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Black Box Corp (NASDAQ:BBOX)

F3Q10 (Qtr. End 12/26/09) Earnings Call

January 26, 2010 05:00 pm ET

Executives

Gary Doyle - Director, IR

Terry Blakemore - President and CEO

Mike McAndrew - VP and CFO

Analysts

Greg Burns - Sidoti & Company

Scott Blumenthal - Emerald Advisors

Nat Kellogg - Next Generation Equity Research

Jeff Beach - Stifel Nicolaus

Josh Overholt - ICM

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter fiscal 2010 earnings call. At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions, the instructions will be given at that time. (Operator instructions). And as a reminder, this conference is being recorded.

I’d now turn the conference over to your host, Mr. Gary Doyle, Director of Investor Relations. Please go ahead.

Gary Doyle

Thank you. Good evening, and welcome to Black Box Corporation’s third quarter fiscal of fiscal 2010 earnings conference 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 third quarter fiscal 2010 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 markets 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 shareholder derivative lawsuit and related matters.

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 revenue comparisons.

We will limit any non-GAAP financial discussions today to the specific measures in our press release. 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 schedule that accompanies the press release for a reconciliation of non-GAAP financial measurements to the most directly comparable GAAP financial measurements and other supplemental information.

We have a very busy IR calendar for the rest of this quarter. We will present at the Emerald Advisors Conference on February 4 in Philadelphia, the Credit Suisse Global Services conference on February 23 in Phoenix, the Next Generation Research One-on-One conference in Chicago on March 1. And the Sidoti Spring Conference in New York on March 23. Now I would like to turn the call over to Mr. Terry Blakemore.

Terry Blakemore

Thanks, Gary. I am pleased to report that our results for the third quarter of fiscal 2010 demonstrate our business continues to show signs of stabilization. As we build a strong foundation for growth and anticipation of economic recovery. Revenues for the third quarter were $253 million, a 3% decrease from last year’s $262 million and a 9% increase over last quarter’s $232 million. In the third quarter, each of our business segments posted sequential organic growth. We believe that this is an indication of stabilization in our served markets.

Year-to-date revenues were $721 million, a 5% decrease from last year’s $758 million. Our third quarter results include $11 million of revenue which was accelerated as we completed certain projects ahead of schedule. Mike will discuss the impact of this event later in the call. Our third quarter operating earnings per share were $0.77, down $0.08 from last year’s $0.85 and up $0.05 from last quarter’s $0.72.

Year-to-date operating earnings per share were $2.20 compared to $2.47 for the same period last year. Third quarter free cash flow was $11 million equivalent to the $11 million last year. Free cash flow for the year stands at $41 million versus $49 million for the same period last year. Free cash for the quarter was used to fund acquisitions and pay dividends. Also during the quarter, we finalized a new distribution agreement with Avaya. We are very excited to again have Avaya in our portfolio of communication solutions that we offer to our clients.

We are working diligently to build our capabilities to sell, install and maintain Avaya products at the high levels that our clients have come to expect from Black Box. I'll give you more detail on our efforts later in the call.

Although we remain cautious with respect to the near-term economic conditions, I'm very encouraged by the work that our management team has done globally to prepare us for future growth. Recovery will come and Black Box will be financially and strategically positioned to take advantage of the anticipated opportunities.

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

Mike McAndrew

Thank you, Terry. As Terry just mentioned, we posted quarterly revenues of $253 million versus $262 million for the same period last year. Excluding $43 million of incremental revenue contribution in the third quarter related to acquisitions over the last two years and a $4 million positive impact from foreign currency, same office revenues for the third quarter are down $28 million or 12% over the third quarter of the prior year.

On a sequential basis, revenue was up $21 million from $232 million in the second quarter of fiscal 2010, excluding $4 million related to acquisitions last quarter and a $1 million positive impact from foreign currency, same office revenues were up 7% sequentially.

This represents our first quarter sequential growth since the fourth quarter of our fiscal 2008. On a year-to-date basis, total revenues are $721 million down, $37 million from last year's $758 million. Excluding the $190 million of revenue contribution in fiscal 2010 related to acquisitions and a $4 million negative impact from foreign currency.

