ScanSource, Inc.
Q3 2016 Earnings Call Transcript

Published: 8 Nov 2016

[Operator:]

Welcome to the ScanSource Quarterly Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mary Gentry, Vice President, Treasurer and Investor Relations. Ma'am, you may begin.

[Mary Gentry:]

Thank you, and welcome to ScanSource's earnings conference call for the quarter ended September 30, 2016. With me today are Mike Baur, our CEO and Charlie Mathis, our CFO and Gerry Lyons, our Principle Accounting Officer. 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, including our expectations for the second 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 Form 10-K for the year as filed with the SEC today. 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 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 those amounts in our slide presentation and in our press release. These reconciliations can also 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.

[Mike Baur:]

Thanks, Mary, and thank you for joining us today. We are pleased to report solid results for our first quarter of net sales of $933 million they grew 7% and exceeded our forecast range led by more big deals in our barcode segment and growth in our business in North America. This additional sales volume led to GAAP EPS and non-GAAP EPS above our forecast middle [ph]. At the end of August we successfully completed our acquisition of Intelisys, the industry leading technology services distributor of telecommunications and cloud services and Intelisys' sales services for the world's leading telecom carriers and cable companies such as Centrylink, Level 3, XO, Comcast, Winstream and others as well as many cloud services providers. Intelisys acquisition broadens our growth opportunity in several important ways. The Intelisys suppliers need to expand their indirect channel capacity to be able to serve the growing demand from S&B customers. The suppliers are excited to have access to the ScanSource bar base of over 30,000 reseller customers and we have been pleased to learn that many of the over 2000 Intelisys sales partners are very interested in selling hardware and software from ScanSource or partnering with and ScanSource bars to provide complete solutions to their end user customers. Importantly with Intelisys we have a remarkable combination of strategies, views and cultures. This great strategic fit began to crystalize during events held over the past two months including internal team building, ScanSource partner conferences and the Intelisys channel connect partner even. ScanSource was especially well received at this event with more than a 1000 sales partners, supplier partners and guests as summed up in a quote from one of the partners. The best thing to come out of Channel Connect this year is that every doubt, every fear about the ScanSource acquisition has been eradicated. Our strategic plan for the full year fiscal 2017 indicates strong growth in adjusted EBITDA compared to fiscal 2016, we expected this adjusted EBITDA growth will lead to an improved ROIC for full year fiscal 2017. Our balance sheet remains very strong and provides us with the ability to execute our capital allocation plan which includes organic growth, strategic acquisitions and share repurchase. Today we announced that Charlie will be leaving ScanSource to join a company in the defense industry. Charlie has been a great partner to me and the ScanSource management team and we truly wish him and his family well in the future. With that I will turn the call over to Charlie to discuss our financial results in more detail.

[Charlie Mathis:]

