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Executives

Gary Doyle - Director of IR

Terry Blakemore - President and CEO

Mike McAndrew - Vice President and CFO

Analysts

Jeff Beach - Stifel Nicolaus

Josh Overhalt - Investment Counselors of Maryland

Black Box Corporation (BBOX) F2Q09 (Qtr End 9/27/08) Earnings Call October 28, 2008 5:00 PM ET

Operator

Welcome to Black Box Corporation second quarter fiscal 2009 earnings call. At this time, all participants are in a listen-only mode and later we will conduct a question and answer session with instructions being given at that time. (Operator Instructions) As a reminder, today's conference is being recorded.

And I would now like to turn the conference over to your host, the Director of Investor Relations, Mr. Gary Doyle. Please go ahead, sir.

Gary Doyle

Thank you. Good evening, and welcome to Black Box Corporation’s second quarter fiscal 2009 Earnings Call. My name is Gary Doyle and I am the director of Investor Relations for Black Box. With us today are Terry Blakemore, President and CEO of Black Box Corporation, and Mike McAndrew, our Vice President and Chief Financial Officer.

Earlier today, we announced our second quarter fiscal year 2009 results by issuing a press release and furnishing it to the Securities and Exchange Commission on Form 8-K. We also posted this press release on our website at blackbox.com.

We will start today's call with an overview of our results from Terry Blakemore, followed by a more detailed discussion from Mike and Terry. Following this, we will field questions as time allows.

Before we begin, and as a reminder, matters discussed in this call may contain forward-looking statements that involve risks and uncertainties concerning Black Box's expected financial performance. Actual results may differ materially from expected results and reported results should not be considered as an indication of future performance. Potential factors that could affect our business and financial results include changes in economic conditions in our end market and the general market at large. Additional factors are included in our most recent Form 10-K and today's press release, including the ongoing SEC investigation and shareholder derivative lawsuits.

On this call and as presented in today's press release, we will discuss some financial information that includes non-GAAP financial measures, including operating net income, operating earnings per share, free cash flow, EBITDA, adjusted EBITDA, and organic or same-office comparison. We will limit any non-GAAP financial discussions today to these specific measures. As I said earlier, our press release was filed with the SEC and posted to our website prior to this call. Please refer to the schedules that accompany the press release for a reconciliation of non-GAAP financial measurements to the most directly comparable GAAP financial measurement and other supplemental information.

On the IR calendar, I would like to let everyone know that Terry and Mike will be presenting at the UBS Global Technology & Services conference on November 18th in New York City. Please check our website as that date approaches for a press release with more specific information on the conference.

Now, I would like to turn the call over to Mr. Terry Blakemore.

Terry Blakemore

Thanks, Gary. I am pleased to report that the results for the second quarter of fiscal 2009 demonstrate Black Box's ability to generate well diversified revenues, solid sustainable margins, and consistent positive cash flow.

Revenues for our second quarter were $254 million, a 3% decrease from last year's $261 million and a 5% increase over last quarter's $243 million. Year to date revenues were $496 million, a 3% decrease from last year's $513 million.

Our second quarter operating earnings per share were $0.94 cents, up $0.07 cents from last year's $0.87 cents and $0.20 cents from last quarter's $0.74 cents. This is a record quarterly operating earnings per share for Black Box and strong evidence of our ability to effectively manage our cost structure in a challenging economic environment. Year to date operating earnings per share were $1.67 versus $1.60 for the same period last year.

Second quarter free cash flow was $26 million compared to 8 million last year. On a sequential comparison basis, our first quarter '09 free cash flow was $12 million. Year to date free cash flow stands at $38 million versus $15 million for the same period of last year. Of our $26 million in free cash flow in second quarter of '09, $24 million was used primarily to fund acquisition activity and $1 million was used to pay dividends.

I'll turn it over to Mike now for a more detailed discussion of our financial results.

Mike McAndrew

Thanks, Terry. As Terry mentioned a moment ago, we posted quarterly revenues of $254 million versus $261 million for the same period last year. Excluding the contribution in the second quarter of '09 of $19 million related to acquisitions and a positive $2 million impact from foreign currency, same-office revenues were down 27 million, or 10% year to year.

