新聚思 (SNX) 2014 Q2 法說會逐字稿

Good afternoon. My name is Sharon and I will be your conference operator today. At this time I would like to welcome everyone to the SYNNEX 2014 second-quarter earnings conference call.

(Operator Instructions)

Today's conference is being recorded. If you have any objections, you may disconnect. Thank you.

At this time, I would like to pass the call over to Ms. Dierdre Skolfield, Director of Investor Relations at SYNNEX Corporation. Ms. Dierdre Skolfield, you may begin your conference.

Thank you, Sharon. Good afternoon and welcome to the SYNNEX Corporation fiscal 2014 second-quarter conference call for the period ended May 31, 2014. Joining us on today's call are Kevin Murai, President and Chief Executive Officer; Dennis Polk, Chief Operating Officer; Marshall Witt, Chief Financial Officer; and Chris Caldwell, Executive Vice President and President of Concentrix Corporation.

Please note that some of the information you'll hear today will consist of forward-looking statements, including without limitation those regarding revenue, net income, EPS, EBITDA, expenses, tax rates, hiring, cash flows, and shareholder value. Actual results or trends could differ materially from our forecast.

For more information, please refer to the risk factors discussed in our Form 10-Q for the fiscal 2014 first quarter and our Form 8-K filed with the SEC today, along with the associated press release. We assume no obligation to update any forward-looking statements which speak as of their respective dates.

Also during this call we will reference certain non-GAAP financial information. Today's earnings release and the related Form 8-K available on our website presents a reconciliation between our non-GAAP and GAAP reporting.

This conference call is the property of SYNNEX Corporation and may not be recorded or rebroadcast without our specific written permission. Now I'd like to turn the call over to Marshall for an update on our financial performance. Marshall?

Thank you, Dierdre. Good afternoon, everyone, and thank you for joining our call today. I will summarize our results of operations and key financial metrics and conclude with guidance for the third quarter of fiscal 2014 before turning the call over to Kevin.

Technology Solutions and Concentrix business segments performed very well in quarter two. Our Q2 revenues, non-GAAP net income and non-GAAP diluted EPS all came in above the high end of the outlook provided in our Q1 call.

Let me share some details behind our fiscal Q2 consolidated performance, starting with revenue. Total revenue was $3.45 billion, up 33% compared to $2.59 billion in the same quarter of the prior year. Technology Solutions segment revenues were strong in the US and Japan and continue to improve in Canada. Revenue was $3.2 billion, up 24% year over year and up 26% on a constant currency basis. Concentrix revenues were $293 million, up 528% year over year due to the IBM CRM acquisition.

Moving on to profitability. Q2 consolidated gross margin was 8.1% compared to 6.0% in Q2 of 2013. The increase was due largely to the impact of the IBM CRM acquisition.

Q2 total selling, general and administrative expenses, excluding one-time acquisition and integration expenses and amortization costs, increased as a percentage of revenue to 5.21% or $180 million. This compares with 3.89% of revenues or $100.9 million in the second quarter of fiscal 2013. The increase was due primarily to the significant increase in Concentrix revenues.

One-time acquisition and integration expenses included in selling, general and administrative expenses were $15.7 million for quarter two. Legal, consulting, retention, stamp duty and VAT comprised the majority of these expenses.

With the completion of Wave 2 closings of the IBM CRM acquisition more than 99% of the overall acquisition has been completed. One-time acquisition and integration expenses during the second half of 2014 are expected to decline.

We continue to expectantly manage costs as we drive flexibility and efficiencies within our support structure as our business grows. We also continue to make significant investments in people and infrastructure to support profitable growth, in both Concentrix and Technology Solutions segments.

Q2 consolidated GAAP income before non-operating items, income taxes, and non-controlling interest increased by over 30% to $68.1 million or 1.97% of revenues, compared to $52 million or 2.01% in the prior-year second quarter. Excluding one-time acquisition and integration expenses and amortization costs, non-GAAP operating income increased over 80% to $99 million, or 2.87% of revenues.

At the segment level, Q2 Technology Solutions' GAAP income before non-operating items, income taxes and non-controlling interest was $70.1 million or 2.2% of revenues, up 44% from the prior-year quarter result of $48.7 million or 1.91% of revenues. For Concentrix, the GAAP loss before non-operating items, income taxes, and non-controlling interest was $2.2 million or a negative 0.74% of Concentrix revenues, compared to operating income of $3.3 million or 6.99% of revenues in the prior year quarter.

