Scansource Inc (SCSC) 2017 Q2 法說會逐字稿

Welcome to the ScanSource quarterly earnings conference call. (Operator Instructions.) 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, Vice President, Treasurer and Investor Relations. Ma'am, you may begin.

Thank you, and welcome to ScanSource's earnings conference call for the quarter ended December 31, 2016. With me today are Mike Baur, our CEO, and Gerald Lyons, our interim CFO. We will review our 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, including our expectations for the third quarter and full year, will be forward-looking statements. 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 earnings release that we put out today and in ScanSource's 10-K and 10-Q as filed with the SEC.

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 disclaims any duty to update any forward-looking statements to reflect actual results or changes in expectations, except as required by law.

We will be discussing both GAAP and non-GAAP results during our call and have provided reconciliations between these amounts in our slide presentation and in our press release. These reconciliations also can be found on our website and have been filed with our Form 8-K.

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

Thanks, Mary, and thank you for joining us today. We delivered stronger-than-expected bottom line results in the second quarter. GAAP diluted EPS of $0.91 and non-GAAP diluted EPS of $0.75 exceeded the upper end of our forecast. Higher gross margins in both segments contributed to our EPS upside.

Net sales of $905 million fell below our forecast range, primarily in our worldwide barcode, networking, and security segment. We missed our sales forecast for two main reasons. First, a couple of anticipated big deals for ScanSource KBZ were delayed, and second, we had unusual supply constraints in multiple geographies. However, our outlook midpoint for the third quarter reflects a return to year-over-year organic sales growth for both segments.

We earned a 10.9% gross margin the second quarter, which includes the first full quarter of Intelisys results. Excluding Intelisys, the gross margin blended to above 10% from an increased mix of higher-margin sales.

Our Intelisys business unit is doing very well, and it's an excellent example of our strategic plan to invest in high-margin recurring revenue opportunities. Intelisys achieved record net sales for the quarter, growing more than 20% over the prior year. Importantly, our team sees exciting channel growth opportunities ahead from our telecommunications, cable, and cloud services providers, and we are continuing to invest in resources for this business.

In January, Avaya filed voluntary petitions under Chapter 11 of the US Bankruptcy Code to restructure its balance sheet to better position the company for the future. We are committed to supporting Avaya and our partners, and it is business as usual. We have seen no disruption in our support and resources from Avaya.

Now let me talk about key opportunities for growth for 2017. They include the following. First, we expect growth in our physical security business from market growth in video surveillance and the expansion of our line card. Second, we plan for growth in our Cisco collaboration business, and also our ZCare offering. And third, ScanSource Communications is executing a strategy to recruit and support VARs currently buying from our vendors direct.

As we indicated last quarter, our strategic plan for the full year of FY17 shows strong growth in adjusted EBITDA compared to FY2016, leading to an improved ROIC for full year FY17. For the second quarter, we delivered a 13.8% return on invested capital with improved margins and sequential EPS growth.

With that, I'll turn the call over to Gerry to discuss our financial results in more detail.

Thanks, Mike. We are very pleased to deliver stronger-than-expected profitability and EPS performance for the second quarter. On the profitability side, we exceeded our gross margin forecasts and our operating income forecast.

Our GAAP diluted EPS results of $0.91 per share and non-GAAP EPS results of $0.75 per share are summarized on Slide 4. Our GAAP results include $12.8 million, pre-tax, or a $0.32-per-share benefit from a confidential legal settlement, which is recorded on the income statement in other income. We view this settlement as a one-time item, and it is not expected to impact our business operations going forward.

As Mike indicated, the net sales for the second quarter decreased 9% to $905 million. The majority of this decrease was in the worldwide barcode, networking, and security segment. And as a reminder, our December 2015 quarter included an unusually large $38 million government deal.

Our second quarter 2017 gross profit margin was 10.9%, higher than the sequential and prior-year quarters. The margin reflects the addition of Intelisys results for a full quarter and an increased mix of higher-margin sales. This included higher margins for our international business. And on Slide 5 and 6, you can see our current quarter, sequential quarter, and prior-year quarter margins by segment. For both segments, second quarter 2017 gross margins came in stronger than our forecast.

