Mary M. Gentry – Treasurer and Director, Investor Relations
Mike Baur – Chief Executive Officer
Charles Mathis – Chief Financial Officer
Dominic Ruccella – Northcoast Research Partners LLC
ScanSource, Inc. (SCSC) F4Q13 Earnings Conference Call August 22, 2013 5:00 PM ET
Welcome to the ScanSource Quarterly and Year End Earnings Conference Call. All lines have been placed in listen-only mode until the question-and-answer session. Today’s call is being recorded. If anyone has any objections, you may disconnect at this time.
I would now like to turn the call over to Mary Gentry, Treasurer and Director of Investor Relations. Ma’am, you may begin.
Mary M. Gentry
Thank you and welcome to ScanSource’s earnings conference call for the quarter and year ended June 30, 2013. With me today are Charlie Mathis, our CFO; and Mike Baur, our CEO.
We will review operating results for the quarter and then take your questions. A slide presentation of the Company’s our comments and webcast is posted in the Investor Relations section of our website. Certain statements made on this call will be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from such statements.
These risks and uncertainties include but are not limited to, those factors identified in the release and in ScanSource’s SEC filings. Any forward-looking statements represents our views only as of today and should not be relied upon as representing our views as of any subsequent date. ScanSource undertakes no duty to update any forward-looking statements to actual results or changes in expectations.
We will be discussing both GAAP and non-GAAP results during our call and have provided reconciliation between these amounts in our press release, which can be found at our website and has also been filed with our Form 10-K – with our Form 8-K.
Mike Baur will now begin our discussion with an overview of the quarterly results.
Thanks, Mary and thank you for joining us today. For the fourth quarter 2013, we reported net sales of $713 million, which was below our expected range. We had a diluted EPS loss of $0.48 including impairment charges for our ERP project and for goodwill in Brazil and Europe Communications, which we will discuss later in this call. Excluding these non-cash impairment charges, our adjusted diluted EPS totaled $0.71 per share, higher than our expected range. Charlie will go into more detail on the numbers in a minute.
The overall story for our weaker revenue versus our expectation was a lack of big deals in our Barcode & POS business and weaker than planned sales from our Catalyst business. We had lower big deals due to delays in purchasing decisions from end-users and larger projects being broken into smaller ones.
In Catalyst, we had good sequential growth from the March quarter. However, our expectations for stronger growth from our Avaya Enterprise business fell short. While our overall sales missed our plan, we had record sales quarters for ScanSource Communications in North America, our Security business unit and our Barcode & POS business in Mexico, and it was our second best sales quarter in Brazil as measured in local currency since our April 2011 acquisition of CDC Brasil.
As we discussed last quarter, our vendor incentive programs are very dependent on revenue growth. With the weaker demand for our products, we have experienced vendor program targets that are difficult to reach. We anticipate these targets continuing to stay above our ability to maximize our incentives, because we have always managed our business to ROIC targets and knowing that our gross margins are under pressure from the lack of consistent vendor programs, we’ve begun pulling the other levers available to us that affect ROIC.
So during this quarter and last quarter, we made decisions to reduce our inventory levels with certain product lines where we have reduced profitability. These efforts by our merchandising teams resulted in faster inventory turns for almost every business unit without sacrificing fill-rates to our customers. This was our best quarter all year for inventory turns. In addition, we are focused on managing our headcount to match the value added services we are being paid for by our customers.
We ended our fiscal year with a fourth quarter return on invested capital of 17.2% excluding the impairment charges. This represents a sequential increase from 13.3% for the third quarter and then reflects higher margins, better working capital management and our focus on value-added growth.
We announced a new management structure that became effective July 1 to enhance our worldwide technology markets focus and our growth strategy. With this structure, which you can see on Slide 4, we changed from a geography focus to a technology focus, to leverage our leadership in specific technology markets.
We believe this change in structure will also provide more resources and experience to our international markets. As we believe the growth opportunities are still there. Buck Baker was promoted the President for our Worldwide Barcode & Security segment, which includes our POS & Barcode and our Security business units.