Same-office revenues for fiscal 2010 are down a $108 million or 15% from the prior fiscal year. During the third quarter, we recognized approximately $11 million in revenue and the related cost for our current project with a federal government client.

When we provided guidance on last quarter’s call, we did not anticipate realizing this revenue in the third quarter. Accordingly, certain metrics for the quarter do not align with expectations. Specifically, revenue, gross margin and backlog were all affected by the shift in revenue. Normalizing same-store revenue by excluding $11 million in the third quarter would reflect sequential growth of approximately 2%.

I will discuss the gross margin and backlog effects later in the call. We believe the decrease in same office revenues on a year-over-year basis is attributable to continued signs of caution from our commercial clients related to both capital investments and IT spending.

We believe the sequential growth achieved in the current quarter further reflects from stabilization in our end markets. Looking more deeply at our revenue by the two segments that we report, the highlights are as follows. Initially from a service type segment perspective, our third quarter revenues were comprised of 63% of voice, 18% of data and 19% of hotline products.

Secondly from a geographic segment perspective, our third quarter revenues were made up of 86% from North America, 11% from Europe and 3% from what we call all other which is primarily the PacRim and Latin America. Our gross margin for the quarter was 34.3%, down from last quarter’s 35.5%. As I noted earlier, the acceleration of revenue from our federal government project effective gross margins. Our government work often carries a lower gross margin profile than much of our commercial work. Government projects were also a much larger percentage of the revenue mix in the third quarter than we typically see.

We attribute approximately 1% of the 1.2% gross margin decrease to this change in mix. The remainder of the margin decrease resulted from compression in our data services segment related to general competitive pricing factors. Before, we discuss EPS, I would like to remind you that we have and will continue to discuss some financial information that includes non-GAAP financial measures.

Please refer to today’s press release for a reconciliation of any GAAP to non-GAAP financial measures. Our third quarter operating earnings per share were $0.77, down $0.08 from last year’s $0.85 and up $0.05 from last quarter’s $0.72. This brings year-to-date operating EPS to $2.20 versus $2.47 for the same period last year.

In the third quarter just ended we did take additional actions to right size our workforce relative to the revenue decreases in certain of our markets. In total, we reduced our staff by approximately 50 team members during the third quarter. Accordingly, we have excluded $860,000 of employee severance cost from our operating expenses in this quarter.

For the year-to-date we have excluded approximately $2.6 million of employee severance cost from our operating expenses. These items are included in the pretax reconciling items presented in today’s press release. We believe that the exclusion of these costs and the related tax impacts provides more accurate reflection of the company’s ongoing financial performance.

Going forward, these rightsizing actions in the third fiscal quarter will decrease our ongoing operating expenses by approximately $2.2 million annually with approximately $1.7 million of the projected annual decrease related to cost of goods sold and the remainder related to operating expense. The operating cost impact of these reductions will be included in the guidance that I will provide shortly. The total reconciling items excluded from our operating earnings per share represented $0.14 per share for the third quarter of fiscal 2010, compared to $0.29 per share for the same period last year. Reconciling items represented $0.66 and $0.36 per share for the year-to-date fiscal 2010 and fiscal 2009 respectively

GAAP diluted earnings per share for the third quarter were $0.63, this is a $0.07 increase from last year’s $0.56 and a $0.16 increase from last quarter's $0.47. GAAP diluted EPS for the year-to-date was $1.54, a 27% decrease compared to $2.11 for the same period last year. GAAP cash provided by operating activities for the quarter was $12 million compared to $13 million for the same period last year. On a sequential comparison basis, second quarter cash provided by ops was $14 million. For the fiscal year-to-date, cash provided by operating activities was $42 million versus $52 million for the same period last year.

Third quarter free cash flow was $11 million, equivalent to $11 million that we did last year at the same time and on a sequential comparison basis, free cash flow was $40 million in the second quarter of fiscal 2010. Free cash flow for the fiscal year-to-date stands at $41 million, compared to $49 million for the same period last year. Of our $11 million of free cash flow in the quarter, $10 million was used to fund acquisitions and $1 million was used to pay dividends.

