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Black Box Corporation (NASDAQ:BBOX)

Q1 2015 Earnings Conference Call

July 29, 2014, 17:00 PM ET

Executives

Mike McAndrew - President and CEO

Tim Huffmyer - VP and CFO

Ken Davis - EVP of North American Commercial Services

Gary Doyle - VP of IR

Analysts

Greg Burns - Sidoti & Company

Brad Evans - Heartland Advisors

Operator

Ladies and gentlemen, thank you for your patience as we assemble the call. Welcome to the First Quarter Fiscal 2015 Earnings Call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Gary Doyle, the Vice President of Investor Relations. Please go ahead.

Gary Doyle

Thank you. Good evening and welcome to Black Box Corporation's first quarter of fiscal 2015 earnings conference call. With us today are Mike McAndrew, President and CEO of Black Box Corporation; Tim Huffmyer, our Vice President and Chief Financial Officer; and Ken Davis, our Executive Vice President of North America Commercial Services.

Earlier today, we announced our first quarter of fiscal 2015 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.

In addition to commentary from our executive team, we have a brief slide presentation supplementing the call. The slides are available for download on the IR section of our website at blackbox.com. For those of you who are accessing the webcast, the slides will present on your screen.

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.

On this call and as presented in today's press release, we will discuss some financial information that includes non-GAAP financial measures, including adjusted operating income percentage or adjusted operating margin, operating net income, operating earnings per share, free cash flow, EBITDA, adjusted EBITDA and revenues excluding foreign currency. We will limit any non-GAAP financial discussions today to the specific measures in our press release.

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.

Now, I’d like to turn the call over to Mr. Mike McAndrew.

Mike McAndrew

Thanks, Gary. Welcome everyone and thank you for joining us today. I’d like to start by recognizing the team for delivering a very solid first quarter of fiscal 2015. Our results reflect sequential and year-over-year growth in North America services revenue and overall revenue backlog.

In addition, overall results were in line with the guidance that we provided in our fourth quarter call. I’m pleased with our progress as we continue on the path to transform the company and generate value for our clients and shareholders.

Before we go into more detail, I’d like to start with a review of our first quarter fiscal 2015 results. Our revenue was 245 million with operating earnings per share of $0.41. We consumed 6 million in cash flow from operations and we continue to provide value to our shareholders with $3 million of stock repurchases and approximately 1.4 million of dividend payment.

As I mentioned, overall, this was a solid quarter. I’ll ask Tim to give us the financial update. Then I’ll come back with additional comments on the quarter, our plan for fiscal 2015 and to take your questions.

Tim Huffmyer

Thanks, Mike. In the first quarter, we posted revenue of 245 million, an increase of 7 million or 3% over last quarter and at the high end of our guidance range we provided last quarter of 240 million to 245 million. Maintenance revenue, which is derived primarily from long-term agreements with our service clients, was 46 million or 19% of our revenue for the first quarter.

Our six-month order backlog now stands at 198 million compared to 183 million at the end of last quarter. The increase in the backlog is attributable to large contracts in our commercial services business within North America.

Gross margin for the quarter was 30.7%, down from last quarter’s 31.7% and consistent with the guidance we provided last quarter of approximately 31%. In the first quarter, SG&A was 64 million which included 600,000 of restructuring expenses. Total SG&A increased 1 million from last quarter’s total of 63 million primarily related to higher operating costs specifically related to non-cash stock-based compensation costs and certain investments related to the analysis and improvement of our services sales process.

Restructuring expenses will reduce our projected SG&A by an annual run rate of approximately 800,000. As noted in prior quarters, we expect the savings generated from our restructuring activity to be invested in our growth programs.

Our adjusted operating income margin for the first quarter was 4.8%, down from last quarter’s 5.9% primarily due to the expected decrease in gross profit margin and non-cash stock-based compensation costs.

First quarter operating earnings per share was $0.41, which was down from last quarter’s $0.48 and within the guidance range we provided last quarter of $0.40 to $0.45. During the first quarter, we rode off certain deferred tax assets related to unrealized performance-based equity awards.