This $27 million revenue decrease is primarily driven by the following: An $8 million decrease in revenue resulting from the loss of the Avaya distribution agreement, which we announced in August of 2007, and a $5 million decrease in revenues resulted from the expected post-transaction revenue attrition from the commercial operations of the NextiraOne acquisition. These two items make up approximately half of the total same-office revenue decrease.

In addition, at a more macro level, we believe the balance of the decrease in the same-office revenues is primarily related to the continued signs of caution from certain of our clients' capital investments. In particular, we continue to see reduced spending in the retail and banking verticals.

Looking more deeply at our second quarter revenues by the two segments that we report the highlights are as follows. Initially from a Service Type segment perspective, second quarter revenues were comprised of the following: $154 million or 61% of voice service revenues; $57 million or 22% of hotline service revenues; and $43 million or 17% of data service revenues.

As we look at that from a geographic segment perspective, our second quarter revenues were comprised of the following: $211 million or 83% from North America; $32 million, or 13% from Europe; and $11 million or 4% from what we call All Other, which is primarily the Pac Rim and Latin America.

Our second quarter operating earnings per share were a record $0.94 up $0.07 from last year's $0.87 and $0.20 from last quarter's $0.74 bringing year-to-date operating EPS to $1.67 versus $1.60 for the same period last year. Included in operating expenses in the second quarter of '09, was approximately 850,000 of severance expense related to cost alignments in our field offices. In the first quarter, we incurred 250,000 of severance expense.

As noted in our press release, operating earnings per share excludes the following items. Restructuring, severance and other acquisition integration costs, amortization of intangible assets on acquisitions, stock-based compensation expense, asset write-up depreciation expense on acquisitions, historical stock options granting practice investigation costs, the change in fair market value of our interest-rate swap and 409A expenses. Further details of these expenses can be found within today's press release.

In total, these excluding items represented $0.12 and $0.23 per share for 2Q '09 and 2Q '08 respectively. Excluded items represented $0.12 and $0.50 per share for year-to-date fiscal 2009 and year-to-date fiscal 2008 respectively.

GAAP diluted earnings per share for the second quarter of fiscal '09 were $0.82 an $0.18 increase from last year's $0.64 and a $0.09 increase over last quarters $0.73 cents. Year-to-date GAAP diluted EPS was $1.55 versus $1.10 for the same period last year.

Moving on to cash flow, GAAP cash provided by operating activities for the quarter was $26 million, which compares to $5 million for the same period last year. On the sequential comparison basis, first quarter '09, GAAP cash provided by operating activities was $12 million. For the first half of fiscal 2009, GAAP cash provided by operating activities was $38 million versus $12 million for the same period last year.

Second quarter free cash flow was $26 million, which compares to $8 million last year. And on a sequential comparison basis, free cash flow was $12 million in our first quarter. Free cash flow for the first half of fiscal 2009 was $38 million compared to $15 million for the same period last year.

We believe that free cash flow defined by the company as cash provided by operating activities less net capital expenditures, plus proceeds from option exercises, plus or minus foreign currency translation adjustments is an important measurement of liquidity, as it represents the total cash available to the company.

In our second quarter of '09, EBITDA was $30 million compared to $28 million for the same period last year and on the sequential quarter comparison basis, first quarter '09 EBITDA was $24 million. EBITDA for the first half of fiscal 2009 was $54 million compared to $50 million for the same period last year.

Adjusted EBITDA for the quarter was $30 million compared to $29 million for the same period last year and as we compare that to the first quarter of '09, adjusted EBITDA was $25 million. Adjusted EBITDA for the first half of fiscal 2009 was $55 million, which compares to $53 million for the same period last year.

We believe that EBITDA defined as income before income taxes, plus interest, depreciation and amortization is a widely accepted measure of profitability that we believe may be used to measure the company's ability to service its debt. Adjusted EBITDA, defined as EBITDA plus non-cash stock compensation expense may also be used to measure the company's ability to service its debt.

Looking at some of our other key metrics. At the end of the second quarter, we had cash and cash equivalents of $26 million and total debt of $211 million for a net debt position of $185 million. This is an $18 million increase from a net debt position of $167 million at the end of the first quarter of '09. Currently, our borrowing rate stands at 3.5%.