Buck is an 18 year veteran of the Company and has recently returned from a six month assignment in Europe, where he did a great job coaching our Barcode POS and our Communications management teams. Buck spent time previously in our North American Communications and our Barcode POS business units.
Mike Ferney was promoted to President for our Worldwide Communications & Services segment, which includes our Communications business units, ScanSource Catalyst and ScanSource Services Group. Mike has been with the Company for 15 years and has recently been leading the Catalyst team with John Gaillard. Before that, he was a key executive in the North American Communications unit.
All of our key vendors and customers are very familiar with Buck and Mike and we expect both of them to provide strategic vision, establish consistent operational metrics and provide leadership to our teams. This new structure provides great opportunities to share best practices among our technology teams and leverage our size and experience to deliver more value to our vendor and reseller partners in our existing markets. We expect to grow our top line revenue and gain operational efficiencies with this new structure.
Now let me comment on the $28.2 million non-cash impairment charge that we took for our ERP project. Since fiscal year 2009, we’ve been working on the development of a standardized ERP system using the Microsoft Dynamics AX-based ERP software. We have not implemented this ERP software.
In January 2013, we filed a lawsuit against our former ERP software systems integrator, Avanade. The lawsuit alleges, among other things, fraud, misrepresentation and breach of contract and we are seeking recovery of damages.
We engage Tata Consultancy Services, TCS to replace Avanade. In March, TCS presented a plan. They had the cost to complete the project, approaching the $72 million upper end of our previously disclosed total project cost with no assurance that the system would be successful.
In April, we moved the significant number of ScanSource team members who are working on the project, the ERP project back in our business rolls while we evaluated our next steps. In the current quarter, the ERP team has been focused on working with Microsoft on alternative options to facilitate completion of projects.
In addition, the ERP team met with other software vendors for an understanding of how their software could meet the needs of the Company. In connection with the preparation in our view of the financial statements for the year ended June 30, 2013, we reviewed the project and decided not to move forward with Microsoft Dynamics AX.
While we have impaired our Dynamics ERP software, we remain committed to the implementation of a new ERP system. We are currently evaluating our alternatives for next steps. Meanwhile, our legacy ERP systems continue to run our business successfully.
With that, I’ll now turn the call over to Charlie to discuss our fourth quarter financial results in more detail.
Thanks, Mike and good afternoon everyone. As you’ve heard Mike talk about the changes in the organization structure, let me add that I will be discussing the financials related to these organization changes through our two new reporting segments, Barcode & Security, and Communications & Services rather than the geographic segments previously used.
The information can also be found in our press release in the accompanying slide presentation starting on Slide 8 as well as in the Annual 10-K, which we will file next week. Barcode & Security combines our most mature business unit, POS & Barcode with the fastest growing unit security.
Also you can see from the slides that Communications & Services has consistently delivered higher operating margins and understand why we can continue our investment in Europe, changed our organization structure in order to expand Communications business in other geographies, so as it can perform very well if executed effectively.
Also I will be covering a lot of the financial information for the quarter and full year related to these new segments and again this information can be found starting on Slide 8 through 11 in the presentation.
We generated worldwide sales of $713 million in the fourth quarter 2013, a decrease of 6% from the prior year and an increase of 4% over the March quarter. For the full year, worldwide sales declined 4.6% to $2.9 billion in fiscal year 2013 from $3 billion in fiscal year 2012.
In the fourth quarter 2013, sales for our Barcode & Security segment were $445 million or 2% decrease from the prior year quarter. Year-over-year Worldwide Barcode & Security sales were basically flat and increased 1.4% excluding the impact of foreign exchange.
Turning to our new Communications & Services segment, sales decreased 11% from the prior year quarter to $268 million. As a reminder, our distribution agreement with Juniper Networks ended in September 2012 and Juniper sales represented approximately $32 million in net sales in fourth quarter 2012. Year-over-year worldwide sales of the Communications & Services segment decreased $129 million, largely as a result of the Juniper vendor termination.
Turning to the gross margin, in the fourth quarter 2013, the overall gross margin increased to 10.62% or an 83 basis point improvement from the June 2012 quarter and 54 basis points sequentially. The fourth quarter 2013 gross profit margin was better than expected, largely due to our European operations.