SG&A expenses, excluding the amortization of intangible assets and acquisition costs, increased $4.6 million from the prior-year quarter to $69 million for the second quarter of 2017. This increase reflects the addition of Intelisys, which was not in the prior-year quarter, and additional investments, including headcount, to support key initiatives in our strategic plan. These investments support the growth opportunities that Mike described earlier.

Our second quarter 2017 non-GAAP operating income was $29.6 million, or 3.3% of net sales, compared to $36 million, or 3.7%, in the prior-year quarter. Sequentially, non-GAAP operating income improved from $26.7 million, or 2.9% of sales.

We have a $111 million contingent consideration on our December 31, 2016, balance sheet, reflecting the present value of expected future earn-out payments for our acquisitions of Intelisys, which occurred in September 2016, and Network1, which occurred in January 2015. For the second quarter 2017, we recorded a loss for the increase in fair value of contingent consideration of $1.8 million. For third quarter 2017 forecast, we estimate the change in fair value of contingent consideration to be a loss of approximately $3.7 million.

Our effective tax rate was 35.6% for the second quarter 2017 and 34.7% for the prior-year period. For the FY17 forecast, we're using 35.3% effective tax rate. The tax rate for the quarter is higher than the full-year rate due to a higher mix of income in the United States, including the legal settlement. Second quarter 2017 GAAP diluted EPS of $0.91 increased both year over year and sequentially, while non-GAAP diluted EPS of $0.75 decreased year over year and increased sequentially. Average diluted shares for second quarter 2017 totaled $25.3 million, down 6% from the earlier period year as a result of share repurchases.

Now shifting to the balance sheet and the capital allocation plan, our working capital, balance sheet and cash flow measures are referenced on Slides 7 and 8 in our presentation. One of the highlights from Slide 8 is $128 million of operating cash flow generated over the last 12 months. Although some of this relates to timing, the business teams have increased working capital efficiency, and we expect continued improvements for the remainder of FY17.

Inventory turns remained at 6 times, and we decreased inventory levels by 10% over the prior quarter and 15% year over year. DSO, excluding Intelisys, came in at 60 days, still higher than our typical range, and primarily reflects the aging of customer-specific accounts in North America and Brazil.

Our balance sheet remains very strong and continues to provide us with the ability to execute our capital allocation plan, which includes organic growth, strategic acquisition, and share repurchases. At December 31, 2016, we had cash and cash equivalents of $45 million and debt of $142 million, for a net debt of $97 million. Our leverage totaled approximately 0.88 times trailing 12-month adjusted EBITDA, and ROIC was 13.8% for the second quarter of 2017. During the quarter we repurchased $3.5 million of shares, and at the end of the quarter, we had approximately $100 million remaining on our share repurchase authorization.

Now turning to our forecast on Slide 9, we've missed our sales forecast range over the last few quarters, primarily from the timing of big deals in ScanSource KBZ. We expect net sales for the third quarter FY17 to range from $800 million to $860 million, and GAAP diluted earnings per share to range from $0.42 per share to $0.49 per share, and non-GAAP diluted earnings per share to range from $0.62 per share to $0.69 per share. The foreign exchange rates used in our forecast are summarized in our presentation slides, and the midpoint of our sales forecast reflects year-over-year low-single-digit organic growth.

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

Thanks, Gerry. We have two reporting segments, and I'll start with worldwide barcode, networking, and security, which represented 66% of overall sales this quarter. Net sales of $595 million decreased 14% from the prior year. Overall, we believe our POS and barcode business has maintained market share. We saw good results with vendor maintenance services contracts, and our customer configuration center offerings continue to see strong demand. ScanSource KBZ had significant competitive wins this quarter and continues to have success with ZCare Services. Extreme Networks completed the acquisition of Zebra's wireless LAN business in October, which led to ScanSource being authorized as an Extreme distributor.

For the quarter, initial results were good. Competition in our wireless and networking business continued as a result of consolidation by certain key vendors, and this led to lower sales for the quarter. As we come out of this consolidation phase, we would expect to grow net sales and improve the profitability of our networking business.

Our physical security business, including video surveillance cameras and video management software, had a strong quarter, with upper-single-digit year-over-year growth and, as I said earlier, we are planning for good growth due to the strength of the video surveillance market and the planned expansion of our line card.