EBITDA for the third quarter was $24 million, which compares to $27 million for the same period last year, and on a sequential quarter comparison basis, second quarter EBITDA was $20 million. EBITDA for the fiscal year-to-date was $65 million, compared to $81 million for the same period last year. Adjusted EBITDA for the third quarter was $26 million, which compares to $28 million for the same period last year.

And looking at that sequentially, second quarter adjusted EBITDA was $21 million. For the full fiscal year-to-date, FY 10 starts at $70 million compared to $83 million for the same period last year. Looking at some of our other key metrics, at the end of the third quarter, we had cash and cash equivalents of $29 million and total debt of $236 million for a net debt position of $207 million. This is a $7 million increase from a net debt position of $200 million at the end of the second quarter.

Currently, our incremental borrowing rate is 1.1%. Total availability under our line of credit is $350 million and as of December 31, we had approximately $112 million available for future borrowing. As a note, our credit facility expires in January of 2013. Companywide DSOs were 52 days. This is a one day increase from the second quarter of 51 days. And we look to make progress in this area to return to our target DSOs of 50 days. Accounts receivables reserve was $10 million or 6.2% of the gross AR balance. This compares to the second quarter’s AR reserve of $9.9 million or 6.6% of the gross AR balance.

Turning to inventory, our net inventory was $53.8 million with inventory returns of 9.3 times or 39 days. This compares to the second quarter net inventory of $53.3 million or 8.4 turns. Having reached our established goal of 8 turns, we will continue to stay focused on maintaining our turns throughout the fiscal year.

Inventory reserves were $20.5 million or 27.6% of gross inventory. This compares to the second quarter inventory reserves of $19.8 million or 27.1% of gross inventory. For the third quarter, we had new capital expenditures of $540,000 bringing our year-to-date CapEx to approximately $1.6 million.

Interest expense for the third quarter was $2.2 million or 0.9% of revenues. This amount excludes a positive non-cash impact of $300,000 attributable to the interest rate swaps discussed in today’s press release. This compares to the second quarter interest expense of $2.1 million or 0.9 of revenues excluding the negative non-cash impact of approximately $380,000 attributable to the interest rate swap.

Looking at backlog, our six months order backlog now stands at $191 million compared to $207 million at the end of the second quarter. As noted earlier, approximately $11 million of revenue expected to be recognized in the fourth quarter was appropriately recognized in the third quarter.

This amount would have otherwise been included in the backlog at the end of the third quarter. You may recall that we mentioned the increase in backlog for this project on our first quarter call. Accordingly we do not believe that the sequential decrease of backlog is an indication of a decrease in demand. As a reminder, backlog represents expected revenue related to execute a client purchase orders or contracts that we estimate to be complete within 180 days of the quarter end.

As we look at maintenance revenue which is derived primarily from long-term agreements with our voice clients, it stands at $56 million or 22% of our revenue for the third quarter. Revenue under these agreements is recognized ratably over the term of the agreement which is typically 1 to 3 years for our commercial clients and 3 to 5 years for our government clients. I'd also like to point out that this recurring maintenance revenue amount gives a subset of the backlog number that we disclosed.

Our team member staffing stands at 43.84 at the end of the third quarter and although our team does move around between data, voice and hotline somewhat perspective, our Black Box team breaks down approximately as follows.

2600 are mostly voice, 1200 are mostly data and 600 are mostly hotline. As of the end of the third quarter, the weighted average common and common equivalent shares stood at $70.548 million and there were no stock repurchases during the third quarter of fiscal 2010.

I'd like to now provide guidance for the upcoming quarter. For the fourth quarter of fiscal 2010 we're targeting reported revenues of $240 million to $245 million. Our operating EPS range is $0.73 to $0.78 with an expected tax rate of 37.5%. And we expect capital expenditures of approximately $1 million in the fourth quarter. As a reminder, this guidance includes the expected results from all acquisitions to date. As we discussed last quarter, beginning with fiscal 2010 we have made a change to our computation of operating net income. In the past, we have excluded non-cash stock based compensation expense from this computation.

Beginning with the first quarter of fiscal 2010, we are including non-cash stock based comp as a component of our operating expenses. And we are expecting to have approximately $1.7 million of non-cash stock based comp expense in the fourth quarter of fiscal 2010. This change is reflected in our target operating EPS range.