Thanks Mike. And let me say that I'm most appreciative to you and the Board of Directors for the opportunity over the last four years. ScanSource is a truly exciting growth company and I'm confident in it's long term success and the strategic initiatives that we have executed on. As Mike indicated first quarter financial results exceeded expectations. On slide 6, net sales for the first quarter increased 7%, $930 million and includes acquisitions. Net sales rebounded strongly from the June quarter up $55 million and 6% quarter over quarter. Our first quarter 2017 gross profit margin was 9.8% compared to 9.4% for the sequential quarter and 10.1% for the year ago quarter. The margin reflects sales mix for more big deals and lower international margins. This scan be seen more clearly in the segment financial charts on side seven and eight where the worldwide barcode networking and security segment gross margins declined to 7.9% compared to 8.1% for the sequential quarter and 8.4% in the prior year quarter. The gross margin for the worldwide communications and services segment up 13.9% which includes Intelisys reflects an improvement from 12.1% for the sequential quarter and 13.3% for the prior year quarter. SG&A expenses excluding amortization of intangible assets and acquisition costs were $65 million or 7% of net sales compared to 59 million or 6.8% of net sales in the prior year quarter. This year over year increase includes expenses from the KBC and Intelisys not in the prior year. Our first quarter 2017 non-GAAP operating income was $26.7 million or 2.9% of net sales compared to $28.4 million or 3.3% in the prior year quarter. Sequentially non-GAAP operating income improved from $18.9 million. Non-GAAP operating margins for the worldwide barcode and security segment were basically unchanged from the prior year. Non-GAAP operating margins for the worldwide communications and services decreased 60 basis points in part from higher bad debt expense. With the acquisitions of Intelisys we recorded a $95 million contingency consideration reflecting the present value of expected future earn out payments. For the first quarter of 2017 we recorded a change in fair value of contingency consideration, $800,000 with second quarter 2017 we expect a change in fair value of contingency considerations of total approximately $3.1 million. In addition we recorded intentional assets of $63 million with related amortization of 0.5 million in the first quarter of 2017 and 1.6 million expected for the second quarter 2017. These purchase accounting entries will have a significant impact on the GAAP reported financials going forward but not on the non-GAAP. To illustrate for the month of September Intelisys was diluted to GAAP EPS by less than a penny and added $0.03 for the non-GAAP for the quarter. Our effective tax rate was 34.8% for the first quarter of 2017 and 34.5% for the prior year period. For the fiscal year 2017 forecast we’re using 34.8% effective tax rate. First Quarter 2017 GAAP EPS at $0.58 increased $0.02 year-over-year and non-GAAP EPS of $0.68 was unchanged. Average diluted shares for the first quarter of 2017 totaled $25.8 million down 8% from the year earlier period as a result of share repurchases. Now shifting to the balance sheet and capital allocation plan, our working capital balance sheet and cash flow measures are referenced in slides 9 and 10 in our presentation. One of highlights from slide 9, is a $116.8 million of operating cash flow generated over the last 12 months although some of this relates to timing the business teams have done an excellent job of improving our working capital by increasing inventory returns and reducing the paid for inventory days. Inventory returns improved to six times compared to 5.3 turns a year ago. As you may recall in the prior year we increased our inventory levels to support the SAP Go Live implementation in North America This decrease in inventory levels was part of our plan and the team has executed well by achieving this. We expect continued improvements in working capital efficiency for the remainder of fiscal year 2017. The DSO excluding Intelisys came in at 59 days higher than or typical range and primarily reflects the aging of customer specific accounts in North America and Brazil. One point of clarification relates to the Intelisys working capital model. We have included two months of accrued accounts commissions receivable and accrued accounts commissions payable on the balance sheet as required by U.S. GAAP. These two accruals basically offset one another and therefore have no impact on our overall working capital result. As Mike said earlier the balance sheet remains very strong. At September 30, 2016 we had cash and cash equivalents of $45 million in debt of $166 million or net debt of a $121 million. Our leverage totaled approximately onetime's trailing 12 months adjusted EBITDA from increased debt following our acquisition of Intelisys. ROIC was 13.1% for the first quarter 2017 and again as Mike mentioned earlier regarding the full year we expect strong growth in adjusted EBITDA and a higher ROIC compared to last year partially from Intelisys. We paid $83.8 million for the initial cash purchase price of Intelisys and repurchased $17 million of shares. As of the end of the quarter we had approximately 103 million remaining on our share authorization. I would now like to turn the call back over to Mike.

[Mike Baur:]