The Q2 loss includes $15.7 million in charges related to the IBM CRM acquisition and other integration costs, and $14.3 million in amortization expense. Excluding these charges, non-GAAP operating income for Concentrix in the quarter was $27.8 million or 9.48% of revenues, which is very healthy in light of all of the significant headcount and infrastructure investments beyond the one-time expenses.

Net total interest expense and finance charges for Q2 were $6.2 million, up $1.3 million from the prior-year quarter. The Q2 expense reflects debt associated with the acquisition of the IBM CRM business, which was funded towards the end of January of 2014, and higher working capital needs to fund our profitable business growth.

The tax rate for the second quarter of fiscal 2014 was 35.9% compared to 35.4% in the prior-year quarter. For the remainder of fiscal 2014 we anticipate the annual tax rate to remain in the 35% to 36% range.

On a GAAP basis, our second-quarter net income increased by 29% to $39.6 million, or $1.01 per diluted share. On a non-GAAP basis our second-quarter net income increased over 85% to $59.5 million, or $1.52 per diluted share.

Turning to the balance sheet, our accounts receivable totaled $1.8 billion at May 31, 2014 for a DSO of 48 days, which was up 5 days from the prior-year quarter. Inventory totaled $1.4 billion or 41 days at the end of the second quarter, up 6 days from the second quarter of 2013.

Days payable outstanding was 43 days and net 7 days from the end of the prior-year second quarter. Hence our overall cash conversion cycle for Q2 of 2014 was 46 days, up 4 days from Q2 of 2013 due to the strong growth in both of our business segments.

Our debt-to-capitalization ratio was 38% compared to 18% in the prior-year's quarter and consistent with our expectations. At the end of Q2, between our cash and credit facilities, the Company had over $400 million available to fund growth. The IBM CRM acquisition is expected to generate substantial cash flow in the future.

Other financial data and metrics of note for the second quarter are as follows. Depreciation expense was $9.2 million. Amortization expense was $15.2 million. HP, at approximately 25% of sales, down from 32% a year ago, was the only vendor accounting for more than 10% of sales. The percentage decrease was the effect of the IBM CRM acquisition and other mix changes. HP revenue grew year over year.

Cash capital expenditure for the quarter was approximately $16 million. Annualized ROIC in Q2 of 2014 was 7.2%, including the impact of our acquisition-related expenses.

Trailing four-quarter ROIC was 8.5%, including the impact of our acquisition-related expenses. Excluding the impact of one-time acquisition and integration expenses, the current fiscal quarter's trailing ROIC was 10.4%. Preliminary cash flow used in operations was approximately $200 million for the first half of 2014, and was impacted by strong growth in our Technology Solutions business and the impact of the acquisition of the IBM customer care business.

Now moving to our third-quarter 2014 expectations. We expect revenue to be in the range of $3.3 to $3.4 billion. For non-GAAP net income, the forecast is expected to be in the range of $56.9 to $58.9 million.

Non-GAAP EPS is anticipated to be in the range of $1.45 to $1.50. The non-GAAP net income and non-GAAP EPS guidance excludes acquisition- and integration-related expenses and the after-tax costs of approximately $11.2 million, or $0.28 per share related to amortization of intangibles. Weighted average shares estimated per diluted EPS are $39.3 million.

As a reminder, Q3 of 2013 results included $12.3 million of pretax benefits from a class action legal settlement recorded in other income. Please note that these statements of Q3 expectations are forward-looking and actual results may differ materially.

I will now turn the call over to Kevin Murai, President and Chief Executive Officer, for his perspective on the business and our quarterly results. Kevin?

Thank you, Marshall. Good afternoon, everyone, and thank you for joining our call today. As Marshall discussed, SYNNEX delivered excellent performance and financial results for our second quarter, and I'm proud of the entire SYNNEX team for their achievements this past quarter.

Our results reflect strong execution in both our Technology Solutions and Concentrix business segments. I will take you through the highlights of each.

In Technology Solutions we achieved strong sales and profit performance. Overall, this segment grew 24% year on year with all three countries growing sales well into the double-digits on a year-on-year basis. Two significant tailwinds of Windows XP support expiration and the Japanese consumption tax increase certainly helped, but we believe our sales performance was well above market rate.

Equally impressive was our operating margin performance. At 2.22%, we improved our margin by 31 basis points from a year ago, highlighting our disciplined approach to the market and managing our business portfolio, despite a larger than normal volume of business and commodity line.