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

Terry Blakemore

Thanks, Mike. As I mentioned earlier, in addition to the sequential growth that we have posted for the quarter, we continue to build our business to take full advantage of the economic recovery. Surely, after our last earnings call, we announced that we had signed a distribution agreement with Avaya. Since the closure which was in late December of the Avaya-Nortel transaction, Black Box has achieved platinum status with Avaya.

At the current time, our primary focus is on our large installed of Nortel clients. We continue to support and maintain current systems and work with many of our clients on system upgrades and expansions. Also we have discussed in recent calls, the federal government that has been a very active Nortel client. Since we signed our agreement with Avaya, we have been working with their management team to develop a plan for Black Box’s success in the Avaya channel.

Avaya has been very cooperative and supportive of our efforts to train Black Box team members to sell, install and maintain Avaya products. We are also in the process of recertifying our network operation centers to provide support for Avaya clients. Although we executed the distribution agreement only two months ago, we are making significant progress in these fundamental areas that are the foundation for future success.

It is important to note that we were not given a book of business from Avaya at the start of our new relationship. Our sales team once certified must build their own pipeline of opportunities and close their own deals. This takes time. As a result, we are not expecting meaningful revenue to be generated from our new Avaya relationship in the near term. We do not expect that the investments that we are making to rebuild the Avaya business relationship in advance of revenues will have a material impact on our financial model.

Our complete portfolio of voice offerings gives Black Box the ability to deliver the appropriate communication solution to our clients regardless of their size or need. We announced a great example this morning with the Cisco solution that we are providing to the Pioneer Medical Group.

Pioneer Medical Group selected Black Box to implement and maintain a state-of-the-art communication solution including updating the organization’s wide area network infrastructure and deploying a Cisco unified communications platform. I am also proud to report that our Black Box team has been awarded the Service Excellence Award from Aspect. This is a third consecutive year that we've been recognized with a distinction. Black Box received this award by earning the highest satisfaction of any Aspect North American partner for resolving customer issues.

In addition, we announced that we've extended our platinum level partnership with Aspect through 2010. On the product side, we announced earlier this quarter that our Veri-NAC Network Access Control product was selected among the top products in its category by SC Magazine.

I'd also like to take a moment to welcome our newest board member to the company, Mr. Bill Hernandez. Bill joined our board during the quarter and Bill recently retired from his position as Senior Vice President of Finance and the Chief Financial Officer of PPG Industries.

We have talked a lot today about the steps that we've taken to prepare Black Box for a general economic recovery. Over the last year we've taken actions to right size our workforce where appropriate. We expanded our technical capabilities through investments and strategic acquisitions and expanded our served market with new partner relationships. I believe that as our market grows we will not only grow with it, but we will take additional market share on the strength of our new relationships and our new product offerings.

In addition, we will continue to make strategic acquisitions to enhance our skills and to expand our customer relationships. I know that the entire Black Box team is prepared to drive value for our clients and our shareholders. We would like to now open up the call for any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question is from the line of Greg Burns with Sidoti & Company. Please go ahead.

Greg Burns - Sidoti & Company

Looking at your guidance as mid-points around $242 million and if we back out $11 million from the third quarter here, it’s about sequentially in line, typically we would see normally some seasonality there, a little drop off in the fourth quarter, I am just wondering if you are seeing some increased demand in your end markets that’s the reason for the less than normal seasonality?

Mike McAndrew

Yes, I think really the primary driver that seasonality that we have seen in the past has kind of been diminished as in particular as our federal client base has grown, and we are last tied into some of the cyclicality of retailers as an example. So we wouldn’t necessarily point to anything at this point out of the ordinary except for that pretty consistent performance from our federal client base which two years ago was in the 10% to 12% of our revenue to push in 20% or more, now that’s really driving some of that less seasonal revenue, Greg.

Greg Burns - Sidoti & Company

Okay and in regards to Avaya, are you seeing any increased bidding activity now that Avaya and Nortel have kind of come to an agreement amongst your customers.

Terry Blakemore

We believe there is some increase there and we have seen a lot of the uptick in the bid efforts, especially in the upgrade and expansion mode. We are seeing that primarily on the federal government side and some in the medical vertical that we operate in.