Company-wide DSOs were 50 days, a decrease from the first quarter’s 54 days and we are pleased to have achieved our established goal in this area, which we had set for 50 days and we will strive to make additional improvements from this level over the balance of the fiscal year.

Accounts receivable reserve was $11.1 million or 6.6% of the gross AR balance. This compares to the first quarter '09 AR reserve of $11.6 million or 6.6% of the gross AR balance. Net inventory was $62.7 million with inventory turns of 8.0 times or 46 days. This compares to the first quarter's $64.7 million and 7.1 turns.

Having reached our established goal of 8 turns in the second quarter, we'll continue to stay focused on improving our turns throughout the balance of the year. Inventory reserves were $20.7 million, or 24.8% of gross inventory. This compares to the first quarter inventory reserves of $21.0 million, or 24.5% of gross inventory.

Moving on to capital expenditures, for the quarter, new capital expenditures were $872,000, bringing year to date CapEx to $1.5 million. Capital expenditures for fiscal '09 remains targeted at approximately $3 million to $4 million.

Excluding the non-cash impact of the interest rate swap, discussed in today's press release, interest expense for 2Q '09 was $2.8 million, or 1.1% of revenues. This compares to the first quarter '09 interest expense of $2.4 million, or 1.0% of revenues. And as I mentioned a moment ago, our current borrowing rate is 3.5%. Our current tax rate is 36.5%.

As we move over to backlog, our six-month order backlog now stands at $196 million, which compares to $158 million at the end of the first quarter of '09 and $166 million at the end of the second quarter of our fiscal 2008. As a reminder, backlog represents expected revenue related to executed customer purchase orders or contracts that are estimated to be completed within 180 days of quarter end.

Looking at team member staffing, it stands at approximately 4500 team members around the world, and although our team moves between data, voice and hotline groups somewhat, for perspective, our Black Box team breaks down approximately as follows. 2700 are mostly voice, 1000 are mostly data, and the remaining 800 are mostly hotline. As I mentioned, the team does move around a bit, particularly from a DVH marketing perspective.

As of the end of the second quarter, the weighted average, common and common equivalent shares stood at 17.528 million. And for the beginning third quarter '09 period, this number is an equivalent 17.5 million shares. There were no stock repurchases during the second quarter of fiscal '09.

For our fiscal 2009, we do continue to target reported revenues of approximately $1 billion. We are increasing the lower end of our previously reported operating EPS range by $0.05 cents, which results in a revised operating EPS range of $3.35 to $3.45 for fiscal 2009.

And we continue to expect cash provided by operating activities in the range of 90% to 100% of operating net income. And as a reminder, this guidance is inclusive of our fiscal year-to-date acquisitions.

I would like to now turn the call back to Terry.

Terry Blakemore

Thanks, Mike. Black Box's financial strength lies in our ability to generate well diversified revenues, solid sustainable margins, and consistent positive cash flow. Our business is driven by the strength of our clients' capital expenditures.

As Mike mentioned earlier, and as we have stated on previous calls, we are experiencing some softness in certain sectors of our global market. In particular, we have seen delays in reductions in spending in the retail and financial sectors of our business. This has contributed to the decrease in year-over-year same office sales.

However, on a more positive note, we have also made solid gains in select markets during the quarter. As an example, during the second quarter, we announced that Black Box had been awarded a contract to provide telecommunications and infrastructure support services to Lockheed Martin Space Systems company. The multimillion dollars contract will have an initial three-year base period of performance with a value of approximately $18 million. Under this contract, Black Box will provide technical support services for Lockheed Martin in the area of voice services at facilities located throughout the United States.

Our results are also evidence that we have successfully protected and in some cases, expanded our margins across all three segments of our business. The ability to preserve our margins in a challenging economic environment has been demonstrated in the past through effective cost management. Our consistent focus on margins allows us to generate continued positive cash flow, which will provide Black Box with the resources to capitalize on new business opportunities.

Our plan is to continue to expand our business through the acquisition of complimentary enterprises, thereby enhancing our ability to provide the highest levels of technical service throughout the world. We have demonstrated the ability to acquire and successfully integrate companies while delivering double-digit margins and positive cash flow.