This write-off is considered a discrete item and resulted in an increase to our first quarter GAAP effective income tax rate of 47.2%. Although this discrete item occurred, we are still guiding to an operational and GAAP annual effective income tax rate of 39% for fiscal 2015.

First quarter cash flow used for operating activity was 6 million. The cash outflow in the quarter was driven by an increase in accounts receivable primarily related to in-quarter billing under certain federal contracts. As we have noted in the past, these federal billings have a short-term effect on cash flow and DSO but are fully collectable within the terms of our agreements.

Aggregate DSOs for the first quarter, inclusive of cost in excess of billings and billing in excess of cost, were 84 days, down from our fourth quarter aggregate DSOs of 86 days and slightly below our fiscal 2015 goal of 85 days.

At the end of the first quarter, we had cash and cash equivalents of 28 million and debt of 171 million, resulting in a net debt position of 143 million. This is a $13 million increase from a net debt position of 130 million at the end of last quarter.

Currently, our incremental borrowing rate is 1.5% and our leverage ratio is 2.6 times. While our current ratio is at the high end of our historical leverage ratio range of 1.5 to 2.6 times, I expect our leverage ratio to decrease throughout the remainder of fiscal 2015 as we focus our free cash flow on debt reductions, as discussed at our recent Analyst Day.

Total capacity under our line of credit is 400 million which expires in March of 2017. We remain comfortable with these debt levels based on our historical range and our demonstrated ability to generate free cash flow.

During the first quarter, we repurchased 130,000 shares for $3 million. We currently have authorization to repurchase 950,000 additional shares. Repurchases may continue to occur depending on factors such as cash flow, share price, other potential uses of cash and general market conditions.

While we may continue to repurchase shares for the foreseeable future, there can be no assurance as to the timing or amount of such purchases. We remain committed to a balanced deployment of capital while evaluating long-term growth opportunities for the company and short-term tangible returns for our shareholders.

Now, I would like to provide guidance for the second quarter and fiscal 2015. For the second quarter, we are targeting revenue of 250 million to 255 million; gross profit margin of approximately 31%; operating EPS range of $0.50 to $0.55. This operating EPS range includes stock-based compensation expense of 1.4 million, interest expense of 1.3 million and in operational income tax rate of 39%.

We expect capital expenditures of 2 million and weighted average shares outstanding of 15.5 million. Our second quarter guidance reflects a 1% to 3% increase in organic revenue from the same period last year.

For fiscal 2015, we are targeting revenue of 990 million to 1.010 billion; gross profit margin of approximately 31%; operating EPS range of $2.07 to $2.27. This operating EPS range includes stock-based compensation expense of 6.5 million, interest expense of 5.1 million and in operational income tax rate of 39%.

We expect capital expenditures of 8 million to 9 million and weighted average shares outstanding for the full year of 15.5 million. Our annual guidance projects a 2% to 4% increase in organic revenue from fiscal 2014.

Mike will discuss the programs and initiatives that give us confidence in our ability to generate organic revenue growth in fiscal 2015. This guidance excludes restructuring expenses, intangible amortization and the impact of changes in the fair market value of our interest rate swap.

Now, I’d like to turn the call back over to Mike.

Mike McAndrew

Thanks, Tim. As discussed in our last earnings call and our recent Analyst Day, we’re very focused on generating organic revenue growth in our business in fiscal 2015. Our first quarter results reveal some early green shoots of the growth that we expected.

In the services business, we generated both sequential and year-over-year revenue growth which was entirely from North America. Our Core Telephony and UC business, which has been under pressure for the last few years, was essentially flat with the prior year. Given the dynamics in these markets, we believe relatively flat revenue in the core provides a great base for growth from our other initiatives.

Our Cisco and wireless solutions practices both delivered double-digit year-over-year growth in the first quarter. I attribute this to the investments that we’ve made over the last year and the great work of our teams to deepen and expand our client relationships.

The Cisco pipeline continues to expand as we add opportunities with new and existing clients. Two years ago, our deep Cisco capabilities were primarily region based. In many cases, clients outside of our core region were not fully aware of our Cisco practice and we were not effectively selling into new markets. Our investments are focused on increasing our centralized capabilities and field enablement processes.