Although we do not expect to maintain this gross margin going forward, as you know we had put a lot of resources and focus on Europe over the last couple of quarters. We had higher gross profit margins for our European business units from the favorable resolution of several inventory aging issues and certain adjustments related to timing of vendor programs. In addition we had a favorable product mix and better attainment of vendor programs that contributed to a higher gross profit margin in ScanSource Catalyst versus the prior year’s margin.
Although, we were pleased with the results again let me emphasize the gross margins are higher than we would expect going forward. For the full year, gross margins for 2013 were 10.2% compared to 10% for 2012. We’re also pleased about attaining this double-digit gross margin on a full year basis.
Turning to Slide 8 and 9, our Worldwide Barcode & Security segment reported gross margin for the fourth quarter 2013 of 9.7%, compared to 9.4% for the prior year quarter. For the full year, our Worldwide Barcode & Security segment reported gross margins of 9.2% for both 2013 and 2012.
Our Worldwide Communications & Services segment, which you can see on Slide 10 and 11 reported gross margins of 12.1% for the quarter, compared to 10.4% for the prior quarter 2012. For the full year, our Worldwide Communications & Services segment reported gross margins of 11.9% for 2013 compared to 11.3% for the fiscal year 2012.
Now moving to SG&A expense, for the fourth quarter and excluding the impairment charges, SG&A expenses in the current quarter totaled $46.8 million, compared to $46.6 million in the prior year and $47.9 million in the sequential quarter. The decline from the sequential quarter was driven by lower ERP expenses as expected, lower executive compensation as well as a reduction in bad debt expense. This bad debt expense reduction was important because at the same time, we were able to reduce our exposure in Venezuela to approximately $500,000.
Expenses for the fourth quarter included a charge for ERP impairment of $28.2 million as Mike discussed previously. In addition, we performed our goodwill impairment testing as of June 30, 2013 in two of our reporting units it was determined that the book value exceeded the fair value, primarily as a result of lower projected earnings and cash flow forecast.
Accordingly, we recorded a non-cash charge for goodwill impairment of $5.4 million for our European Communications reporting unit and $15.1 million for our Brazil POS & Barcode reporting unit. After the goodwill impairment, our European Communication reporting unit had no remaining goodwill and our Brazil POS & Barcode reporting unit had approximately $3 million in goodwill at June 30, 2013.
As a reminder, our Brasil acquisition was structured as an upfront cash payment with five annual earn out payments through 2015. The goodwill we recorded at the time of the acquisition was partially based on estimated future earn out payments. The actual earn out payments we’ve made are significantly lower than those forecast at the time of the acquisition.
The amount of expense that has been recorded on the fair value continue to see consideration line in our P&L over the last nine quarters is also significantly lower than what have been otherwise. As a case in point, in the fourth quarter 2012, we recorded a fair value adjustment gain of $1.1 million.
For the fourth quarter 2013, the fair value adjustment was a loss of $447,000. Going forward assuming no changes to the current forecast we would expect the fair value adjustment in each quarter of approximately $700,000, though this can fluctuate based on the assumed discount rate, foreign exchange changes and other factors.
Despite the non-cash impairment goodwill for the quarter, we still maintained that we made an excellent investment in Brazil with an excellent management team and with an earn out structure that has done what it was intended to do.
For the full year, SG&A expense year-over-year was 6.6% of sales in 2013, compared to 6.2% of sales in 2012. The increase in SG&A expenses were largely the result of higher bad debt expense and one-time charges related to our European operations offset somewhat by lower overall head count.
Turning now to the operating income for the fourth quarter with the non-cash impairment charges, we had an operating loss in the current quarter of $20.4 million down from operating income at $28.3 million in the prior year quarter and $20.8 million in the sequential quarter.
Excluding the impact of impairment charges for ERP and goodwill mentioned previously, non-GAAP operating income was $28.4 million or 4% operating income margin compared to 3.8% in the prior year and 3% in the March quarter. Excluding the impact of non-cash impairment and one-time Belgian compliance charges for the full year 2013 non-GAAP operating income was $101.9 million compared to $113.5 million in the prior year of 2012.