Thanks Charlie. We have three reporting segments and I'll start with Worldwide Barcode Networking and Security which represent 68% of overall sales. Net sales of $633 million increased 10% year over year. Overall our business in North America was stronger than our international business. For the segment we had higher big deals in all geographies including a record big deal quarter for North America POS market market business. This includes the benefit from certain big deals we discussed last quarter that were pushed from June into the September quarter. These big deals were at lower gross margins than we have experienced in the past and this led to lower segment gross margins. Competition in our wireless and networking business continued as a result of vendor consolidation. In this resulted lower sales and lower gross margins for the quarter. We expect this market condition to provide headwinds for our team again next quarter however we have received assurances from our vendors that ScanSource and our resellers are a very important value added channel. Now to our second segment Worldwide Communications and Services which represents 32% of our overall sales. Net sales of $299 million increased 1% from a year ago. Similar to our other segment we have lower sales in our international business in Latin America and Europe partially offset by growth in the North America. This growth in North America included a strong end of the quarter for resellers who are focused on enterprise level communications businesses. We have been working to return to growth for the second by adding some new vendors. We've added new unified communications vendors in North America and in Europe but they are still in the early stages for material revenue and profits for this segment. In Brazil we’re making investments to support some exciting new vendors for Network One including the recently signed Cisco, Fortinet and VMWare. With these key vendors we believe we have the best line card of networking, voice data and security offerings in Brazil and LaTam region. In Europe our Imago team will now be led by James Vickerage who was recently promoted to President of Europe Communications. We believe that ScanSource and Imago teams in Europe will be able to leverage our key products and services across the region. They recently launched a provisioning and health desk service offering started in the UK called impromptu for our channel partners to sell to their customers. In our communications business, our operatings include hardware, software and vendor supply maintenance service contracts plus our own branded contracts like the impromptu and iCare in Europe and Total Coverage in North America. Intelisys has been added to the worldwide communications and services segment and was included in our results for the month of September. With Intelisys we added a business that sells technology services and earns recurring commissions on the sales contracts. In addition to the telecom carriers and cable companies we added a growing cloud services business with diversified cloud offerings. Intelisys has a very strong line card and our offers included software as a service, infrastructure as a service and managed communications services. For the month of September, Intelisys had a record month for net sales. Our forecasted to growth in net sales for the December quarter is around 20% year over year. Now turning to our forecast on slide 11. We expect net sales for the second quarter of fiscal year 2017 to range from $930 million to $980 million, GAAP earnings per share to range from $0.47 to $0.53 and non-GAAP diluted earnings per share to range from $0.67 to $0.73. The forecast includes Intelisys for the full quarter and as a reminder we have record sales in record non-GAAP EPS in our December 2015 quarter last year and that also included an unusually large $38 million government deal. We will now open up the questions.

[Operator:]

[Operator Instructions]. Our first question or comment comes from the line of Adam Tindle from Raymond James. Your line is open.

[Adam Tindle:]

Just wanted to start by asking in prior years if I look at the first half EPS, it's typically represented over half of the full year EPS number. Is there something different this year that we should be thinking about in particular in light of your comments about expecting strong adjusted EBITDA growth for the full year?

[Charlie Mathis:]

One of variable say is in Intelisys that we have this year that is given us confidence in our full year forecast and the type of comments we made about the growth for the full year. So as you know we had just one month in the September quarter and so therefore we believe we will be more back end loaded this year than in prior years.

[Adam Tindle:]

Okay And then maybe on the December guidance I think it implies that gross margins is going to remain may be at or below 10% wanted to see if you could confirm that since you gave us some guidance there last call and then lastly last quarter seemed as if many of the issues were temporary such as integration costs, [indiscernible] incentive timing things like that but I look in December should mark the third consecutive quarter of operating income dollar declines on a year over year basis to wanting to understand what is needed to write that trend?

[Charlie Mathis:]

So you're correct and that each quarter has somewhat different elements in it, in the September quarter margins are down due to the large number of big deals in the international mix. In the December quarter you’re correct that the forecast is for the gross margins to remain in those levels and that is due mainly to vendor program changes that we're seeing at the end of the year.

[Adam Tindle:]

And then perhaps on the operating line if we look at kind of the operating income dollar declines and gross margins kind of remaining below where they have been historically that would suggest that perhaps you know something is needed in terms of the cost structure or how do we write the operating income dollar decline?

[Charlie Mathis:]

You're talking about the forecasts or the September quarter? I guess make sure I'm clear on this.

[Adam Tindle:]

Both the September quarter and the implied forecast for the December quarter.