Greg Burns - Sidoti & Company

As you ramp up Avaya here, I am trying to understand, it doesn’t seem like it's going to have much impact on margins if you give us a little more color there and then building on your Avaya capability is kind of put on hold any acquisitions or does this kind of expand your potential targets.

Mike McAndrew

Yes, I think we don’t think it has really an impact on the M&A activity, although I will say that over the last couple of years we’ve had to discount some Avaya-based revenues and targets we looked at, so that opens up on the M&A side. The investments we are making there Greg, are as Terry pointed out in his comments, they will not have a material impact as we are developing this over the next three to six months and ultimately as we train our technicians and our sales folks and get recertification on our NOC that will enable us to go out and capture some of that business.

So really what it does for us is it was really the big gap in our portfolio that was filled out and we will keep you guys clued in as we start getting some traction there on the revenue side, but in the near term, we don’t really see any material movement as it relates to anything upscale. Relative to margin profile which I think was other part of your question we have been in the Avaya business up until 2007 and we believe that profile is similar to that of our technology partners as we're delivering solutions and providing maintenance support for their Avaya applications.

Operator

And our next question from the line of Scott Blumenthal with Emerald Advisors. Please go ahead.

Scott Blumenthal - Emerald Advisors

Could you maybe step back and kind of characterize the effect that the recession if you could has had on the Avaya reseller channel and how that presents an opportunity for Black Box.

Terry Blakemore

Actually over the past two years, we were not allowed to market or install the Avaya product, so I don’t think it’s really had a big impact because we had a sizeable base there that kind of tapered off. Over the past two years, we've really not been that active on the Avaya side at all, but now as we ramp back up we certainly think by mid 2011, we think our capabilities will be fully engaged and our NOC and are up and running and all of our technicians trained.

So we certainly see this is as favorable going forward and as Mike said, it was one of the big gaps in our portfolio that we continually had to dance around and we're just proud to have it, we think it’s going to be very positive for the company going forward, but we do have this ramp up here for the next three to six months to get over.

Scott Blumenthal - Emerald Advisors

Do you think that part of the incentive for Avaya I guess it basically tend to kind of coming back to Black Box, is that they were feeling some pain and possibly some dislocation in their reseller channel without you and that you’ve had to now kind of fill some gaps where they might have lost resellers due to the recession?

Terry Blakemore

I think it was as joint effort, Scott actually and with their anticipation of their bid effort on the Nortel asset which happened many months ago. They knew we were a big player in that space and had a large customer base and had maintained that for a number of years. So, I think that certainly was part of the attraction to us, as well as we were a platinum partner back several years ago with Avaya and had a very large base. We were in their top 15 dealers in the country.

So, we continue to try to get up to speed and get everybody certified on the latest and greatest technology by Avaya and right now our primary concern was to maintain and protect our Nortel base which we are doing and I can tell you Avaya has been very easy to work with there and very supportive of our efforts and we hope this time or next year we hope to have a sizable Avaya base on top of the Nortel base.

Mike McAndrew

Yes, I think to add to that, Scott is, it’s pretty clear Avaya has been public in their view of embracing the channel partners relative to their go-to-market strategy, they demonstrated not just with Black Box, but with some other non-core Avaya channel partners that they have signed up and communications to their channel over the last year so. So I think that all kind of comes together relative to a good positive working relationship with Avaya/Nortel.

Scott Blumenthal - Emerald Advisors

Okay, Mike I think that the last time we spoke which was within I think the last 60 days you might have alluded to the fact that this appears to be more and more of a partnership between Avaya and Black Box where Black Box gets the benefit of a relationship with Avaya and Avaya really couldn’t do the Nortel thing without the Black Box’ support.

So can you talk about and I know Tim mentioned that you weren’t given a book of business when you became Nortel partners again. But can you talk about how maybe the folks over at Avaya have been leaning on you because you are the 800 pound gorilla in the space and maybe some benefits that might flush out from that?

Mike McAndrew

Yes, I think just to clear that up I think what I said is our position with the Nortel base as Avaya was looking into transaction, clearly it would be in the benefits of both organizations and ultimately our clients for us to have a good partnership and so then there was really the motivation from Avaya standpoint and our motivation from Black Box standpoint.