Our growing Cisco sales and engineering footprint is positioning us to capitalize on opportunities that we would not have seen two years ago. As a note, 40% of our Cisco backlog is from outside the original core region.

The wireless practice has seen significant increase in opportunities as we align more frequently with carriers and third party partners on DAS and other wireless installations. These arrangements have expanded our addressable market, shortened sales cycles and increased our near-term revenue opportunities.

Although this go-to-market approach comes with lower gross margins than our enterprise sales, we will continue to pursue these opportunities to strategically increase our growth rates and expand our market presence. We’re seeing the effect of the expanded market as the pipeline for wireless opportunities has increased over 30% since year end.

As expected and as we communicated on our last call, the managed service client contract that we announced last quarter did not generate incremental revenue in Q1 as we continue to prepare to go live in Q2. Part of our revenue growth in the second quarter will come from this contract.

Last quarter, we mentioned that we’ve incurred approximately $500,000 of start-up costs for this contract in Q1. Much of that costs has been pushed to Q2 and is included the guidance that Tim provided. As a reminder, this contract is expected to provide revenue of approximately $20 million in fiscal 2015 with an expected annual run rate of 40 million.

We had solid bookings activity in Q1 of this year in the products business which provides good momentum moving into Q2. Although we did not post growth in the first quarter, our guidance for Q2 includes mid single digit year-over-year growth for the products business.

Continuing to change the trajectory of the business requires focused investment. We’ve already discussed the upfront costs with supporting the major managed service engagement, refining our solution practice operations and our sales transformation initiative. Each of these requires a near-term increase in operating expenses with returns expected in subsequent quarters as the initiatives continue to take hold.

The green shoots that we’re pointing to in North American service revenue along with the increased consolidated backlog are early indicators of a change in trajectory. Our commitment to revenue growth will create opportunity for margin expansion in the future.

We’re demonstrating that Black Box has a sustainable and valuable position in our markets and I’m confident that our quarterly results indicate that momentum is building in the business. Understanding that the transformation that we’ve undertaken will take time, I’m very encouraged by our progress and the focused work of our team. I look forward to providing an update after this quarter’s effort.

With that, Sandy, I think you can open up the line for questions.

Question-and-Answer Session

Operator

I’ll be happy to. (Operator Instructions). Our first question is from Greg Burns with Sidoti & Company. Please go ahead. Your line is open.

Greg Burns - Sidoti & Company

Good afternoon.

Mike McAndrew

Hi, Greg.

Greg Burns - Sidoti & Company

Hi. So a question about the backlog, is that primarily coming from Cisco or wireless? Where are you seeing the increases in the backlog?

Ken Davis

Greg, hi, it’s Ken…

Tim Huffmyer

According to Ken, it is in our North America commercial service business.

Ken Davis

Yes. So we continue to grow our backlog. It’s coming from our Cisco practice, it’s coming from our wireless practice, it’s also coming from our managed service offering capabilities that we’ve been talking about here.

Greg Burns - Sidoti & Company

So it sounds like strength in North America. Could you maybe just give us an update on some of the markets, Europe in particular?

Mike McAndrew

Yes. So, we had a tough comp internationally on the product side. If you recall, we had a $6 million quarter in the first quarter of last year quite large for our [box] (ph) business. With that, I think as you look out through this year, we’re looking for incremental returns on our direct sales team that we put in place last year. But when you put it altogether, we’re looking for probably a couple percent down year-to-year in Europe. So one of our I’d say softer markets.

Greg Burns - Sidoti & Company

Okay. Now in terms of cloud, sales are penetrating that market. Is that an issue that’s kind of on the backburner for you or is that something that you’re looking to put more effort behind or what do you feel you need to do to kind of crack the code on being more relevant in the cloud market on the telephony side of the business?

Mike McAndrew

Yes. No doubt that’s the bright spot and the UC market is UCAS or cloud. It is moving upstream. I think if you look out there, probably average number of seats now are in the mid 30s or 40, so certainly coming out of the smaller end of the market into the higher end of the – or mid market SMB. I would say that we had limited success with our direct sales team on that, Greg. As you know, we have a sales initiative going on and one of the areas that we’re focused on is how do we effectively sell our cloud offerings into the market? And I would say today we’ve had modest success. Our pipeline is probably less than $5 million. We’ve had a couple wins but it is not on the forefront relative to some of the other initiatives we have going on but clearly an area that we plan to address here in the coming quarter to identify if there’s a better approach relative to making that offering a legitimate revenue stream from a Black Box perspective.