[Adam Tindle:]

So, the forecasts number that you're looking at again it is very difficult to compare that to the prior year because that was a record quarter last December which included very large deals including this $38 million deal to the government. If you look at the forecast versus the September quarter you'll see what we're forecasting is sequential sales growth that is in line with what we historically see, it's around 2% to 2.5% and that is also reflected in the margins that I just spoke about the gross margins and the reasons for that excluding Intelisys but if you look at the combined company of Intelisys and current legacy business we believe that the operating income number is going to be slightly increased from there, is increasing because the guidance we gave are higher than the September quarter.

[Adam Tindle:]

Understood. I was looking at a year over year basis but it did make sense perhaps looking at a sequential--

[Charlie Mathis:]

I think it makes more sense in this forecast to look at it sequentially rather than versus prior year because of the record December quarter that we had. December quarter had year over year last year, year over year growth of 9% something like that, it was an extraordinary quarter in there. Part of it had to do with large deals, part of it had to do with vendor programs are very favorable. So I think it's better to look at the sequential and then look at the full year of where the company is going to be with the expected growth in the adjusted EBITDA on a full year basis.

[Operator:]

Our next question or comment comes from the line of Keith Housum from Northcoast Research. Your line is open.

[Keith Housum:]

Guys can you help me understand the acquisition revenue that you guys have highlighted and barcoding of segment roughly $99 million. Was that out of KBZ in the last month of the quarter?

[Mike Baur:]

I'm sorry. So what we're talking about in the September quarter Keith is last year there was only one month of KBZ, that's what you're referring to. There was only one month of KBZ last year and this year we have three months. So there is a debt on the acquisition related to KBZ and it's approximately $50 million to $60 million of additional revenues.

[Keith Housum:]

Okay. So KBZ for the entire quarter it did a roughly $99 million is that what we’re saying?

[Mike Baur:]

Yes.

[Keith Housum:]

Okay. So excluding KBZ and the barcoding segment was down we got it bit correct?

[Mike Baur:]

Excluding KBZ the organic growth was down 1.5%. It was better than our plan.

[Keith Housum:]

Okay. Changing gears over to the accounts receivable increasing. Obviously this is last quarter you said in your script that was due to I think Brazil and perhaps North America is this a onetime or do you expect the receivables to be higher here for quarters?

[Mike Baur:]

No we would expect this to come back down to the normal levels. The company has run into this 55 to 60 days DSOs for many, many years and the businesses build on a mild DSO in that range and due to the couple of specific accounts there the DSO has gone up, we would expect this over time to come back down and we would expect the company to continue on a full year to generate excellent operating cash flow.

[Keith Housum:]

Okay. But the elevated levels were down now you’re saying is due to just a several specific accounts, it's more retiming item than anything else, is that what you’re saying?

[Mike Baur:]

I'm saying it's due more to the specific accounts, two specific accounts North America and in Brazil.

[Keith Housum:]

Okay. So if I look at your forecast sequentially revenue of 930 to 980 is higher than what we have this quarter and then the midpoint of your guidance is $0.70 we will take what the differential from Intelisys that would be your guidance of $0.64 excluding the Intelisys difference. So is the difference really than [indiscernible] incentive programs here next quarter are expected to just be I guess worse than this quarter?

[Mike Baur:]

Now the margins are fairly close to where they were in the September quarter. We're expecting higher volume in the December quarter and flat to slightly lower gross margins in the quarter. And that’s excluding the Intelisys acquisition.

[Operator:]

Our next question or comment comes from the line of Chris McGinnis from Sidoti & Company. Your line is open.

[Chris McGinnis:]

I guess just sticking into restate the comments about that EBITDA for the full year, what you expect?

[Charlie Mathis:]

Yes. So we're expecting solid growth in the adjusted EBITDA compared to the fiscal 2016 year.

[Chris McGinnis:]

That’s largely to provide Intelisys transaction or is there also organic in there as well?

[Charlie Mathis:]

Intelisys is a primary factor in that forecast.