What we bring to the dance that we talk about how we differentiate ourselves out there, we are kind of a unique channel partner I believe as it relates to the breadth of our services, the scale we have and relationships we have in the Fortune 100 circles and with some of the system integrators that perhaps were best positioned to assist Avaya in what all the technology partners are out there doing which is ultimately to capture market share.

Ultimately, the right products we believe that we're a good partner when advocating to the client and our trusted relationship with the client with a good product is a great marriage for everyone.

Terry Blakemore

Yes, just to expand on a little bit, Scott there the Nortel business program, they basically were about 90% of true channel prior to their acquisition by Avaya. They had about 10% direct and about 90% of the business flow through the various channel partners and Avaya at one time was about 50-50 and now Avaya's new management team, the executive team there they're reverting back to supporting the channels on number new opportunities as they arise and so it’s two different types of go-to-market to see whether they are coming together under Avaya now. So we're just proud to be part of that and look forward to continuing to support our customers and going with both products.

Scott Blumenthal - Emerald Advisors

That’s Terrific. Mike you gave us 43.84 I think team members and then you broke them down amongst the various segments? Could you repeat those?

Mike McAndrew

Yes, hold on one second

Scott Blumenthal - Emerald Advisors

I got the 600 hot line.

Mike McAndrew

Yes no problem. Let me just get to that chart here, Yes, we have about 2600 in voice, 12,00 in data and 600 in hotline.

Scott Blumenthal - Emerald Advisors

Have you been hiring?

Mike McAndrew

In spots, we are seeing growth obviously, we need resources to service that. We talked about, we actually have had some reductions within the quarter, because everyone is not growing. We are looking at the aggregate, we’ve different markets that are moving one way and some the other way.

So, in certain markets, we are hiring and in others we are kind of taking it out. So again, in this branch philosophy that we run and there is ebbs and flows in there. We are really looking forward to a less dynamic activity on the downside for sure. And we are hopeful that when this turnaround does occur that we are back into growing our team members and servicing and expanded revenue stream.

Operator

Our next question is from the line of Nat Kellogg with Next Generation Equity Research. Please go ahead.

Nat Kellogg - Next Generation Equity Research

How big was the Avaya business before they decided to take all that in-house?

Mike McAndrew

Yes, we were running approximately at that point about $50 million in revenue.

Nat Kellogg - Next Generation Equity Research

Annually?

Mike McAndrew

Yes, annually. We did retain some revenue, $10 million to $12 million we have been doing in the last couple of years really related to maintenance contracts that we had at the time Avaya didn’t renew our agreement and we did retain about $10 million to $12 million worth of annual revenue for the Avaya solution with specific clients under contract.

Nat Kellogg - Next Generation Equity Research

And what happened to most of the folks that were focused on the Avaya product line, both from a technician standpoint and a sales person standpoint, what happened to most of those folks.

Terry Blakemore

Most of the team actually ended up going to work for some of our competitors, other channel partners that Avaya had and in few events we had employees that went to work directly for Avaya on the larger national/global accounts that we were maintaining.

Nat Kellogg - Next Generation Equity Research

Is it worth it or is there an ability to get any of those people back, especially the people that are working at Avaya, if Avaya changes the strategy, is that an option or is that, that’s really not the best way to go.

Terry Blakemore

Well I mean our marketing efforts are widespread as you could imagine, so we are trying technically to get up to speed which we are making a lot of headway there and we are going to go try to capture some business. So if any of those people are interested in coming back, we will certainly talk with them, but our interest is going out to gaining net new customers.

Nat Kellogg - Next Generation Equity Research

Okay. Alright that’s helpful and then Mike on the charges, those are in SG&A, the severance charges.

Mike McAndrew

Yes, those are all in SG&A.

Nat Kellogg - Next Generation Equity Research

Okay. And the $11 million in government revenue you guys did this quarter, that was sort of a one-time or an item that moved forward, was that particularly low gross margin, that’s what drove the overall gross margin down or that combined with your other federal business drove that gross margin mix down?

Mike McAndrew

Our federal government business does have a large GP characteristic to it. This particular piece of business I wouldn’t say it’s an anomaly, will just normally be spread out a little bit more and but that particular job was in the low teens from the GP standpoint.

