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SED International Holdings, Inc (NYSEMKT:SED)

F4Q 2011 Earnings Call Transcript

September 14, 2011, 4:30 pm ET

Executives

Brandi Floberg - IR

Stan Baumgartner - CFO

Jonathan Elster - President, CEO

Analysts

JD Abouchar - GRT Capital

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the SED International fiscal 2011 and fourth quarter financial results conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions).

This conference is being recorded today, September 14, 2011. I would now like to turn the conference over to Brandi Floberg. Go ahead, please.

Brandi Floberg

Thank you, Operator, and good afternoon, everyone. Thank you all for joining us today for SED International Holdings' 2011 fiscal year and fourth quarter conference call. Joining us today from the management of SED International are Jonathan Elster, Chief Executive Officer, and Stan Baumgartner, Chief Financial Officer.

Before we begin the call, I would like to remind everyone that during this conference call and webcast statements made that are not historical or current facts are deemed forward-looking statements. These statements often can be identified by the use of terms such as may, will, expects, believes, anticipates, estimates, approximates or continue or the negative thereof.

The company wishes to caution you not to place undue reliance on any such forward-looking statements which speak only as of today's date. Any forward-looking statements represent management's best judgment as to what may occur in the future.

However, it is important to remember that forward-looking statements are subject to risks, uncertainties and important factors beyond the control of the company that could cause actual results and events to differ materially from historical results of operations and events and those presently anticipated or projected.

These factors include adverse economic conditions, entry of new and stronger competitors and adequate capital, unexpected cost, failure to gain product approval in foreign countries and failure to capitalize upon access to new markets.

The company disclaims any obligation to revise any forward-looking statements to reflect events or circumstances after the date of today's call and webcast or to reflect the occurrence of anticipated or unanticipated events.

These factors and others are discussed in the management's discussion and analysis section of the company's reports on Form 10-K for the fiscal year ended June 30, 2011 and periodic filings on Form 10-Q.

These reports are available by visiting the Investor Relations section of the company's website at www.sedonline.com as well as on the SEC website at www.sec.gov.

With that said, I would now like to turn the call over to Stan Baumgartner, Chief Financial Officer of SED. Good afternoon, Stan.

Stan Baumgartner

Thanks, Brandi. Good afternoon, everyone, and, again, thank you for joining our call today. I'll provide a brief review of our financial results for the fourth quarter and a full review of the fiscal year 2011 results ended June 30, 2011.

Net sales for the fourth quarter increased 14.6% to $152.6 million compared with $133.1 million reported in the fourth quarter last fiscal year. In terms of revenue by product category, Microcomputer product sales increased by $20.7 million or 17.9% to $136.4 million driven mainly by increases in hard drive products and software sales.

Consumer electronic sales declined 7.1% to $16.2 million compared with $17.4 million in fiscal 2010. the decline was primarily due to a decrease in lower average selling prices year-over-year and the discontinuance of a consumer electronics product line we were carrying.

Looking at the fourth quarter revenues by geography, both our domestic and Latin America businesses posted strong gains in the fourth quarter of fiscal 2011. Domestic revenues, including export sales after eliminations increased 13.8% to $119.2 million. The increase was driven by computer-related sales including specifically hard drives and software product items.

US export sales for the period net of eliminations grew by 11.7% to $25.2 million compared with $22.7 million in fiscal year 2010. The increase in 2011 was attributed mainly to growth from sales of computer products, specifically hard drives, branded PCs and peripheral devices, including printers and consumable printer products.

Our Latin American sales after translation into US dollars increased 11.3% to $34.5 million. When measured in local currencies, Latin American sales rose approximately 10% with this increase driven by higher sales of computer products, printers and consumable products.

Gross margin for the fourth quarter decreased by 64 basis points year-over-year to 4.7% primarily due to a higher percentage of lower margin hard drives and software sales. When accounting for the impact of foreign currency on our gross margins, including the translation gains and losses, gross margin decreased not by 64 but by 31 basis points compared to the fourth quarter a year ago.

Selling, general and administrative expenses, excluding depreciation and amortization expense and foreign currency translation gains and losses, were $6.5 million or 9.7% increase compared with the $5.9 million in fiscal 2010. The main driver of the increase year-over-year was selling expenses, including commissions, which helped drive the 14.6% sales increase.

As a percent of revenues, SG&A was 4.2% of net sales in fiscal 2011 compared with 4.6% in fiscal 2010.

Operating income for the fourth quarter declined 6% to $933,000 due primarily to the lower gross margins and the 9.7% increase in SG&A associated with the higher selling cost but helping to drive growth.