Next let me turn to the reporting segments, operating margins for the fourth quarter, excluding the impact of Brazil POS & Barcode goodwill impairment of $15.1 million, adjusted operating income for Barcode Security segment for the 2013 June quarter was $13.5 million or 3% operating income, down from $17.2 million and 3.8% operating income margin in the prior quarter of 2012.
The decrease in operating income for Barcode Security for the quarter is primarily due to an increase in bad debt expense and the fair value adjustment for contingent consideration in Brazil.
Excluding the impact of European Communications goodwill impairment charge of $5.4 million for the current quarter the Communications Services segment had non-GAAP operating income of $14.9 million and adjusted operating income margin of 5.6% compared to $11.1 million operating income and 3.7% operating margin in the prior year quarter.
The increase in this segment is due to higher gross margins as previously discussed, lower bad debt expenses and lower inventory reserves.
For the full year, excluding the impact of $15.1 million related to Brazil POS & Barcode goodwill impairment, non-GAAP operating income for the Barcode & Security segment for fiscal year 2013 was $49.8 million or 2.7% operating income margin, compared to $56.7 million or 3.1% operating margin in fiscal year 2012. The change in operating income is primarily due to cost associated with the Belgian tax compliance issues and higher bad debt expenses particularly in Latin America.
Excluding the impact of the $5.4 million related to European Communications goodwill impairment, non-GAAP operating income for the Communications segment for fiscal year 2013 was $50 million or 4.8% operating margin, compared to $56.8 million and 4.8% operating margin in fiscal year 2012. The decrease in operating income dollars is primarily the result of lower gross margin dollars, resulting from lower sales in fiscal year 2013 and the effect of ScanSource Europe restructuring cost.
Interest expense was $419,000 for the quarter and interest income was $590,000. For the full year 2013, interest expense was $775,000 compared to $1.6 million in 2012, due to higher cash balances and lower borrowings. The effective tax rate was 32.3% this quarter, compared to 30.9% in the prior year quarter and 34.6% for fiscal 2013 compared to 33.2% in fiscal 2012. We expect the fiscal year of 2014 effective tax rate to range from 34% to 35%.
Excluding the impairment charges of $48.7 million, our return on invested capital totaled 17.2% for the quarter, compared to 18.1% and 13.3% in the prior year and sequential quarters respectively. For the full year, our ROIC for 2013 was 16%, compared to 17.2% in 2012.
Diluted earnings per share was a loss of $0.48 for the fourth quarter, excluding EPR and goodwill impairment charges during the quarter of $18 million and $15.2 million net of taxes respectively, non-GAAP diluted earnings per share was $0.71, compared to $0.71 and $0.50 for the prior year and sequential quarters respectively.
On a full year basis, diluted earnings per share were $1.24 in 2013. Excluding the impairment charges and one-time charges associated with Belgian tax compliance, adjusted net income on a non-GAAP basis was $2.47, compared to $2.68 in full year 2012.
Moving to the balance sheet and you can see this on Slide 12 of the presentation. Cash and cash equivalents on hand totaled $148.2 million at the end of the quarter, compared to $29.2 million at June 30, 2012. Our days sales outstanding DSO was consistent with the prior year and sequential quarter at 55 days.
Inventory turn 6.2 times during the quarter compared to 5.4 times in the prior year and sequential quarters. We had 5.7 paid for inventory days at the end of June 2013 versus 9 and 13.5 days for the prior year and sequential quarters respectively.
Paid for inventory days are down from prior periods primarily due to lower inventory levels. We reduced inventory levels by $15 million during the quarter and $85 million for the full year. The company held $5.4 million of interest bearing debt as of June 30, 2013 compared to $9.7 million at June 30, 2012. Average debt for June 2013 quarter decreased to $5.4 million from $41.3 million in the June 2012 quarter.
Our balance sheet is exceptionally strong and we generated $53 million in cash from operations during the fourth quarter 2013 and approximately $129 million for the full year.
The company will continue to focus on ROIC and its variables as our key performance metrics going forward. With that, I’ll turn it back over to Mike.