Recently we closed on acquisition of ACS Communications, Incorporated, a privately held data services company headquartered in Austin, Texas; and Network Communication Technologies, Incorporated, a privately held company based out of Charlotte, North Carolina. Annual historical data service revenues of ACS and NCT are approximately $60 million. We welcome the ACS and NC teams and customers to our Black Box family.

So for this year, we have added over $100 million in annualized revenue through acquisitions funded by our low cost debt and operating cash flow. The companies that we have acquired have given us a clear strategic benefit, expanding both our capabilities and geographic foot prints. They also bring talented teams and a solid customer base.

In closing, our second quarter of fiscal 2009 results reflect the current economic environment and its effect on our end markets. We are pleased with our record operating earnings per share revenues and cash flow results relative to our previously disclosed outlook for our fiscal year 2009.

Relative to achieving our financial objectives for the year we remain committed to focus on our profitability through effective management of our cost structure consistent with expected revenue levels over the coming quarters.

We will now open up the call for any questions.

Question-and-Answer Session

Operator

Thank you (Operator Instructions). We will go to the line of Jeff Beach of Stifel Nicolaus. Please go ahead.

Jeff Beach - Stifel Nicolaus

Yes. Congratulations on the best quarter I have seen in a while.

Terry Blakemore

Thank you, Jeff.

Jeff Beach - Stifel Nicolaus

The acquisitions you just made, can you expand a little bit more on the targeted end markets that you are going after or geographic markets?

Terry Blakemore

We sure can, Jeff. Actually the geographic markets, I will start with ACS out of Austin. They are actually headquartered out of Austin. They have operations throughout the Southwest US and the Northwest and actually have some business scattered across the country. But primarily in the Southwest, Northwest US with some very large Fortune 500 clients as well as some small business customers.

They are basically doing a lot of data services work, providing some product, more or less professional services and engineering and support to these clients. With our acquisition, we see very complimentary cross selling here with our [DV&H] hopefully bringing voice services into the ACS team, as well as cross-selling our own Black Box products and our brand. So, we are very excited about that.

And NCT is based out of Charlotte. They have a couple of branch offices, one in Greenville, South Carolina, and one in the Raleigh area of North Carolina. They are also data services type businesses doing copper, fiber optics and predominantly data services.

They have some medical customers. They have a couple of large retail accounts. And there too, we see a big synergy of putting our DVH capabilities on top of the NCT existing customers and existing team members they have to compliment that business going forward. And we are very excited to have both of these companies come on board.

Jeff Beach - Stifel Nicolaus

All right. You haven't done any share buyback in the last quarter focused on these acquisitions, is this something that you are considering?

Mike McAndrew

Yeah. I will take that one, Jeff. This is Mike. How are you doing?

Jeff Beach - Stifel Nicolaus

Great.

Mike McAndrew

Good. We are always balancing availability of our cash flow and where to put it best use of. Right now, we believe that this M&A targets really are better suited relative to longer-term strategic investment. No doubt our share price, where it sits right now is clearly attractive and would be accretive.

So, we continue to evaluate that balancing our expectations of cash flow and determining, where the best use of that capital is. So, at this point, we have authorization of approximately 870,000 shares and we will be reviewing that as we review that pipeline that we are looking at on the M&A side.

Jeff Beach - Stifel Nicolaus

All right. The last question, you moved up your gross margins sequentially in all your businesses, a little bit of pressure it looks like in data. But overall, your gross margin is up on 10% organic decline. Can you discuss obviously the decline in organic revenues is not pressuring your margins. Can you expand a little bit on why that's occurring?

Terry Blakemore

Yes. Let's start with data. If you kind of follow that it trail around, Jeff, trying to jumps around a bit from quarter-to-quarter. I mean, it’s heavily project-centric business. So bounces between 29% and 30% generally. So, we look forward to stay in that range. I think we are disciplined in our pricing and so relative to movements, the significant movements around that, I wouldn't see a whole lot.

On the Hotline side, it's easy. It's a product-based revenue stream. So, the GPs have really come down to cost of product and selling price. It's really managing the operating expenses below that relative to revenue trends. And lastly, but most importantly, I guess, voice [itself] makes up 60% of our revenues. We follow the same thing there. They are pretty disciplined.