Greg Burns - Sidoti & Company

Okay. And in terms of managed service pipeline, what does that pipeline look like? Do you have any other kind of (indiscernible) or large type of deals that would move the needle for you in the pipeline of managed services?

Mike McAndrew

Yes. So the answer to that is – I mean this one is definitely a needle mover, right, with significant revenue. The characteristics of this client aren’t unique to that client, so we have identified other opportunities and are beginning discussions or engagement with those potential clients to expand our existing relationship into a more robust managed service engagement. The cycle we went through on the last one took over a year, so this isn’t some – we will have line of sight of this as the material ones come into play. At the lower end, we do have a lot of activity there. On our Analyst Day we talked about a couple clients that we have that are in the medical area and so on. So regionally we are pursuing probably a half a dozen legitimate deals that come in at maybe $2 million a year or so that we’re looking at really around transportation, around medical, hospitals and areas where we’ve had success on a regional level. So relative to the big elephant hunting, the game is on. We’ve identified some targets and we’ll give you updates as we sort of get into deeper stages of weighing those opportunities.

Greg Burns - Sidoti & Company

Okay. And then lastly the partnering you talked about with your wireless offerings, something new you haven’t talked about in the past. Is that something that lends itself to the wireless business in particular or is there other aspects to your business that you might be able to go to market partnering with the carrier or third party?

Mike McAndrew

I’ll take this and I’ll turn it over to Ken on the expansion of what we’re doing in our DAS or wireless practice. But we have relationships with carriers today. We’re under traditional telephony and support side. This is sort of a unique aspect of what the carriers in some of the tower guys are tackling as it relates to high end DAS. So it’s sort of discrete but clearly our relationships that we have in place are beneficial relative to getting the traction we’ve gotten thus far so quickly.

Ken Davis

Yes, and to add to that, Greg, so about six or nine months ago we explored growth opportunities outside of this space we typically operate in which is in the enterprise space and the carriers and the third party builders, the tower builders out there pretty much dominate that particular part of the market. They are the gatekeepers per se. We recognized that there was opportunity there. We made investments going back into last year in engineering and project management capabilities. We’ve met with carriers and the third party builders. They saw value in our capabilities that we can bring to the table for them. So they quickly engaged us on opportunities. We continue to see a lot of opportunity with them. We’ve bid a lot, we’ve won a lot. The GP profile is somewhat different than enterprise. It’s slightly lower but the opportunity for revenue is significant and actually the majority of our backlog increase in North America is attributed to this initiative. So a great opportunity for us in this space. We focused a lot around the wireless with the carriers and the third party builders. We do, as Mike said, work with them out there on the voice side, so they are familiar with us especially the carriers. That relationship has helped us in many instances and in various jobs that we have where we’ve done both UC or voice work as well as wireless. So partnering with those carriers and the third party builders is something that we’re really bullish on and we continue to make investments in.

Greg Burns - Sidoti & Company

Okay. Thank you.

Operator

(Operator Instructions). We have a question from Brad Evans with Heartland. Please go ahead. Your line is open.

Brad Evans - Heartland Advisors

Good afternoon, everybody.

Mike McAndrew

Hi, Brad.

Brad Evans - Heartland Advisors

Thanks for taking the questions. Can you just speak to segment profitability on the products side of your business please for the quarter or maybe whatever timeframe you’d like to maybe frame it for us?