In the United States, with few exceptions, the market was strong across all product and market segments. In our commercial business, we continued to see demand driven by Windows XP support expiration, which seemed to raise the water level across the entire business. Beyond PCs, we also saw a good strength in tablets, networking and security and peripherals. From a market perspective, SMB was strong as well as state, local and education and our consumer business

Our Hyve Solutions business continued its strong sales and profit performance and was a notable contributor to our overall results in the Technology Solutions segment. Our success in Hyve Solutions was one of the drivers of increased working capital investment this past quarter.

In Canada we continued to see the market strengthen. And in particular, our commercial business experienced strong organic growth consistent with what we saw in the US. In Japan, March was exceptionally strong, coming up to the consumption tax increase. And although we experienced the impact of the tax increase in April, we continued to experience growth through market focus and share gains.

With the robust sales performance, we drove leverage in our business and achieved excellent profit results. Overall we had stellar performance in our Technology Solutions segment. Outstanding execution and traction along our strategic path have been the keys to our success.

Now, turning to the Concentrix segment. In total we delivered $293 million in sales and a non-GAAP operating margin of 9.5%. I'm proud of this performance, given we are still integrating the businesses and have not fully achieved all of the synergies of this investment.

In addition, we closed our second wave of countries on April 30 and have now closed about 99% of the business. We expect to close the few remaining countries in our current quarter.

As you can see from our sales performance, we are now managing the vast majority of legacy IBM CRM contracts. We have been focusing on growing the business through the combined portfolio of services and clients, and this past quarter we again achieved excellent sales results.

Some of the new business wins came as a result of the combined capabilities of legacy Concentrix and IBM, underlying the benefit of the synergies we expect to gain from this investment. And the post-close integration work continues to proceed on plan. As we assume more of the back office work from IBM, we expect to experience a short period of duplicate costs, which will impact our EBITDA performance, but once completed we expect to achieve our cost synergy targets at our first 12-month EBITDA target of $120 million.

For more color on the Concentrix business, I'll turn the call over to Chris Caldwell. But before I do, I want to thank Chris and his management team for their strong leadership throughout this process. I could not be more proud of what they've accomplished. Chris?

Thank you, Kevin. It has indeed been a productive and exciting quarter as we have executed to our plan. As Kevin and Marshall mentioned, we have had a number of highlights this quarter that we are extremely proud of.

The first was the closing of the additional countries. We again executed seamlessly with no interruption to the business. These countries have now been rebranded to Concentrix. The staff have been integrated and migrated to our HR systems and we are starting to see the business development as we've expected. Now, only a few small countries remain to be closed, which we are planning to complete this quarter.

I'm happy to say the integration is also progressing well and is on schedule. This mainly consists of taking over work currently being supported by IBM, which are primarily back-office financial systems and processes and are not client-facing.

To date, we have already assumed a number of these processes across many functional areas. We have a dedicated team planning and executing on the transfer of work, while at the same time, building out our own infrastructure to support it. I'd like to remind you that this does create duplicate costs in a few areas as we work through the integration process, which we expect to be completed early in the new year.

We also continue to be extremely pleased with our reception in the marketplace by both new and existing clients. Currently we are in the process of ramping well over 2,000 new staff members driven by deals we have signed with existing clients as well as new clients globally. Again, validating our thesis for the IBM CRM acquisition. The business now we are signing in terms of margin profile, industry verticals, contract length are substantially similar to the businesses we purchased.

When we closed the transaction, we spoke about being focused on 10 key verticals. Within these 10, we are especially focused on four top verticals which are banking, healthcare, insurance, and technology. These represent areas of superior margin performance, requirement for our technology platforms and analytics, as well as higher value processes. You'll see us make additional investments in these verticals.

One highlight of the quarter was winning the largest single deal in Concentrix history. More importantly was that this win was only possible because of our scale and capabilities resulting from the IBM CRM acquisition.

Our insurance platform and our renewals platform also continued to gain traction with new deals and installations taking place this quarter. While the new sales cycle is longer than legacy Concentrix business, we are very pleased with our momentum and pipeline.

With the new business won, as well as our pipeline of business strengthening we are making further investments in our infrastructure in the US, India, UK, Costa Rica, Philippines and Bulgaria. While there's still a significant amount of work to be done, as always we are committed to making the right-long term investments to profitably grow the business.

In summary I'd like to thank the well over 45,000 Concentrix team members who have successfully executed this quarter and who have been dedicated to building a bigger, stronger and better business for us and for our clients. I'll now turn the call back over to Kevin.

Thanks, Chris. Now, moving to the current market environment, our third quarter guidance reflects strong continued demand and profit performance in our Technology Solutions segment and continued execution in the integration of our Concentrix segment.