Nat Kellogg - Next Generation Equity Research

Okay. So you would expect obviously the gross profits to bounce back a little bit, I mean obviously that’s in your guidance?

Mike McAndrew

Yes, we are looking at that moving into the fourth quarter and that is we'll get back to 2Q like levels with that mix reverting back to the normal mix.

Nat Kellogg - Next Generation Equity Research

It looks like billings in excess of cost was a little bit higher, was that related to that government revenue, was there something going on there or that sort of that for you guys to able to sort of bring that down and collect some of that as we move in to the fourth quarter.

Mike McAndrew

Yes, you’re right on there we have a couple of large contracts that we have milestone billing and this happens to be the big driver in that increase. So as we invoice that out, roll in AR and then ultimately we’ll collect it hopefully before March 31. That’s our objective, but it’s typical on some of these larger projects relative to the billing cycle and as we're recognizing revenue on a cost-to-cost basis for them to get out of sync a little bit.

Nat Kellogg - Next Generation Equity Research

Okay and then it looks like the CBS technologies you guys paid a little over about $10 million bucks for that?

Mike McAndrew

You look at cash flow there, that actually was two acquisitions in there. We bought CBS technologies, but we also bought a company, Quanta, both of these were roughly $12 million in revenues and that sort of a combo pack in there. We did both of those deals in January.

Nat Kellogg - Next Generation Equity Research

Tell me did you pay and that was $12 million as well.

Mike McAndrew

Yes so in total, $24 million revenue between the two.

Nat Kellogg - Next Generation Equity Research

Okay that seems to be a little bit lower price to sales than you guys maybe have been paying recently. I mean that’s just due to the economy or that was mostly federal business and seemed like pretty steady performer correct.

Mike McAndrew

Well that one was actually commercial business. Quanta was the federal business and so where do we attribute that to? Good negotiation and a willing partner on the other side. Let’s see if we can keep those kind of metrics up.

Nat Kellogg - Next Generation Equity Research

Brilliant management.

Mike McAndrew

It’s something like that.

Operator

And our next question from the line of Jeff Beach with Stifel Nicolaus. Please go ahead.

Jeff Beach - Stifel Nicolaus

Typically looking back, your third quarter is lower sequentially, I think generally than the second quarter and I think some of it, sometimes is the timing of holidays. I don’t know if that was an impact this quarter, but can you remind us and then just looking at modest, but sequential increase when typically your business is off. When end markets are picking up? And are there any end markets that are still in decline to find a bottom?

Mike McAndrew

Let me take the first part and then Terry can talk about the verticals. We talked about the season, I think couple of calls ago, when we were more of a hotline centric mix of business, September was always a strong quarter and particularly it was driven by government spending in their budget cycle. And we were able to realize, we get an order we are able to shift the product out, 95% of our orders go out same day.

So, very little backlog there. So, we are getting demand at the end of the budget cycle. It would increase revenues in hotline domestically in particular. So, we always had kind of seasonal lift there in the September quarter, but back to the investments we have made in the federal business over the last few years through acquisition and NextiraOne's federal business and then ultimately we bought a company called MTS out of Massachusetts, that government cycle occurs, but as opposed to a product-based order, we are getting service orders that ultimately when we get that award at the end of September, there is a planning cycle and the delivery cycle. So that September to December drift again back to this mix of federal business is kind of taking some of the curve out of the seasonality.

So that’s really what’s driving that, Jeff, not only in the third quarter as we roll the same projects as you might imagine, not done in three months’ cycle into the March quarter as well.

Terry Blakemore

On the verticals, Jeff, as we’ve been reporting from the last quarter to the federal activity we had a lot of backlog there. That’s actually converted into contracts or purchase orders and that area has been our most progressive over the last several quarters on the federal side. We’re seeing the most growth there. We’ve also in the medical area where we have large hospitals or campus-type hospitals. We have done a number of new either upgrades to the existing systems or either some new platforms in those cases.

We’ve heard a lot of noise about state governments, that’s anxious to start projects that are earmarked for stimulus funds and we are anxious to get those started as well, but we’ve just not, it doesn’t seem to be flowing yet. The monies are not being released to support those requirements. So, we are hoping soon to start seeing some of that. We’ve only had one opportunity that was in excess of the $1 million that was stimulus related that we could tie that down. But to answer your question the federal government sector is the best vertical going right now and right behind that is our medical, but the others seem to be flat just in take-care-of-it mode and no new expansions at this time.