[Chris McGinnis:]

Just on the competitive landscape, can you maybe just touch on how your maybe it sounds like it still remains tough. How are you reacting to that? Maybe is it better dealing with vendors or maybe competing in a different capacity in the regions that you’re being impacted, can you maybe just discuss that a little bit?

[Mike Baur:]

I think what we're seeing is in a slower growth environment the deals that we have in references in the call for example the big deals that we compete in actually we saw more competition from a margin perspective on big deals historical and big deals always come with lower gross margins they came with even lower gross margins now and as you know as well a lot of that is driven by vendors competing for deals and we've always been somewhat at the mercy of the vendors to manage our margins frankly on those transactions. They're very concerned about not losing business on a large deal in a slow growth environment for them and so we're definitely seeing that and of course our strategy is to make sure that our reseller partner and ScanSource are positiond with the vendor as driving more value than our competitor so that we can realize a fair margin but that's what we're experiencing right now is more pressure on the gross margin primarily in the big deals and that's kind of an across the board statement, across both segments and also geographically and that's causing us to have more pressure than we had say a year ago.

[Chris McGinnis:]

Sure. Can you say that in your prepared Mike there they promised that in time they will come back or are you clear of those comments that you made about I think it was around the vendors supporting you a little bit more?

[Mike Baur:]

Yes that was specific on the networking vendors, Chris is that we haven't consolidation you've had the a Aruba acquisition, Ruckus acquisition, Zebras selling their wireless LAN business we've got a lot of consolidation if you will in our wireless networking business and along with that comes some new competitors in some cases that we've already experienced for the last two or three quarters and there is new competitors come in not because the vendor thinks we're not doing a good job and of course they always promise us hey this won't affect you guys we will do everything we can to help you and once we see an effect it takes a quarter or so for the vendor to construct a program that will help us get compensated appropriate so these are not hey we’re going to give you an extra discount point these are more programmatic that they have to be able to rationalize internally with their management team. So that was why my methods was we don't believe they've given up that we were stuck with the margins we have but it is a headwind to us right now and at least through the next quarter.

[Chris McGinnis:]

And then just lastly, I know we’re past the implementation of it maybe any gains you’re seeing from the ERP? Can you maybe just talk about where that’s at? How it's been implemented but any gains that you’re seeing across the board from that?

[Mike Baur:]

Well I think one of the key areas is that we've seen expected and continue to see is in our back office is we're getting much more -- we have the ability now to handle more business with the back office team that we have so I believe what we're going to see is leverage on our cost structure ScanSource continues to grow whether that’s through acquisition or organically. We now have a world class platform that allows us to not only leverage our existing business but additional businesses that come along whether they're integrated or not into a back office with SAP we have a system that any other system we acquire can't plug into and we're able to do that very quickly and more efficiently than we could in the past. And that's a huge advantage plus the other piece of that is our IT team is now much more scalable because we have more knowledge about our system than ever before. In the past we had the knowledge of our IT system frankly constrained to a few people in our company because it was a very, very old custom built system and now we have a much more talented group of team that can help us with our IT needs in the future. So we think some of that we're seeing now and more to go.

[Chris McGinnis:]

And I guess last with Charlie maybe your outlook for a new CFO and maybe timing of that?

[Charlie Mathis:]

We have got Gerry Lyons with us today. Gerry has been with us now nine plus years and he's been managing all of our financial team as our Principal Accounting Officer and been doing a fantastic job and Gerry is going to be our interim CFO until we decide what we're going to do long term but Charlie and I discussed it with our Board and everyone felt very confident that we’re in good hands and we’re not in any hurry to make a decision and look forward to you meeting Gerry in the near future.

[Operator:]

[Operator Instructions]. I'm showing no additional audio questions in the queue at this time. I'd like to turn the conference back over to management for any closing remarks.

[Mike Baur:]

Great. Thanks for joining us today. We expect to hold our next conference call to discuss December 31, quarterly earnings results on Tuesday February 7, 2017.

[Operator:]

Ladies and gentlemen thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.