Thanks Charlie. I’ll start with our Worldwide Barcode & Security segment summarized on Slide 13 which represents 62% of overall sales for the quarter. Worldwide Barcode & Security sales of $445 million increased 2% sequentially and decreased 2% year-over-year. Net sales for our POS & Barcode business units in North America and Europe declined year-over-year principally from lower big deals but the number and the average size of big deals decreased as end users rolled out projects more slowly and vendors took some larger deals direct.
In addition, we saw softness in the mobility market as end users delayed purchasing decisions given heightened uncertainty, surrounding macroeconomic conditions, new operating systems and the availability of new devices.
Our POS & Barcode units also faced more aggressive competitive landscape, including pricing and credit terms. Despite this in North America, the number of active consumers increased and we had good year-over-year growth with our small and mid-size vendors.
Recently added two new vendors [Code] and J2, Brazil outperformed the market this quarter with double-digit year-over-year and quarter-over-quarter sales growth in local currency despite an uncertain economic climate. This quarter was the second highest since the acquisition of CDC in 2011.
Brazil continues to be profitable with good gross margins even with lower growth rates than previously forecasted. Our management team has done a very good job of managing operating expenses to our current run rate of business. We remain positive on our business there and expect to continue to get strong support of our value-added model from the market.
Our results in Latin America vary country-by-country during the quarter. In Mexico, we had a record sales quarter, we benefited from a stronger economy and good vendor support, struggles related to the economic and political climate in Venezuela continue, including the scarcity of U.S. dollars to make payments.
We have assigned one of our Senior Executives, Yvette McKenzie to work with our LA team in Miami. She has been implementing best practices and sharing resources from our North American operations to better streamline our business and manage the Latin American business for growth.
Our Security business in the U.S. and Canada had a record sales quarter with double-digit growth driven by the Cisco physical security business and a record networking quarter. We have record quarters with Cisco, Ruckus, Panasonic, Sony, Exacq, Samsung and March Networks.
Panasonic continues to see value in the ScanSource Security business model and recently reduced the number of distributors. June quarter is the seasonally strong quarter for our Security business and we had another record big deal quarter with lots of school projects. Our customer count continues to expand and we’re starting to win deals with the large national security integrators.
Security continues to be a growth initiative for us and market trends point to continued growth opportunities. In July we added Pivot3 as the new vendor and recently signed Speco, a leader in analog cameras as well as the new national contract with Bosch first advantage line. We are adding salespeople to this business unit to continue our momentum and gain market share.
Now turning to our Worldwide Communications & Services segment on Slide 14, which is 38% of overall sales this quarter. Worldwide Communications & Services net sales of $268 million increased 9% sequentially but declined $32 million year-over-year or 11%. ScanSource Communications in North America had a record sales quarter led by a record quarters with Polycom Voice, ShoreTel, Sonus and Chief. Big deals were up both year-over-year and quarter-over-quarter. We also achieved our ShoreTel new reseller launch goal including good revenue growth from our new resellers that we’ve recruited over the past year.
ScanSource Catalyst sales declined year-over-year but they grew on a sequential basis over 10%, we missed our sales plan for this unit as Avaya Enterprise sales did not grow as much as we had expected, however, we had good growth with Avaya IP Office and Avaya data networking. Over the last two quarters, we’ve been seeing more big deals though they are still lower than a year ago. It is still a cautious spending environment particularly for enterprise big deals. We had another quarter of double-digit growth with our wireless vendors including a record Aruba quarter.
In June, we successfully launched the Cisco collaboration products, formally the Tandberg products, providing value-added distribution for the existing channel and recruiting new resellers to the Cisco story. We would expect our Cisco collaboration sales to build at a measured pace throughout the year as customers become aware of our offers and experience and experience to Catalyst value-added advantages in this space.
We believe our growth opportunity with Cisco is great; we want to make sure we are winning customers due to our value-added services. We have introduced a Catalyst collaboration tool to help our customers with their Cisco configurations. Our Services Group have rolled out a suite of Cisco Network readiness services and we have added enablement specialist to assist in the on-boarding of new Cisco collaboration resellers.