Net income for the fourth quarter was $443,000 or $0.09 per diluted share compared with $663,000 or $0.14 per diluted share reported in the fourth quarter of fiscal 2010. The decline in net income for the period was primarily due to the decrease in gross margins previously mentioned which combined with a moderate increase in SG&A resulted in the lower income for fiscal 2011 fourth quarter.

Turning towards our full fiscal year results, net sales increased 12.1% to $607 million in fiscal '11 compared with $541.7 million reported in fiscal 2010. Our revenue breakdown by product segment was as follows.

Microcomputer sales, including handling revenues, increased 16.1% to $537.7 million with the growth driven primarily by the increase in computer products and specifically, again, hard drives, PC, peripherals and accessories.

Consumer electronic sales declined 11.7% to $69.3 million compared with $78.5 million reported in fiscal 2010. This drop was due primarily to the decrease in television unit sales but also primarily to lower average selling price year-over-year.

Looking at revenue by geography, our domestic and Latin American businesses both posted strong gains in fiscal 2011. Domestic revenues, including the export sales and after eliminations increased 10% to $467.9 million. This increase was due to an increase in the computer sales and software as previously mentioned.

Our US export sales net of eliminations grew by 5.5% to $89.8 million compared with $85.1 million in fiscal 2010. This increase was also attributed to the sales of computer products and to consumable printer products.

Latin American sales increased 19.7% year-over-year to $139.1 million. When measured in local currencies, the Latin American sales increased by 15.4% with this increase driven by computer products, printers and, again, consumables.

Gross profit for the year improved by $3.2 million to $31.7 million for fiscal 2011, an increase of 11.2%. Gross margin for fiscal 2011 was 5.2% compared with 5.3% in fiscal 2010. The decrease in gross margin was primarily due to the product mix as previously mentioned, including the sales of lower margin items.

On a pro forma basis, including the impact of foreign currency, gross margin decreased by only 3% year-over-year. Gross margin in Latin America, net of currency transactions, improved by 50 basis points in fiscal '11 compared with fiscal year 2010.

For fiscal 2011, selling, general and administrative expenses, excluding depreciation and amortization expense and a one-time settlement charge and foreign currency translation gains, rose 7.9% to $26.6 million in fiscal 2011 compared with $24.7 million in the same period last year.

This $1.9 million increase was attributed primarily to several factors including an increase of approximately $2.1 million or 11.2% attributed to domestic headcount as well as commission and selling expenses associated with driving higher sales growth and, in Latin America, an increase in government mandated wage increases as well as headcount additions made in fiscal 2011.

There was also a decrease or $175,000 in bad debt expense, a net decrease of approximately $350,000 in professional fees, a moderate increase of $150,000 in municipal taxes in Columbia and an increase of approximately $100,000 in other miscellaneous items.

Depreciation and amortization expenses rose to $440,000 in fiscal 2011 compared with $380,000 in fiscal 2010. The increase was primarily due to 2011 capital expenditures representing investments in warehouse automation equipment and upgrades in lease hold improvements.

SED has had significant US dollar denominated liabilities reported in Latin America. The revaluation of the Columbian and Argentina currencies versus the US dollar results in a foreign currency transacting gains of approximately $285,000 in the fiscal year compared with a gain of $201,000 in the fiscal year 2010.

Operating income improved to $4.9 million compared with $2 million in fiscal 2010 which include the $1.9 million provision for contract settlement related to the retirements of a senior executive.

Excluding that provision, the operating income improved 36% year-over-year compared with a 14.6% sales increase.

Income tax expense for fiscal 2011 rose to $831,000 compared with $450,000 in fiscal 2010. This provision was attributed to the income generated by our Latin American subsidiaries as SED in the US has the benefit of a tax loss carry forward.

The higher income tax provision this year was due primarily to the increase in favorable income experienced in Latin America.

Net income in fiscal 2011 grew to $3.1 million or $0.63 per diluted share. This is compared with $300,000 or $0.06 per diluted share in fiscal 2010. However, excluding the previously mentioned $1.6 million provision for the contract settlement, net income improved 64% year-over-year.

SED's return on invested capital for 2011 was 6.6% compared with 6.1% in fiscal 2010. As of the end of fiscal 2011, we had both cash and cash equivalents of $4.8 million. At June 30, 2011, our available borrowings under our credit facilities with Wells Fargo and Helm Bank were approximately $18.2 million after deducting $5.7 million in reserves for outstanding letters of credit.

During the fourth quarter, we reached an agreement with Wells Fargo bank to increase our revolving credit line to $60 million and to extend the expiration date to January 1, 2015 providing increased support for our growth initiatives.

