Black Box Corporation (NASDAQ:BBOX)
Q3 2016 Earnings Conference Call
January 26, 2016, 5:00 pm ET
Ron Basso - EVP
Mike McAndrew - President & CEO
Tim Huffmyer - VP & CFO
Greg Burns - Sidoti
Good day, ladies and gentlemen, and welcome to the Black Box Corporation Third Quarter of Fiscal 2016 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions].
I would now like to introduce your host for today's conference Mr. Ron Basso, Executive Vice President of Black Box Corporation. Please go ahead, sir.
Thank you. Good evening and welcome to Black Box Corporation's third quarter of fiscal 2016 earnings conference call. With me today are Mike McAndrew, our President and CEO; and Tim Huffmyer, our Vice President and Chief Financial Officer.
Earlier today, we announced our third quarter fiscal 2016 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 in the Investor Relations section of our website, blackbox.com.
In addition to commentary from Mike and Tim, we have a brief slide presentation supplementing the call. Those slides are also available in the Investor Relations section of our website. 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 certain 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 in 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 non-GAAP financial measures. Please refer to the schedules that accompany the press release for a reconciliation of these non-GAAP financial measurements to the most directly comparable GAAP financial measurements and other supplemental information.
Now, I'd like to turn the call over to Mike.
Thanks, Ron. Welcome everyone and thank you for joining us today. I'd like to start with a review of our third quarter of fiscal 2016 results. Our revenues were $222 million, with operating earnings per share of $0.37, and cash from operations of $29 million.
During the quarter, we experienced above average gross profit margin that along with our cost containment efforts allowed us to come within our profit guidance despite lower than expected revenues. As expected, we had a strong cash flow quarter. This allowed us to achieve our lowest net debt position in over 10 years and to reduce our leverage ratio to 2.8 times.
Regarding our revenues for 3Q 2016, our Federal business and products business performed as anticipated, and so our mix was primarily due to our commercial services business. Currency also had a slight impact on revenues for the quarter. But our immediate challenge continues to be sales execution in our commercial services business. Following Tim's remarks, I will discuss this in more detail.
Our revenue mix in 3Q 2016, along with a sequential decrease in backlog in both our commercial and federal services businesses, are negatively impacting our view for the remainder of fiscal 2016. Our federal business will also be adversely impacted by a delay in a large project that was scheduled for 4Q 2016. Given that we've not been achieving our revenue guidance; our revised outlook to some extent reflects an addition dose of conservatism due to the performance of our sales organizations and our federal business. In addition, we expect gross margin to return to more traditional levels and that is reflected in the 4Q 2016 guidance.
Given this outlook, we will continue to focus on managing our expenses in line with these lower revenue and margin expectations. But while we remain diligent on appropriate spending levels, we recognize that we cannot cut our way to greatness. We must overcome the challenges of sustaining top-line revenue growth so that we can invest in our business to take advantage of our assets in the markets in which we compete today and to develop new offerings to move into adjacent markets that are relevant to our clients.
After Tim provides the financial update; I will talk about some of the measures we're taking to address our sales challenges and to take your questions.
Thank you, Mike. As Mike noted, for the third quarter we posted revenue of $222 million, down $14 million or 6% from $237 million last quarter, and slightly below our guidance range.
Products performed near expectation. Currency had a negative impact of approximately $1 million to the third quarter revenue shortfall relative to guidance. Within North America services, our federal services business performed as expected and consistent with last quarter's guidance.
Within the commercial services business, the solution practices and our large managed services contract also performed as expected. Core commercial activity was again lower than expected due to some of the challenges that Mike will discuss. As a reminder, we consider all of our commercial services business, other than our solution practices, and our large managed services contract, as our core commercial services offering.
Maintenance revenue which is derived primarily from long-term agreements with our services clients was $43 million or 19% of revenue.
As Mike noted, backlog is down, six month order backlog is $173 million, down $9 million from $182 million last quarter, and up $4 million from $169 million in the prior year. The sequential decrease in backlog is related to North America services most notably related to the core commercial activity due to lower bookings and the federal business due to a lack of past quarters.
Gross margins was 31.3% up from 30.1% last quarter and above our guidance, all related to product and service mix. As Mike noted, we anticipate gross margins returning to traditional levels next quarter.
In the third quarter, SG&A was $60 million which included $900,000 of restructuring expenses and was in line with our guidance. The restructuring expenses mentioned will reduce our projected SG&A by an annual run rate of approximately $1 million.
Adjusted operating income margin was 4.7% up from 4.6% last quarter and down from 5% in the same quarter last year. Operating earnings per share was $0.37 and within the guidance provided last quarter. The operational income tax rate was consistent with our guidance at 38.5%.