Jeff Beach - Stifel Nicolaus

No, vertical that’s particularly still in a down swing quarter-to-quarter?

Terry Blakemore

No I think we've been through that with the retail vertical and the financial vertical we're just kind of holding our own there.

Jeff Beach - Stifel Nicolaus

Okay and then the last question going back to this. I don’t know at this point, 6 to 7 year experience with the stock options in those lawsuits and everything, with this settlement today is everything totally put to bed on every aspect of this?

Mike McAndrew

We had a couple of balls in the air on that one. As it relates to the SEC that is concluded, we finished that off in December and so what's still out there is the derivative class action where a settlement has been agreed upon by the parties, but ultimately there’s a process that needs to go through. It involves a notice to the stockholders of the terms of the proposed settlement and ultimately there'll be a hearing before the court consider a final approval of the settlement. And so we're looking for that timeline, knock on wood everything goes fine through that process which we expect at this point that this will be concluded in finality in the next 3 to 6 months.

So that is still open out there although all the related parties are in agreement of how this thing should close out.

Operator

Thank you. (Operator Instructions). We go next to the line of Josh Overholt with ICM. Please go ahead.

Josh Overholt - ICM

A quick question for you on acquired revenue. What was the acquired revenue number in the quarter?

Mike McAndrew

Yes, you are talking within the quarter how much was contributed by that two acquisitions.

Josh Overholt – ICM

Yes, acquisitions.

Mike McAndrew

Yeah, there is actually table in there that you can get to that. It’s approximately $4 million. A sequential $4.4 million.

Josh Overholt – ICM

Okay and what’s the expectation then in Q1 for that same group?

Mike McAndrew

Yes, we got pieces of a quarter. They weren’t all close at the beginning of the quarter. So, we got 4.4, you know they are on a combined $24 million run rate. So, you divide that by four and all things be equal.

Josh Overholt – ICM

Pretty linear revenues and that you acquired as well.

Mike McAndrew

Yes, sir.

Josh Overholt – ICM

Okay. So, the organic growth that you showed this quarter, you’re probably not going to see quite that, but again we have talked a little bit about the seasonality. So, you still pretty happy with the tone of the business you are saying?

Mike McAndrew

I would say relative to this time last year or even six months ago that is a very true statement.

Josh Overholt – ICM

Okay. Next question I guess then is a little bit focusing on the sales force. You are adding Avaya to the product mix, but I am guessing that you’ve got quarters currently for your existing sales force and you are pushing them to meet quotas. So are you going to need to bring on additional sales people to really expand the Avaya revenue or you will be able to do that with your existing sales force and if so how?

Terry Blakemore

Yes, we will do a combination effect on that. We will certainly train and arm some of our existing sales teams to market and support the product. In addition with we will bring on some professionals that already have the knowledge to hit the street running.

Josh Overholt – ICM

Okay and any idea on kind of the size of that force to bring on or is it not going to be really material.

Terry Blakemore

It’s not going to be really material. I mean we are already in the process of working on that and it’s not material event for us.

Operator

And I will now turn it back to our speakers for any closing remarks.

Terry Blakemore

We thank you for your time today and as a reminder, our press release has been filed on Form 8-K and on our blackbox.com website. As Gary mentioned earlier, we will attend a number of investor conferences over the next few months. Please look for the press release describing each of the events in more detail. I look forward to seeing many of you at one of the conferences that are coming up and again thanks for joining us and this does conclude today’s conference call. Thank you.

Operator

Thank you ladies and gentlemen. Today’s conference call will be made available for replay that begins today at 7:00 p.m. eastern time. The replay of the conference runs until February 9 at midnight eastern. You may access the AT&T teleconference replay system by dialing area code 320-365-3844. Please enter the replay access code 140275. That number again, area code 320-365-3844 and the access code 140275. And that will conclude our conference call for today. We thank you for your participation and for using AT&T’s executive teleconference.

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Source: Black Box Corp. F3Q10 (Qtr. End 12/26/09) Earnings Call Transcript
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