Around fiscal 2011, SED was committed to improving shareholder value and accordingly we reserved an additional $1.3 million for purchases under our stock repurchase program under which 410,307 shares of SED were repurchased in fiscal 2011.

This authorization brings the aggregate dollar amount authorized by the SED board of directors to more than $1.5 million since the inception of the repurchase plan in August 2009 under which we have repurchased a total of 461,915 shares at an aggregate cost of $3.74 as of June 2011.

That concludes our summary of financial results. I'd now like to turn over the call to our Chief Executive Officer, Jonathan Elster. Jonathan?

Jonathan Elster

Thank you, Stan, and good afternoon, everyone. Thank you all for joining us today. Fiscal 2011 was a year of great momentum for our company. We achieved double-digit growth across both our top and bottom line, increasing our net income by 36% on a normalized basis and revenue by 12% year-over-year. In addition, in the last fiscal year, our stock price has appreciated more than 75%.

While macro environment factors and a [fall to] market continue to be prominent headlines, we're a small and nimble organization. This advantage enables SED the flexibility to rapidly adapt to changing markets and consumer demands.

That said, we are not immune to the global economy. With consumer confidence down and a struggling labor market, consumer budget remains high and the back-to-school season was below optimum levels.

During the fourth quarter, our sales mix for the period was weighted more heavily toward lower margin hard drives and software, which impacted our margins. In addition to lower margins, increased SG&A based on achieved higher sales goals had a notable effect on our bottom line for the quarter and market conditions remain challenging.

Even so, our fundamentals remain strong and we expect to continue our growth in 2012 through a number of key initiatives that are well underway. We have a solid mix of product and are working to increase sales of higher margin products as we ramp our small appliance business, leverage our newly expanded vendors and Linecard and emphasize channel segments and sales to drive growth.

Despite uncertain economic forecast, what we have found is that consumers continue to spend money on technology. Having just come from the nationwide primetime show in August, it's clear from attendance and general sentiment that we are optimistic for a reason that extends beyond our business as it remains relatively strong strength among the spending capability of the independent retailer.

It has only been a short six months since we listed on AMEX and we continue to move our business forward, executing on key operational, financial and strategic growth objectives.

In the US, sales grew 10% for the fiscal year, driven primarily by sales of computer products where we continue to see strong demand. The last 12 months, we've added a number of new vendors to further enhance our Linecard offering and we will continue to expand our network of our offerings to address the latest trends and service markets where we see opportunities to grow our business.

To highlight just a few of our recent partnerships, we most recently signed a distribution agreement with Lenovo to expand our notebook, desktop and tablet offering with a specific focus on the SMB market.

We just recently added Asus mother boards to our Linecard for the national partnership with Pinnacle Speakers and expanded our Samsung and Cannon relationships. This past June we signed a massive distribution agreement to become the exclusive North American distributor of all Polaroid imaging and printer products. This high profile brand exclusivity was a huge win for SED.

We also developed a well rounded tablet PC offering during the past two quarters, resulting in a total of 10 tablet brands to offer to our customers. Some of those brands including Acer, USonic, Dell, Lenovo and [Leader].

In the US we have made some small but critical adjustments to our operations to help drive our growth. In addition to strengthening our relationship with key appointments, including Stan Baumgartner as our new CFO, and some recent hires to our sales team, we expanded our distribution center and relocated our corporate headquarters to a property in Lawrenceville, Georgia with greater space and efficiency and warehouse capacity all at a lower cost than our prior location.

As a result of success achieved in certain customer segments through our focused sales approach, we also began implementation of a plan to restructure our sales team to align our sales manager and sales representatives along customer segment channels.

By becoming an expert in a single customer segment, each sales rep will be better equipped to succeed and armed with more knowledge to go to our current customers and potential new customers.

Through the dedicated focus, they will be better able to deliver exceptional service, something we've always taken pride in.

Turning to Latin America, for fiscal 2011, we increased our sales by 15% and we continue to see opportunity for continued product diversification and geographic expansion in this region.

Similar to the US operations, we are expanding our Linecard in Latin America and recently added key vendors for a well rounded offering of products that continue to support our leading sales of computer products, printer and consumable printer product sales.

New vender additions during the year were highlighted by Acer Latin America, Dell and LG monitors, projectors and optical drives. As a result of continuing growth in the segment of our business, we have recently promoted Ronell Rivera to Senior Vice President for Latin America and we welcome his leadership and expertise to the team.

There remains growth opportunity across our business lines and geographies as we will continue to improve and grow our business. One of the most exciting initiatives is a recent launch of our SED Lehrhoff position.