During the third quarter, the GAAP effective income tax rate was 1% down from the second quarter rate of 14%. The 1% tax rate is the result of a reduction in the liability for uncertain tax positions, partially offset by the write-off of deferred tax assets associated with equity awards. Our GAAP annual effective tax rate is expected to be 12% for the fiscal 2016 which includes the impact of the non-deductible goodwill from the second quarter. We continue to guide to an operational income tax rate of 38.5%.
Cash flow provided from operating activities was $28.8 million up from cash flow used for operating activities of $6.5 million from last quarter. Our year-to-date cash flow provided from operating activities now stands at $14.9 million up from cash flow provided from operating activities of $9.5 million in the prior year.
DSOs were 62 days up from 59 days in the prior quarter and the same as the prior year. Aggregate DSOs inclusive of cost and excessive billing and billings in excess of cost were 80 days down from 83 days in the prior quarter and down from 84 days in the prior year. Our fiscal 2016 goal is 80 days.
We have net debt of $111 million down $20 million from $131 million in the prior quarter and down $32 million from $143 million in the same quarter last year. Our leverage ratio now stands at 2.8 which is close to our near-term target of 2.6 and within our historical range. Our current incremental borrowing rate is 2.1%.
We currently have authorization to repurchase 670,000 shares. Repurchases may occur depending on factors such as cash flow, share price; other potential uses of cash and general market conditions. While we may repurchase shares, there can be no assurance as to the timing or amount of any repurchases.
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 will provide guidance for the fourth quarter and fiscal 2016. For the fourth quarter, we are targeting revenue of $217 million to $222 million, gross profit margin of 30% to 30.5%, operating EPS range of $0.25 to $0.30. This operating EPS range includes stock-based compensation expense of $1.1 million, interest expense of $1.1 million, operational income tax rate of 38.5%. We expect capital expenditures of $3 million and weighted average shares outstanding of $15.4 million.
The mid-point of our fourth quarter guidance reflects a 10% decrease in reported revenue from the same period last year. Foreign exchange will impact our revenue in the quarter. At current rates and the mid-point of our guidance; revenue will be negatively impacted by foreign exchange by $1 million compared to prior year. This impact is reflected in our guidance.
For fiscal 2016, we are targeting revenue of $905 million to $910 million, gross profit margin of 30% to 30.5%, operating EPS range of $1.21 to $1.26. This operating EPS range includes stock-based compensation expense of $5.4 million, interest expense of $5.2 million, operational income tax rate of 38.5%. We expect capital expenditures of approximately $11 million and weighted average shares outstanding of $15.4 million.
The mid-point of our annual guidance projects a 9% decrease in reported revenue from fiscal 2015. Foreign exchange has and will impact our revenue in the fiscal year. Based on actual results to-date, assuming current exchange rates and the mid-point of our guidance, revenue is negatively impacted by foreign exchange by $15 million compared to prior year. Again this impact is reflected in our guidance and at the mid-point of our annual guidance implies a 7% decrease in revenues from last year.
In light of our revised guidance, we will continue to align operating cost with projected revenue levels, while maintaining an appropriate level of investment to support our essential transformation initiatives. As certain phases of our initiatives are achieved, opportunities exist to remove redundancies within the business and become more cost efficient. Our guidance excludes restructuring expenses, intangible amortization, the goodwill impairment loss, and any cost related to recruiting and hiring a new Chief Executive Officer.
Now I will turn the call back to Mike.
Thanks, Tim. I would like to spend a little time talking more depth about our businesses. First, our product business remains on track for modest organic growth in fiscal 2016. More importantly, we've proven that the strategy of focusing on key technology ecosystems in which we can be a leading player primarily through strong channel partners and integrators is a successful one and allows us to differentiate in markets. We will continue to work to identify additional opportunities in markets that fit these criteria for the products business as we move forward.
We also know that we need to continue to focus on our run rate products business as well since many clients are dependent on us to have the products and solutions they need on a day-to-day basis to keep their networks operational. This blend has proven to work well and generates attractive margins and steady cash flow.
In our federal business, as I mentioned in the past, we secured key contract vehicles that will enable us to compete for some very large infrastructure and UCC projects that are needed to upgrade those networks on many armed services bases as well as to participate in relocation projects such as the one we've been performing in Korea over the last several years.
Our track record of success on winning projects and our sweet spot is good and so I believe that this business is poised for growth once funding on those bid opportunities begins to present itself. As you might imagine reasonably we spend a lot of time focusing on our sales organization in our North America commercial services business evaluating what is working and what is not.
