our restructuring, we have reorganized our go-to-market strategy, and committed to bringing best practices from our successful North America team to Europe. We are focused on our key vendor partners, and have built a sales plan for growth and profitability.

Our newest business unit, ScanSource Services Group, provides education and training, network assessments, custom configuration, marketing, and our SUMO partnership community principally in North America. ScanSource Services Group exceeded its plan in all areas, including a record quarter for our Custom Configuration Center. As an authorized training partner for Avaya, Polycom, and ShoreTel, we added more classes including a new Avaya enterprise class and launched virtual services. As I mentioned earlier, the new Cisco services are an additional opportunity for revenue, and to assist in selling more Cisco hardware and software.

Turning now to our next fiscal quarter, we believe net sales for the quarter ended September 30, 2013 could range from $715 million to $735 million, and our earnings-per-share could range from $0.56 to $0.58 per diluted share.

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

Thank you.

(Operator Instructions )

Dominic [Rusella] with Northcoast Research.

Hello guys. I'm sitting in on the call for Keith Housum. Thank you for your time. Just to start us off here, I've heard you mention this about that inventory levels have been low. We're just wondering what you guys see in that area going forward, and what any type of impact that you can expect in the business?

Yes, hello Dominic. It was our plan to have inventory levels to match the programs and the margins that we're receiving from certain vendors. And so, we felt like we could reduce our inventory levels, but not affect our fill rates to our customers. And we believe we came through the June quarter successfully doing that. We started this effort back in the March quarter, and we do these inventory planning programs cooperatively with our vendors so that we don't surprise their teams. We don't want to upset their supply-chain, so we believe that it was a good business decision for us, and frankly our vendors at this stage understand it. So our goal would be to keep inventory levels at similar levels as they are now, but we are prepared to increase them based on sales opportunities.

Perfect. Thank you very much. And then the next question, in terms of the macro overall environment and how it effects your business, do you guys see that improving at all going forward? Is there anything in particular that you guys have noticed that would point to any signs of where we can expect that to be over the next quarter?

Well I think relative to that, our sense right now is our run rate business, which is our small to medium type customers and transactions not the big deals, so the regular run rate business continues to be steady and strong. It's the lack of large opportunities that's really causing us some concern, and that really haven't materialized this year like we thought. So when we talk to our key vendors, either those customers, as I indicated earlier, are not buying right now. They're on the fence or they're holding. Or they're taking those large deals and they're splitting them up into smaller transactions. And in some cases, because ScanSource is the leader in most of our markets, we have the largest amount of big deals compared to our other distributor competitors. So the reduction in large big deals probably has hurt us more, but we believe in the normal run rate business we're still maintaining strong market share.

Okay. Great. Thank you very much. And then, just a last question while we're here. We noticed the cash flows have been growing pretty consistently. Do you guys have any specific plans for that cash, or has that just been through normal course of business?

Yes, this is Charlie here. I'll take that one. So yes, the cash balances has grown through the year, and we continue to look for ways to deploy the cash to profitably grow the business. The Company has historically made acquisitions over the last 20 years, and so we'll continue to look for those opportunities and use of the cash to profitably grow the business.

Okay. All right. Well that will take care of it for me. Thank you very much.

Thanks Dominic. Take care.

(Operator Instructions )

And at this time I show no further questions.

Okay. Thank you Kim. Thank you for joining us today. Our next conference call to discuss our September 30th quarterly earnings is expected to be on October 24th, 2013.

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