Mike McAndrew

Yes, sure thing. So our products business, we have – let me just grab some trailing data here for you, Brad. On our services business, we run last year at about 6% OM in that business. I’m sorry, I’m looking at the wrong piece here. We ran at around 7% last year. This year, first quarter, 4.4%. We clearly see opportunities in getting this operating margin profile closer to double digits. It has a great fall-through. That platform is very mature and we see tremendous fall-through as it relates to incremental revenue that we achieved and we talk a lot about the direct sales team that we put in place last year. They contributed worldwide about $20 million of revenue. We look for that to increase to $30 million. I think we have some softness in Europe that I mentioned earlier in the call. But we should be seeing mid single digit growth out of our products business on the top line with tremendous fall-through relative to operating margin and we should be seeing that as we work our way through fiscal '15. So it isn’t something that we’re going to have to wait for sometime unless our investments have been made, we have line of sight of growth at least at this point and so we should see margin expansion in that business moving forward.

Brad Evans - Heartland Advisors

Other than absorbing corporate overhead, what are the biggest synergies between the products and the services business as you see them today?

Mike McAndrew

I would say clearly the brand, I’d start there, the Back Box brand has a value we believe as it relates to quality of service and products and service. Other geographic footprint that comes along with our product business enables us for large multinational appliance, most of them domesticated here in the U.S. for us to do work more easily, differentiate ourselves from other partners that they’re looking for on the service side. And I would say those are probably the top two. There are some marginal cost savings as it relates to certain product sets that we use on the service side that are significant on our products business, but I would say that’s marginal at this point.

Brad Evans - Heartland Advisors

Okay. I’m sorry and you said the high incremental should allow you to get that business to what type of contribution margin you think longer term?

Mike McAndrew

I would say, over the next two to three years, we should be pushing 10% in that business.

Brad Evans - Heartland Advisors

Okay. And Tim mentioned the deleveraging going forward is – I understand you got a range of where you’d like to be, but what – is there a level you feel is optimal?

Mike McAndrew

Optimal, I would say – as you know we’re focused internally on getting stronger returns out of our core business. This is a transformation. It’s taking time. We’ve cooled it off on the M&A side but I think M&A – I shouldn’t say I say think, M&A will be a component of the strategy further downstream. I think that as we approach that as an avenue for accelerating growth and profitability in the company, we’d like to be under two times for sure. So the lower half of our range is where we’d like to be in the next probably four to six quarters.

Brad Evans - Heartland Advisors

And right now is there a priority between M&A and buying back stock at this point, does one supersede the other?

Mike McAndrew

Yes, I would say that clearly we don’t expect M&A and we have a lot of great things going on. We’re doing a lot of restructuring in a company and reengineering if you will. So over the next 12 months, you should not expect to see M&A from Black Box.

Brad Evans - Heartland Advisors

So that would imply that perhaps you might have similar to all to be a little more aggressive on the share repurchase program if the stock were to kind of stay at this level in light of perhaps improving fundamentals?

Mike McAndrew

Yes, I think you’ll see a balanced approach. I mean clearly we should see expansion in EBITDA over time as we model out our expectations for this year and carry that out for our longer term business model which will enable us to not only continue to buy back stock but reduce our debt levels.

Brad Evans - Heartland Advisors

I’m just looking at the numbers here, I mean the step-up in debt quarter-over-quarter from fourth to first, I mean that’s largely explained by a timing on the working capital front?

Mike McAndrew

Yes, sir.

Brad Evans - Heartland Advisors

So assuming you can hit your guidance for the full year and perhaps shrink the balance sheet a little bit, that would imply free cash flow in excess of 40 million for the full year. Is that a number that is reasonable?

Mike McAndrew

Free cash flow I would say probably mid 30s to 40, yes.

Brad Evans - Heartland Advisors

Okay. So nearly a 10% free cash flow yield, so it would just seem like while maintaining a prudent balance sheet which we support completely, becoming a little more aggressive on the share repurchase program which seem to make economic sense. Just a statement, I guess, not a question. Okay, thanks guys. Thanks for taking the questions.

Mike McAndrew

Thank you, Brad.

Operator

There are no further questions in queue. Please continue with any comments.

Gary Doyle

Well, we thank you for your time today. And as a reminder, our press release has been filed on Form 8-K and is available on blackbox.com. Mike and Tim will present at the Three Part Advisors IDEAS Conference in Chicago on August 26. We look forward to seeing many of you there. Thank you again and this concludes today’s conference call.

Operator

Thank you. That concludes our conference for today. Thank you for your participation and for using the AT&T Executive Teleconference. You may now disconnect.

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