Through ArchBrook Laguna's bankruptcy proceedings in August for approximately $5 million, we acquired substantial assets from their established distributor of small appliances, including inventory, intellectual property and including customer vendor records and a lease to a century located distribution center in New Jersey.

We view this as an extremely low-risk asset-based transaction to augment our current business line, first and foremost, our small appliance offering. Small appliances has been a relatively small business for us to date but one we have seen as quite attractive with healthy margins.

This acquisition strengthens our positions in the small appliance business. The Lehrhoff brand has historically carried annual revenues of $45 million and $55 million with margins in the teens. As we work to resurrect this reputable operation, we expect to return to this run rate and bolster our margin profile with modest contributions beginning in the first half of fiscal 2012.

We mean to get significant progress with this integration, hiring a new staff in addition to selling small appliances also hold consumer electronics related expertise and relationships but also actively transferring customer and vendor contracts to SED to shore up existing Archbrook Lehrhoff relationships.

We see tremendous growth opportunity for SED in both the US and Latin America where we continue to expand our business. As we forge ahead, expense control and margin improvement are key things. Those initiatives and the recent achievements I have outlined are designed to foster these improvements over the course f the fiscal year.

I believe we have a terrific opportunity to capture growth across our business segments and strengthen our foothold in key geographies which will provide the foundation for our accelerated profitability to both our current fiscal year and as we continue to expand our business.

With that said, we'd now like to open the call for questions. Operator, we're ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions). At this time, I show no questions. Your first question comes from the line of JD Abouchar - GRT Capital.

JD Abouchar - GRT Capital

I have a question for you. Obviously the margins got somewhat impacted this year by the softening CE environment. What's your three-year game plan? Where do you think they can go? What steps are you going to take to shore them up in this economy?

Jonathan Elster

Yes, so the margins, as mentioned, were down. Some of the things we spoke about recently that we plan to do, for example, the small appliance business, we have a lot of confidence in that business with Lehrhoff acquisition. That'll bring higher margins.

We also, on the CE side you mentioned we've expanded our category offerings. This past year TVs represented a larger portion of that business. We now have expanded our business into digital cameras with a recent announcement of Polaroid and expanding our relationship with Cannon. We believe that will also help margin.

Another area of cost that I mentioned was our new focus from the sales environment. The restructure of the entire sales force we believe will make our sales people experts in specific channels we should also drive margin.

So those are just a few things that we'll be doing. Again, I'm optimistic. It is challenging. It's a challenging economy. However, we feel we have the right plans in place to achieve higher margins.

JD Abouchar - GRT Capital

Is some of the other areas of CE like cell phones or just generally accessories and stuff, those carry higher margins. Is that an area to expand into?

Jonathan Elster

Well, typically cell phones are the business we're not in today. However, accessories are the business we're in. Again, obviously from selling TVs, all the cabling, the mounts that we do sell should drive higher margins. That’s a business we substantially grew this past year and we'll continue to focus on that business.

JD Abouchar - GRT Capital

Then finally, when we met you were also talking about the fulfillment business, maybe just a quick update there and plan going forward.

Jonathan Elster

Yes, so the fulfillment business is still strong for us. We saw a roughly 32% growth year-over-year in our fulfillment business. That is the end user fulfillment. So one of the main reasons why we restructured our sales force is about two years ago we decided to put more focus on that fulfillment business and we put a sales team dedicated on that channel of business.

We immediately saw growth because those sales reps were experts in that channel. That was the main reason why we restructured their entire sales force. So to answer your question, we're going to continue to focus on that business. Right now, overall in the US, a little bit over 50% of our orders are drop ship to the end user, so we expect to see growth in that channel as we add more vendors and as we add more vendors to those specific customers.

JD Abouchar - GRT Capital

Margins there, above, at, below corporate average?

Jonathan Elster

Corporate average, the margins in the US on the fulfillment customers.

Operator

(Operator Instructions). At this time, I show no questions in the queue. You may continue.

Jonathan Elster

Again, thank you very much for joining us today. Once again, I appreciate everyone's participation. I invite you to watch our progress as we continue to build our business. Thanks for your time today and look forward to speaking with you next quarter.

Operator

Ladies and gentlemen, this concludes the SED International fiscal 2011 and fourth quarter financial results conference call. This conference will be available for replay after 7:30 Eastern Standard time today through midnight September 28 Eastern Standard time.

You may access the replay system at any time by dialing 1-800-406-7325 and entering the access code of 4469260. Thank you for your participation. You may now disconnect.

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