Now to our second segment, worldwide communications and services, which represents 34% of our overall sales. Net sales of $309 million increased 2% from a year ago and 3% from the sequential quarter. This is our first full quarter with Intelisys. We had a great quarter with Intelisys, and they continue to add new sales partners, hire new employees to grow and support sales, and build relationships through events such as Intelisys Mindshare events held throughout the year across the country. The Intelisys team is also developing new programs and marketing plans to recruit ScanSource VARs.

We had good results with many of our unified communications vendors, including our enterprise voice, video, and services business. We had very good results with Barco and Jabra, two vendors who are helping us expand our video and voice solutions. In North America, we had a record big-deal quarter, and we see opportunities to compete in new customer segments to gain market share. In December, ShoreTel named ScanSource Communications as its Value-Added Distributor of the Year.

In Europe, we are working to gain scale as we build out our integration of Imago in our European communications business. We expect to grow revenues as we compete for market share across the UK and Europe. We have strong support from our key vendors in this business unit.

We had a solid quarter for Network1 in Brazil, with good sequential growth from new vendors, including Fortinet, VMware, and Veritas, and from our cyber security vendors. In December, HP recognized Network1 as its Best Value-Added Distributor of 2016 in Brazil. Cisco recently appointed Network1 as a distributor last quarter, and we see tremendous opportunities as we began to sell Cisco in Brazil in calendar year 2017.

We will now open it up for questions.

Thank you. (Operator Instructions.) Keith Housum, Northcoast Research.

Hey, Mike, can you provide a little more color on the delay from the KBZ deals in the quarter and some of the supply constraints? I guess, do you see those issues continuing in the second quarter, or do you see fulfilling both of those issues occurring?

Well, factored into our forecast is a resolution on both of those issues. So in the case of the KBZ deals, this isn't the first time that we've had some of the big deals move around on us. And part of it is we're used to seeing, frankly, the energy behind deals -- big deals that are closing -- happening generally in the same quarter end as ScanSource. And in the KBZ case, our key vendor there has a quarter end that's a month different than ours, as you recall from last quarter and a year ago. So that's part of what's causing this, and that's why our reference was to a delay.

And sitting here now, we're building our forecast based on that business as well as in the supply constraints, which is very unusual. I can't recall the last time we had a supply constraint at ScanSource with any of our suppliers. But there were some unusual situations, and frankly, it was in each of our geographies. And it led to deals that we had expected to happen that did not. And so again, built into the forecast is the resolution of that, too. So it's not an ongoing supply issue.

Okay, great. And then following up with more on Intelisys, can you drill down a little bit further in terms of what was the impact to the gross margin and the operating margin from the Intelisys addition for the quarter?

Sure, Keith, this is Gerry. Without Intelisys, the gross margin was not 10.9%, but 10.1%.

And how about the operating margin?

I don't have that number right in front of me, so I'll have to get back to you on that.

Okay, no worries, no worries. And then, Mike, if I heard right, from the WLAN sale from Zebra to Extreme, it sounds like you didn't miss a beat, then, with the addition of Extreme.

Yes, that's right. That's the reason I called it out, is it was good, good news. We certainly were somewhat worried about it, because it was a change for not only Zebra, Extreme, but also our partners, and we weren't sure how easily it would be for us to move that business over and work under the Zebra team. But both Zebra and Extreme did a great job making sure we got connected with the right people, got the right programs in place. And frankly, yes, it was a real bright spot in that deal. I mean, it's rare to see a deal happen that smoothly.

Great, thanks. I'll jump back in the queue.

Thank you. Adam Tindle, Raymond James.

I just wanted to ask -- you saw a strong recovery in the communications business operating margin. It looks like there's some opportunity in the barcode networking and security business still, which I think, Mike, you alluded to in the prepared comments. If you could just maybe talk about what needs to happen to get back to the mid-2% level that you've seen in the past. And is that something that could happen quickly, or will it take time?

Yes, thanks, Adam. One of the things that we realized, of course, is that we built a business that has capacity, and it's always been our plan to do that, because we want to be prepared whenever our vendors see growth coming. And we've always had a strategy of having either sometimes a little more inventory than we maybe should and a little more headcount than maybe we should. And then what we've said all along is if the vendors don't provide us the margins we need to support that infrastructure, we would de-invest, and you've heard us talk about that in the past.