Specific to technology solutions, we expect IT demand will remain strong in all our geographies, with positive impact from Windows XP support expiration subsiding this quarter. We also expect demand in Japan to normalize in the second half of this year as the positive impact associated with the consumption tax increase is now over. We expect to continue to perform better than the market in all three geographies.

In the Concentrix segment we expect our progress on integrating the legacy Concentrix and IBM CRM business to remain on or ahead of plan and to continue to make good progress in winning new business. This is an exciting time for SYNNEX and I'm confident that the investments we've made on top of our solid business foundation will provide a clear path to continued increases in shareholder value.

I would like to acknowledge the hard work and dedication of all of our associates around the world, from both our Technology Solutions and Concentrix businesses. I also want to thank our vendors, customers, and shareholders for their continued partnership and support. And with that, let's turn the call over to the operator for questions.

Thank you.

(Operator Instructions)

Our first question comes from Scott Craig of Bank of America Merrill Lynch.

Thanks. Kevin, with the outlook for the fiscal third quarter, definitely looks like on a relative basis to history, you're being conservative. And I understand the rationale behind it, but can you dive in a little more deeply? Like how much of an impact do you think the XP and Japan had on the quarter specifically?

And then secondly, with regards to margins, can you discuss the TS margins on a quarter-over-quarter basis? It sounds like even with a bit of a worse mix, if I read that right in your statement, that the margin surprised you guys to the upside. So how much is that volume related or something else? Thanks.

Yes, thanks, Scott. So when we look back on Q2, obviously the performance, the sales performance in Technology Solutions, came in ahead of our own expectations. So we did get, I guess, more significant tailwinds from both the Windows XP expiration and from Japan than we anticipated, too.

And that really did drive a lot of leverage in our business. In particular, in Japan, we achieved what I would consider to be North American-type operating margins for that quarter. We do see the demand in Japan normalizing, because both of those drivers, Windows XP as well as the consumption tax increase, are now over.

So we do expect more of a normalized-type demand environment there. We do expect, by the way, to grow faster than market in Japan. But we also don't expect to see the same kind of profit performance in Japan that we saw in Q2.

But we also got leverage in our US and Canadian businesses, as well with the tail winds that we got in particular from XP. It kind of raised the water level across the board. We did get better margin performance as well.

All that being said though, when you take a look at a normal Q2 to Q3 on the Technology Solutions side, we do see it coming a little bit down seasonally from what we had seen in the past. But again, what we're seeing is continued strong demand. We do expect that we're going to grow faster than the overall market. And we do expect that we're going to deliver solid margin performance as well.

Thank you.

Our next question comes from Jim Suva of Citi.

Thanks very much. So you talked a lot about Windows XP expiration in Japan. And you continued to, I want to be blunt, dance around the question, or the answer. Your outlook for the next quarter, it's never been down quarter over quarter. You mentioned you expect to gain share again.

So we're trying to really get our arms around what the impact was this quarter. Or why would it be down sequentially quarter over quarter next quarter? Because history shows that that's a not normal situation. So we're trying to bridge those comments and to see that building in a lot of conservatism, or help us do the math, or it just doesn't jive.

Yes, Jim, Q2 to Q3 is relatively flat. Actually when you look at our guidance, we're not calling it down that much on a sequential basis. But there's no question that the tailwinds that we've got from XP and from the consumption tax certainly did increase our sales. We grew over 25% on the Technology Solutions business in top line last quarter. And that's really speaking more to revenue.

When you look at our overall profitability, keep in mind that Chris noted the investments that we're making in the Concentrix business as well. On-boarding over 2,000 new people to support business that we've won recently, which we expect to get the benefit shortly after that.

So we are continuing to invest in profitable growth, but overall what we see is just an overall good market. It's just the dynamics that we saw that were probably unique to this year in our second quarter.

Okay. And if you could help me then, as my follow-up be, you mentioned that normally Q2 to Q3 is flat. But I look back historically to your model and I see a 4%, 5%, 6% from the past several years sequentially. So was that from acquisitions? Or why are you saying that normally it's flat when statistically it's up?

Yes, I'm not even sure that there is anything normal over the past few years because we have done a number of acquisitions over the past number of years. Most recently, our Supercom acquisition last year, which did actually not have a full impact in second quarter last year. It was partial to that. So that is one reason for that. But then when you go in years prior to that, our seasonality has changed quite a bit as we brought on new businesses and also increased or changed the overall mix of business between retail and our commercial business.