We are seeing a slowdown, as we have mentioned in capital investments is really impacting project-based revenues. And so the slowdown is in that element or that revenue stream within voice. And we do have a significant amount of maintenance contracts. So, a little bit of mixing there certainly going to help us with less, lower margin project-based revenue, as a percentage of the revenue stream and some higher margin maintenance and Mac-type business.

Jeff Beach - Stifel Nicolaus

All right, thanks. That's a good explanation.

Terry Blakemore

Thanks, Jeff.

Operator

Thank you. And next we'll go to the line of Josh Overhalt of Investment Counselors of Maryland. Please go ahead.

Josh Overhalt - Investment Counselors of Maryland

Yes, congrats on a good quarter in a tough environment.

Terry Blakemore

Thanks, Josh.

Josh Overhalt - Investment Counselors of Maryland

Real quick, if you would, if you could just maybe go over kind of the acquisition pipeline, with the economy the way it is right now. Are you seeing some of these guys more open to selling off their businesses, number one.

And number two, could you maybe talk a little bit, there had been some concern I think by those in the industry on the voice side that it could potentially fall off a cliff. Maybe you could help us understand, I think Jeff made comment it may be down 10 organically, but I would say that's a good number potentially in this environment. So maybe help us what you guys are doing organically to continue that solid execution there?

Terry Blakemore

Okay, Josh, this is Terry. I'll take that question. It's really too early to say if there's any major fallout, but we expect the multiples to be in the same range as we have seen in the past. We always have a great pipeline of M&A prospects and we plan to be very active and continue our plans there.

We'll just have to balance our cash flow and our current operations against availability of these high quality companies as we evaluate them. As far as the business falling off the cliff, certainly, we're paying a lot of attention to that in the voice side of the business, as well as our hotline and data side.

What we're seeing there is the opportunities for large new installs is certainly less now than in the past, but the service and the maintenance and some upgrades continue to come in and the customers continue to need to be supported. So we're disappointed in new sales of equipment, but we have a lot of backlog out there as far as proposals and quotes. We're just due to the capital expenditures being on hold by a lot of the major corporations that we support. That has been a problem and probably will be into the future until the economy turns around somewhat.

But I am proud to report that we continue to support these customers with new adds and changes and maintenance. And we have not lost any of these customers during the last three or four months during the economic problems that we're all facing.

Josh Overhalt - Investment Counselors of Maryland

Terry, has it been concern over the economy, or has there been even some kind of cash flow issues from some of your customers with an inability to spend?

Mike McAndrew

I'll jump in there on that one, Josh. I think, no doubt, this is an environment where people are being cautious of not getting ahead of themselves relative to cash outlays, liquidity situation the way it is in the marketplace. I think the people are focused in on generating their own operating cash to the best of their ability and not getting ahead of themselves.

So, I think it's more that, Josh, than anything.. I mean we talked about retail and banking. They are pretty self-explanatory if you read the papers. I mean, the rest of the world -- big picture we're down 10 and we talked about 5 of that, or half of that, I should say, which is really related to some things we had expected, which is that NextiraOne and the Avaya contract. So we now take a liberty of rationalizing the balance, the other half of the 10%, if you take into account our verticals of retail and banking, which make up about 20% of our business, we see them down about 15% year-to-year. And when we play that out, I would say the balance, while some are up and some are down it’s [not] a couple of percent. So, we are not seeing a huge twist here, but people just being prudent at this point in time.

Josh Overhalt - Investment Counselors of Maryland

Great. Thanks again. Great execution.

Terry Blakemore

Thank you, Josh.

Operator

Thank you (Operator Instructions) And gentlemen, no one else is in queue for questions at this time.

Terry Blakemore

Okay. We thank you for your time today. And as a reminder, our press release have been filed on Form 8-K and on blackbox.com. In addition, we are planning on filing our quarterly report on Form 10-Q with the SEC on Thursday, November 6th.

Also, we will present at the UBS Global Technology and Services Conference on November 18th in New York City. If you have any questions, please call our Investor Relations line at 724-873-6788. Again thanks for joining us and this concludes today's conference call.

Operator

Thank you. And, ladies and gentlemen, this conference will be available for replay after 7:00 pm Eastern Time today until midnight, November 11. You may access the AT&T Executive Playback Service at anytime by dialing 320-365-3844 and entering the access code of 963020.

Those numbers again are 320-365-3844 with the access code of 963020. That does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.

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