And so what I was indicating today was we believe that the growth opportunities are there in this business unit and that we have infrastructure and capacity to serve. And so we believe right now, if we improve the volume on the top line with the SG&A we have, Adam, that we can then improve the operating margins to levels similar to what you're describing. I think that's a reasonable place to be, yes -- mid-2.5%. That range would be appropriate.

Got it, makes sense. And then you mentioned expecting solid year-over-year growth in adjusted EBITDA for FY17, which I know you've mentioned on previous calls. Based on results and March guidance, it does imply a very strong June quarter. So just hoping you can maybe expand on what's driving the upswing there and your level of visibility into the implied June quarter. Thanks.

Yes, Adam, this is Gerry. I think, as we said the last time, it's really the addition of Intelisys that's the primary factor that gives us our confidence.

Okay. I was just looking at it from a sequential standpoint and Intelisys being in the business for both the March and June quarters. But it looks like you'd need to have a pretty significant sequential uplift in the June quarter. So I didn't know if maybe there was any programs or backlog or anything that you would point to based on how the June quarter looks like it's lined up.

No, I don't think so, Adam. It's Mike again. If you go back and look at our historical, the March to June is always an increase. And I didn't do that math, because we're not forecasting June today, of course. But it would be normal for us to see an uptick in the business. And the overall indicators that our teams brought us as we reviewed the quarters was that the business overall looks good. And so whether that's in communications or in our barcode segment, we felt good about the initiatives we've got in place.

And I mentioned a couple of things in particular, the physical security business. We think that that does have some renewed growth, and we haven't been talking about that for a while. And as part of that, to take advantage of what the end markets are telling us, we need some vendors that are new to that space that have come out with more competitive offerings. We're going to expand our vendor line card in that physical security space.

And then don't forget, we also said here for a couple of quarters that our Network1 business has new vendors, and we just announced Cisco, but we've also had several vendors that have been on line now for about two or three quarters, and we expect those vendors and those business units to start contributing from that. So that's why June would not be surprising to have a reasonable uptick.

Okay, got it. Thank you and best of luck.

Thank you. (Operator Instructions.) Chris McGinnis, Sidoti and Company.

So I guess just to start off on the gross margin and maybe the -- obviously, I know Intelisys drove the improvement to that. But I guess looking forward, does that contribution, Gerry, I think that you mentioned 10.1% versus 10.9%, should we think about that going forward as that higher margin than the traditional 10% that you target?

Yes, that's right, Chris. That's what we're forecasting for the third quarter, is something very similar to what you saw our results for the second quarter.

Okay, okay, thank you. And then maybe, Mike, if you'd touch on -- you talked about penetrating the VARs.

What's that, Chris? We lost you. Sorry.

Oh, the VARs that you're looking to go after instead of them going direct. Could you just talk maybe a little bit about your strategy?

Yes, sure, yes. So typically in our business, we have had some of our vendors that have always had a reasonable amount of direct VAR business. They call them various things, whether they're one tier or just direct or certain medallions. But we've got a few vendors that have recently started working with us on a plan to -- for different reasons, for their own different reasons -- to encourage those direct VARs to choose a distributor and/or to move into distribution as a choice, but one with a recommendation or a push from the vendor.

So we've got a program in several of these cases where we're having to build some initiatives to make sure that that VAR wants to buy from a distributor versus direct. We don't think it's going to be a difficult conversation, but sometimes those are things that we want to do very carefully. And in the history of the Company, we've always had these opportunities come along. But this is the first time in probably a year or so that we've seen some growth coming from some of these one-tier channels choosing distribution. So that was worth noting this quarter. We see that already starting, and we expect more of that to happen.

Great. And then last, just a question, maybe just on the appetite for acquisitions. Obviously, the Intelisys deal has been seemingly pretty good here. Maybe just the going-forward strategy and appetite.

Well, as we said about our capital allocation plan, number one, we want to support our organic growth; number two, acquisitions. And I would say that as we've talked over the last few months with you guys and our investors, is we really love this idea that there are more services-type, recurring-revenue, high-margin businesses that are similar to Intelisys that would be complementary to our existing hardware business. And that has -- we've identified several; we're not going to talk about them today. But we believe there are other places and other opportunities for the Company that will be complementary to what we're doing, and we'll see those generally happen from acquisition.