Okay. And since you're an off-quarter Company and it's almost July 4th, is it fair to say June, that Windows XP expiration continued to be strengthened? Or we're starting to see it wane to more normalized?

Because in your prepared comments you'd mentioned in the back half of the year you expect it to normalize. So it almost seems like you're still waiting for it to normalize. Or are you actually already seeing signs of it normalizing?

We're starting to see signs of it normalizing now. We're still today enjoying some of the benefit of it. But for the most part, commitments that were made for Refresh driven by Windows XP, that's really the incremental business that we're achieving right now. But we do expect that to subside this quarter.

Great, very helpful. And again, congratulations on great top-line and bottom-line results, you and your team.

Great. Thank you, Jim.

Our next question comes from Matt Sheerin of Stifel.

Yes, thanks. Good afternoon, everyone. So a couple of questions, Kevin. On the distribution business, obviously you've seen substantial increase in your retail business over the years. I believe that's like 15% to 20% of revenue, right?

It's actually a little bit higher than that.

Higher, yes. So could you talk about the seasonality you're seeing there? Looking at August, I know you're guiding down a little bit. Maybe a little bit softer than seasonal. Sounds like that's mostly on the corporate side.

So could you talk about what you're seeing on the retail side? And do you see an upgrade cycle in terms of the educational markets and consumer markets in August? And then also in that business, you've been expanding your product lines. I'm wondering if that has something to do with your strong growth rate in retail. I've also noticed the addition of some wearable devices. Could you talk about how that might impact your business?

Sure. Matt, your second to last comment, in terms of picking the winners, I think that's probably one of the key factors that drives our success in particular in retail. So overall retail business is stable and okay, but our performance in retail in particular in the US and Japan has been much, much stronger than market. That really is as a result of having the right products and really having an eye for what's going to be hot.

We've experienced a much higher than market growth in our New Age business here in the US over the past year or so because of that. And then the same thing in Japan too. So we continue to look for those new opportunities. Obviously one of the hot new growth areas is going to be in wearable technologies.

I think the announcement that you're referring to is the iriver announcement. That has to do with wearable technology that measures biometrics as you're exercising. So obviously very, very useful. It's a small part of our overall portfolio today, but we do expect it to be one of high growth. Hopefully when we're talking again in one or two years from now, it's a much bigger part of the portfolio.

Answering your other question around education. In particular, the state, local and education segment of our business continued to be very strong. That's been the case over the past few quarters. And certainly, this past quarter was no exception to that.

We are seeing continued investment in education in particular. We support a number of different platforms. Obviously the Microsoft platform is very, very important in that segment. But also with our recent partnership with Google, we've really been able to leverage incremental share with a pro-management console and selling Chromebooks as well.

So we do see a lot of growth there. That of course, then raises the overall water level around the infrastructure, including Wi-Fi, campus and installations as well.

Okay and do you see, can you give us an idea of what inning you see in terms of that whole upgrade cycle within public schools around the country?

To us it's just a big opportunity. For years we've had a dedicated focus on public sector, education being a big part of that. We've really doubled down our focus there, because we do see that that is one area that is really being focused on to invest in.

Really, Matt, what it's driven by is just higher levels of productivity. As dollars are harder to come by in funding education, most educators are looking to technology to really drive more and more improvements in access and productivity. That's where I think the whole technology community benefits.

Okay, that's helpful. Then on the gross margin, it sounds like mix is working against you a bit here for the things that you just talked about, obviously Chromebooks, desktops and notebooks. So as that begins to moderate or stabilize, do you see gross margin start to move in the other direction?

Well you know, Matt, our focus really is around operating margin. The different growth markets that we invest in, in some cases they are going to be higher gross margin, higher OpEx.

But the focus for us is how are we able to grow and how do we grow into more profitable businesses? So looking at our performance in our second quarter, where we were able to drive leverage and growth, but also through some mix changes in a positive way going forward on higher operating margin categories, that's really where we see the big benefit.

Okay, great. And just one last question, if I can, regarding the seasonality in distribution. It sounds like Japan continued to be strong, moderating there for the reasons that you're stating. So should we assume that Japan was still growing faster than your overall business in the May quarter? And it may end up decelerating at a greater rate than North America?

Yes, Matt, that's a fair assumption.

Okay, thanks a lot.

Thank you.

Our next question comes from Lou Miscioscia of CLSA.