ScanSource Communications in Europe had its lowest sales quarter this year, principally from lower big deal volume in Germany. We had a good sales quarter in the UK, our second best quarter ever, driven primarily by small and mid-sized business growth.
In April, as you may recall, we took steps to better align the cost structure of this business unit at the appropriate scale. Following our restructuring, we have reorganized our go-to-market strategy and committed to bringing best practices from our successful North America team to Europe. We are focused on our key vendor partners and have built a sales plan for growth and profitability.
Our newest business unit ScanSource Services Group provides education and training, network assessments, custom configuration, marketing and our SUMO partnership community principally in North America. ScanSource Services Group exceeded its plan in all areas including a record quarter for our custom configuration center.
As an authorized training partner for Avaya, Polycom, ShoreTel, we had a more classes including a new Avaya Enterprise class and launched virtual services. As I mentioned earlier, the new Cisco Services are an additional opportunity for revenue and to assist in selling more Cisco hardware and software.
Turning now to our next fiscal quarter, we believe net sales for the quarter ended September 30, 2013 could range from $715 million to $735 million and our earnings per share could range from $0.56 to $0.58 per diluted share.
At this time, we’ll be glad to answer your questions.
(Operator Instructions) Our first question comes from Dominic Ruccella with Northcoast Research. Your line is open.
Dominic Ruccella – Northcoast Research Partners LLC
Hi, guys. I’m sitting on the call for Keith Housum. Thank you for your time. Just to start this off here I heard you mentioned Mr. Baur that inventory levels have been low. We’re just wondering what you guys see in that area going forward and what any type of impact you can expect on the business?
Yeah. Hi, Dominic, it was our plan to have inventory levels to match the programs and the margins that we’re seeing from certain vendors and so we felt like we could reduce our inventory levels, but not affect our fill-rates to our customers and we believe we came through June quarter successfully doing that.
We started this effort back in the March quarter and we do these inventory planning programs cooperatively with our vendors, so that we don’t surprise their team, we don’t want to upset their supply chain. So we believe that it was a good business decision for us. And frankly our vendors at this stage understand this. So our goal would be to keep inventory levels at similar levels as they are now, but we are prepared to increase them based on sales opportunities.
Dominic Ruccella – Northcoast Research Partners LLC
Perfect. Thank you very much. And then the next question in terms of the macro overall environment and how it affects your business, you guys see that improving at all going forward? Is there anything in particular you guys have noticed that would point to any signs where we can expect that to be over the next quarter?
Well, I think relative to that, our stance right now is our run rate business, which is our small to medium type customers and transactions, not the big deals. So the regular run rate business continues to be steady and strong, it’s the lack of large opportunities that’s really causing us some concern and that really haven’t materialized this year like we thought.
So when we talk to our key vendors either those customers that I indicated earlier are not buying right now. They’re on the fence, so they’re holding or they’re taking those large deals and they’re splitting them up into smaller transactions.
In some cases, because ScanSource is the leader in most of our markets, we have the largest amount of big deals, compared to our other distributor competitors. So the reduction in large big deals probably has hurt us more. But we believe in the normal run rate business, we’re still maintaining strong market share.
Dominic Ruccella – Northcoast Research Partners LLC
Okay, great. Thank you very much. And then just a last question while we are here, we noticed the cash [flows] [ph] have been growing pretty consistently. Do you guys have any specific plans for that cash or is that just been through the normal course of business?
Yeah, this is Charlie here. I’ll take that.
Dominic Ruccella – Northcoast Research Partners LLC
The cash balances have grown through the year and we continue to look for ways to deploy the cash to profitability grow the business. The Company has historically made acquisitions over the last 20 years and so we’ll continue to look for those opportunities and use of the cash to profitably grow the business.
Dominic Ruccella – Northcoast Research Partners LLC
Okay, all right. With that will take care of it for me. Thank you very much.
Thanks, Dominic. Take care.
(Operator Instructions) And at this time, I’m showing no further questions.
Okay, thanks Kim. Thank you for joining us today. Our next conference call to discuss our September 30 quarterly earnings is expected to be on October 24, 2013.
Thank you. This concludes today’s conference. You may disconnect at this time.
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