I think from our standpoint -- again, we made, I think, 25 acquisitions over the years -- we've always been a believer in acquiring either a core, highly successful, maybe a smaller franchise that has gotten to a point where they can no longer either fund the growth or they would benefit from the scale that ScanSource can bring, and/or it gives us a way to get into some new geographies. So we've always used acquisitions to give us a jump-start, and frankly, reduce the time it takes to get relevant in the market. And I believe right now, there are some windows of opportunity in these services spaces similar to Intelisys for ScanSource to execute on.

Great. Thanks for taking my questions, and good luck in Q3.

Tony Spinola, Wells Fargo.

Hi, it's Andrew Spinola. Mike, could you just walk me through again the part of the segment that had the supply constraints in the quarter was the wireless and networking part of the segment? Is that correct?

Yes, that's right.

And just so I understand it, that would be -- it's one vendor that is having the issues. Is that correct?

No.

It's multiple. So it's not -- so is it a function of something that's going on at ScanSource, or why would it be multiple vendors that were having shortages at the same time? Is it components or -- ?

Well, you could keep guessing, and I'll probably not confirm, but let me try. Let me try. So it was very unusual, as I'm seeing it. I mean, we were surprised that, gosh, in one quarter you could have literally three different reasons why you would have problems in three different geographies. But they are. They're not connected. And it makes no sense, but as you know, ScanSource never lacks for cooperation with vendors on inventory issues or things. So these are things that have happened in the marketplace that were unexpected, obviously. Because we normally have enough supply; with six inventory turns, my gosh, we've got generally plenty of inventory. So it's unusual. We don't believe there's any -- as a matter of fact, we have good visibility that they're not going to continue to happen. And that's why we feel good about our forecast for March.

Got it. Yes, that actually makes quite a bit of sense. Thanks, Mike. The growth rate's bounced around quite a bit in Q1 and Q2. And you did mention a return to organic growth in fiscal Q3. Just thinking about all of the things that it sounds like are being pushed out of fiscal Q2 into fiscal Q3, in general, is this segment seeing organic growth when you adjust for the push-outs? Or is it really just that you've got a bunch more revenue pushing at the Q3?

Well, and just so I could put -- I try to put a little bit of sensibility to it, too. When I think about it, Andrew, is we're still -- the quarter will still be down sequentially on revenue. So if you think about that respect, it's not that unusual, being that the number we've got set up there is not a crazy number. And so for things that are being pushed, for us to know if they're moving or not, if you think about what we said in our prepared remarks, when they're specific to that KBZ unit and there's a timing issue, I can tell you, we've got enough visibility today to know that those will happen. So those are not difficult to guess.

In other years, in other quarters where there's been these push-out delay stuff, we rarely would ever commit to a number that would be in a forecast, not knowing if we then would -- if it got delayed or deferred or lost. So that isn't what these are about. These are very specific deals, large enough to have visibility and large enough for us today to say we have confidence that they'll be in our forecast. We feel good about it. These are unusual, again, and we wanted to call them out.

Yes, no, definitely, understood. And just one last question. I think you mentioned security is growing high single digits. Networking, you just commented on. Is barcode still growing at this point, or how is that business performing for you?

Well, the barcode and POS business for us, for the last few quarters, we've had some quarters where we've had a lot of big deals, and it's been a big-deal, lumpy story. And this quarter, we didn't talk about that. And I think it's one of those where today, there are some opportunities for growth. And this past quarter, there wasn't anything significant that happened in the quarter. And I would have hoped they would have, but they didn't. But our view for the, if you look at the forecast, the midpoint of the forecast, it suggests that there would be at least reasonable sales in the barcode POS, in that segment. But we're saying we're going to have organic growth. It's going to be small, but we're going to have organic growth. So all of the businesses are helping do that.

Perfect. Thanks so much.

Thank you, and I'm showing no further questions. I would now like to turn the call back over to Mike Baur for any further remarks.

Thanks, and thank you for joining us today. We expect to hold our next conference call to discuss March 31 quarterly earnings results on Tuesday, May the 9th, 2017.

Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. Everyone have a great day.