Okay, thank you. You talked about one of the biggest wins you had in Concentrix and on-boarding 2,000 more people. Can you give us the headcount there? Wondering about if we're getting to the point that your size is large enough now that these new big wins will be more moderate in the sense of, let's say, not hitting you all on the operating margin line, which historically when before IBM on occasion did happen.

So thanks, Lou. On the top line, the actual 2,000 people that we're actually ramping right now, is not inclusive of the deal that we won, which is our largest deal. That has some technology that needs to get built out, and some analytics that needs to be done. That ramp will actually happen further. And it's a significant size, it's many hundreds of people that will be going into Q4 and beyond. So the 2,000 is really deals that we had won with existing customers and new deals within the last quarter outside of that biggest deal.

In terms of these ramps, clearly as we gain greater and greater scale, if we are growing at base rate, you'll see less impact of these ramps within the business. But we've been very fortunate and lucky to continue to win these big deals, which we are aggressively ramping, and therefore taking the burden of that within our quarter of ramp.

Okay. And the headcount there?

In terms of the new deal, largest deal, it's above 500.

No, I just mean what was your headcount, let's say, at the start of -- or the end of the quarter?

It's a little over 45,000.

45,000, okay. And then talk a little bit about how you expect the operating margins to play out. You mentioned that you're going to have some double expenses, I guess, through the end of the year. So did the operating margin that you all achieved here stabilize and flat going forward and you pull out these charges? Or how do you expect to communicate that to us?

So we have not reached our peak of investment to bring across the migration of the IBM systems. That will actually happen within the next quarter, quarter and a half, and then phase down until the end of Q1, is the way we are looking at it and seeing it right now as we execute to our plan.

Those investments are not being called out as one-time costs. Those are just being run as OpEx within the business, and are compressing our operating income margin. So if you think of where we are right now, that we have some additional investments to make, then you can extrapolate from there in terms of the operating margin.

So I guess the 9.47% I think you had this quarter, that then, it looks like that -- or 9.48% -- that would actually have to drop somewhat?

We see it being compressed both with the ramp as well as with the investment we need to make over the next quarter and a bit.

And finally, could you size that for us, by chance?

I don't think we're going to size it at this point in time. You'll start to see it next quarter, and then you can take your data points from there. But we are being very effective at managing and moving it across and trying to get off the systems as quickly and controlled as possible, which we have been quite successful with number of the systems prior up until now.

Okay, thank you.

Our next question comes from Brian Alexander of Raymond James.

Okay, thanks. Sticking with Concentrix, Chris, could you guys just ballpark for us what the IBM contribution was in the quarter to revenue and operating income?

It looks like the revenue was well south of the $300 million a quarter that they were running at previously. But I know you didn't have the whole thing closed; and I know there's a lot of revenue recognition issues. I'm just trying to get a sense for where that business is now versus where it was before. And then I have a couple follow-ups.

Brian, we're not going to break it out. Part of that is just because we are selling as one team now. We had some shared customers that we've seen growth within those customers, and so it's hard to break it out to a granular level.

I can tell you it's executing to what our expectations were and what our plan was with the base of customers. We're quite happy from that perspective.

And then are there any major contracts that we should be thinking of that have the potential to get renewed in the next few quarters? How can investors gain confidence that the Company is achieving its targets on renewal rates, on pricing activity, on new contracts, et cetera?

Things that we would want to watch over time. What are the sign posts that we could look for that suggest that the business is performing as you expected?

So Brian, I'd point to two data points. One, as we went through this process, all the major customers had to consent in order for the contracts to come over to Concentrix, which we talked about in last quarter and the quarter before, as it had gone as planned and had done.

During that process, any terms and conditions or changes, or whatever the case may have done for those consents, would have had to have been dealt with at that point in time. I think that gives you confidence that we've got a good understanding of the business and how it's performing and where it is right at the moment.

The only contracts that I'll call out is ones that we've mentioned that are declining in a lower margin that will end. We're just working through that right now, as we talked about last quarter, in terms of sizing it. Because there's some residual business we may or may not keep, providing what the margin profile is.

I think as we get closer to when those are expiring, we will give some more color and indication around that. Right now it's a little too early to discuss it based on where we are.

There's no large contracts that are in the renewal process right now that have come across, because they were all dealt with, with the consent process that happened. I think when you look at our sales growth over the next coming quarters and looking at the ramp, we're clearly getting that from our existing customers and new logos and being successful in the marketplace. That will continue to drive our success.

Okay and a couple on the Technology Solutions side. Kevin, I think last quarter you quantified how much Japan was up. It was around 40%, as I remember. Can you give us a sense for how strong it was this quarter?

And then, is the right way to think about Tech Solutions growth for the August quarter, is that it decelerates but it's still up double-digits, maybe low double-digits? As opposed to 25%-plus, which obviously is not sustainable.

So Japan's growth last quarter was consistent with where it was in Q1. And that's in local currency, of course. And we do expect that number, as I said, to come down and normalize. But we're still looking at growth, and certainly growth above where we see the overall market performing.

You're correct. Without getting too specific, we are still calling for double-digit growth in Technology Solutions, but at a bit more muted level than where we saw in Q2, and for the reasons that we talked about already.

Great. And then final one. I know you don't like to comment on supply relationships, but given the acquisition of Beats by Apple, and I think Beats is one of your larger consumer brands, is there any change anticipated in that relationship going forward? Or is it business as usual?

Yes, we expect it to be business as usual. We've got a great relationship with Beats. It's like anything, Brian, as long as we continue to help them grow and be successful, we're going to be an important partner. That's really been our MO with all of our vendor relationships.

Okay, thanks a lot. Nice job.

Thank you.

Our next question comes from Ananda Baruah of Brean Capital.

Hi, thank you guys. Good afternoon. Thanks for taking the questions. Just two, if I could.

On the August operating margin guide, I think, Kevin, you referred to incremental costs related to the integration as a reason for the margins being a little bit softer. I just wanted to clarify that. If that's the case, can you walk through what some of those initiatives are? And if there's anything else, I'd love to hear about it as well, thanks.

Yes, the two main reasons that we talked about certainly do factor in. In particular, one thing to remember is that in our third quarter of last year, we did get benefit from two different areas. One was benefit from the LCD settlement, which we called out specifically.

We also had benefit from what we called larger than normal reserve changes. That, I think, that was, Marshall, you help me here. It was 10 basis points or so. So just keep that in mind as you're looking at our comparisons year on year.

Okay, got it. I was more referring to the Q on Q. I know you got some leverage this quarter from the overall demand, from IT demand. It sounds like there's some incremental costs in BPO.

You're saying that you still expect to execute to the EBITDA synergies over the 12 month period. But I just want to make sure there's nothing else in there with regards to --

No. In fact talking to our performance, I couldn't be happier with our performance in integrating the two businesses. So far, and it's still very early in the process, and there's so many puts and takes, but so far we're a bit ahead of plan on our EBITDA performance to our plan.

As we mentioned, we do expect to be some incremental costs over the coming, let's say, next two quarters or so. But we're still confident that we're on track to get to $120 million in the first year after the acquisition.

Excellent. And then a quick follow-up on the Concentrix margin. What's the right way or framework for us to think about where the margins can ultimately go? Any sort of anecdotal long-term view of what you guys' strategy is around the margins and the levers that go along with that strategy?

Sure. I think our second quarter margin gives you a sense of what is possible in the business. Our long-term goal of double-digit operating margins in Concentrix has not changed.

We're just going through a period of integration where there's going to be so many puts and takes through the quarters. Really, that's why we're focused more on here is what we expect after the full year. Here are the categorical costs that we expect to incur over the next, say three to six months. But overall, our focus on driving that level of margin has not changed.

Excellent, thanks a lot.

Thanks, Ananda.

Our next question comes from Osten Bernardez of Cross Research.

Hi, good afternoon, and thanks for taking my questions. To begin, I just want to follow-up on some of the Concentrix questions. It seems that the IBM business, just as you were acquiring it, was already running close to, at least according to the filings put out by yourself and IBM, close to around $120 million in EBITDA. That's inclusive of what they called out, $80 million to $90 million in allocated expenses?

So I was trying to get a sense for how much of that $80 million to $90 million in expenses that basically the Company was paying to back office support from IBM, do you view as an opportunity to expand that EBITDA margin from a longer-term perspective, let's say, at least in year two?

So Osten, it's Chris. As we've talked about, we actually have some more duplicated costs right as we bring those across. Obviously we think we can be more efficient and are seeing that in some of the processes we brought across. So we do see that declining, but I hesitate to give you a target on that until we've gone through the complete process.

Okay. And then separately, with respect to TS, your inventory levels were up about 16% quarter-over-quarter versus TS sales of up 9%. I wanted to know how much of that pace differential is due to, say, Hyve or other segments? Or is it just the timing of purchases?

Osten, this is Marshall. It's more just timing.

Okay. Would you be able to give any additional color as to what's happening, what's trending with respect to Hyve?

Osten, Hyve, all I can tell you is that it continues on its strong growth pattern. Successful business for us and strategically plays right in one of the key growth areas and skilled data center build-out.

As you know, though, we don't provide a lot of detail around that. But again, just to say that it is successful, it was a good contributor in second quarter and we expect it to continue going forward.

Thank you.

Thank you.

Our next question comes from Rich Kugele of Needham.

Thank you, good afternoon. A couple questions and a clarification/observation.

Just on the question side, let's look at Japan for a second. Competitively, can you talk about how you view your position right now? That the business has been streamlined the way you like? Especially in light of one of your major competitors having an Analyst Day recently where they were talking specifically about Japan, where it looked like they may wind up actually trying to directly engage. And then I have a follow-up.

Okay, I'm sorry, Rich, I don't understand your question on Japan?

Well, I'm trying to understand where competitively are you positioned in Japan right now? Are you now the largest player? And if an entrant were to come in, whether through M&A or organic, your ability to go and withhold them and maintain your position.

I believe if you're not number one, you may be number two in the geography. But any comments on competitive position.

Sure, Rich, we're probably number three or number four. The Japan channel is, the make-up of that channel is not quite as clear as you would find here in North America, or even in Europe, for that matter. Because Japan tends to be more vertically integrated as an industry, you find a lot of other players that have captive distribution capability. So you can't really get a good take, a real good take, on what the pure distribution market looks like.

We're certainly scaled enough in Japan. And we're big enough to be able to drive the kind of cost efficiencies and profitability that we need. Again, it comes down to what we've been working on, which is continued enhancement of how we go to market, as well as continued enhancement of our processes. We're making very good progress a long that path.

I think the fact that we were able to leverage such good profitability out of strong top line is kind of a testament to that, but still more work to go on that. I would tell you that with the opportunities we see in front of us, and in particular when you look at the relatively small share that at least the pure play distributors have in the overall IT market in Japan, there's ample room to continue to grow organically. And that really has been our focus so far.

Interesting. Okay, that's helpful. And then, certainly we've seen what happens with expirations of technologies, with Windows XP. Now we've got Windows Server next year. Are any of your VARs and resellers coming back to you and already discussing that as a potential catalyst? Or is it still too early?

No, we're hearing a lot of questions right now coming from the reseller community. It's interesting, because if I turn the clock back, say to mid last year, the only place that we ever heard any talk around growth in demand resulting from that, was in Japan. We didn't hear it in the US and Canada.

Yet, coming now as we came much closer to that date, we actually did see what the tailwinds could provide from that. I think because of that, we now have the reseller community quite excited about where the growth opportunities are going to be on Windows Server expiring.

So we are even more coordinated now, not just with Microsoft but with our server OEMs, in preparing for that. Hopefully driving some good tailwinds from that too.

Okay. My last comment, if you go and you look at where the Street was for last quarter and for this quarter, and then your actual performance and your guide, you still are, in aggregate, up about $0.10 versus where the Street was. So I'm trying to understand if I can parse out, is some of this just timing? Some of it obviously was seeing better than expected, XP, et cetera.

Some of this also could be just getting Concentrix farther along earlier, the IBM business, further along earlier than perhaps where the Street had. Is some element of this just that dynamic? You did mention in the Q&A here that EBITDA was perhaps a little bit ahead of plan. Is that part of this?

Yes, I think that is part of it. I think there's many other things though too, Rich, in some ways. And it's hard, obviously I don't know what is behind some of the estimates that come out.

But as I mentioned, when I think it was Ananda that was on the phone asking the question, you do have to remember that, especially when you take a look at our year-on-year comparison, that we did benefit pretty significantly in Q3 of last year from some one-time type benefits that we had, which we don't expect to recur on an ongoing basis.

So that is part of it. And perhaps on a year-on-year, not everybody took that into account. But overall, yes, I would say that the tailwinds we saw in Q1 and Q2 were much stronger than we had anticipated they would be.

With Concentrix, we're not able to plan our timing on everything that we do perfectly. We do know that we have some more significant costs that we need to incur as we continue through the integration. But bottom line is, very, very happy that, at least in the first few months of doing the first and second wave close, that our overall EBITDA performance is ahead of where we thought it would be.

Okay, well done. Thank you very much.

Thank you, Rich.

I am showing no further questions at this time. I would like to turn the call back over to Ms. Dierdre Skolfield. Go ahead for closing comments.

Thank you, Sharon. Thank you, everyone, for joining our call today. This concludes our call. Thank you.

This concludes today's conference. Thank you for your participation. You may now disconnect.