As we previously discussed, we launched the national sales organization on April 1, 2015. We developed and trained our sales team on our new sales process and enabled them with experienced sales leadership, focused account management, and more effective tools including a single CRM. Our goal for this unified national sales team is to better position them to present our clients and perspective clients with the full suite of our solutions enabling those client to see the value we create from our distinct competitive advantages. We developed marketing tools and training to enable our sales teams to access the resources of our entire services business so that they can feel comfortable in representing our entire portfolio to clients.
This we believe will enable our sales team to provide existing clients with more services opening the opportunity to gain greater wallet share from those clients who already consider Black Box a value added partner and to create greater opportunity to attract new logos as a result of expanding the solution set offered to the market.
With our new sales organization including tools, training, structure, and support, we have in many instances changed the level of conversation with our clients. Our clients are increasingly looking for a strong and reliable partner that is willing and able to take responsibility for key functions and help manage their complex IT environment, so called bundled or managed services.
In our new sales structure, we are more and more having these discussions, where groundwork engagements with our clients regarding these services. This can involve projects, staffing, service level agreements, and we have the ability to add value to clients through these engagements. In many instances, we are introducing our clients to services as they did not know we even performed.
As clients migrate from complex legacy multiplatform environment that they built or acquired over the years to newer UCC platforms, we're one of the few partners that can manage that type of transformation. We've had some recent wins that show that there is a demand for such services. With these types of engagements and discussions take time to develop and require the right team to gain the clients trust.
We've seen our late stage, or active, pipeline grow throughout the year and this is encouraging. We've learned that these engagements have a longer sales cycle and those take time to reach bookings and additional time to revenues as compared with legacy project work.
We must continue to build our pipeline with qualified opportunities but also must focus on turning those opportunities into wins.
However we also learned that not everyone could perform in this new environment and we've accelerated the pace of change of low performers. In 2015 calendar year, we replaced more than 20% of our sales team and we anticipate that will reach 30% by fiscal year end. For new account managers, we have instituted a formal onboarding program to speed up their acclamation process. For performing team members, we continue to focus on training to increase their ability to cross-sell all of our solutions into our client base.
For sales management and support teams, we're emphasizing the need to continue enforce our sales strategy, sales process, and sales activity. Here is some of the additional steps we're taking to increase the effectiveness of our sales team. Our new sales organization introduced focused account management across our entire platform in a way that was new to Black Box. We are developing detailed account planning workbooks to enable our teams to be more effective within their client's, the respective accounts, leveraging those techniques we found to be the most effective.
We've developed programs to capture new logos and assign those to the teams. Over 6,000 new prospects were identified and assigned in this program. We've developed programs around maintenance renewals. We now have a singular focus on these opportunities to renew maintenance contracts or to convert those opportunities to new solutions. We also recognized that our markets are constantly changing and we're focused on placing emphasis on those markets that are growing, particularly managed services. We need to make further investments in this area so we can stay ahead of the markets to ensure that our offerings are relevant and valued.
With our new CRM tool, we have the ability to measure, monitor, and focus sales activity. While we have improved during fiscal 2016, we need to continue to make improvements in this area to ensure that our teams are engaged in the right activity to drive revenue growth.
Obviously, I'm greatly disappointed in our results to-date. However I believe that the changes we made were essential and correct for the future of this company.
We may have to make some adjustments and alignment, but the general direction is correct. As you know, in December, we announced that I will be transitioning out of the business. Our board is fully engaged on external recruitment of my successor, and as we noted, I will remain fully engaged in the business until my successor is identified and onboarded. So it's somewhat bittersweet that I may not be here long enough to see the full success of this transformation. We're very proud that we have the courage to change the direction of the company and that my team was willing to take on this tremendous task to position Black Box for long-term success.
Now I would like to open up the line for questions.
Thank you. [Operator Instructions].
Our first question comes from the line of Greg Burns of Sidoti. Your line is open.
So in terms of the challenging sales environment or the declines you're seeing, how can you be sure, can you just give us a sense of how much of that is Black Box specific as opposed to market related, is it really just your -- the challenges you're having internally in the sales force or is there something going on in the market that where you're losing share. And to that point, I know you're giving them a platform to sell. But I assume you didn't take away their ability to sell what they knew how to sell well. So why can't you just revert to that and fill the gap if they're having challenges elsewhere?
Yes, so let me talk with evaluating the broader scenario, we are operating; our two primary markets are the infrastructure market wired and wireless and unified communications and collaboration. Our view, the big analysts have come out here in the next several months to tell us how 2015 shaped up. But there are some bellwethers in this space of why Cisco's collaboration line on the infrastructure side comps go both public companies. I think it's fair to say looking at how they have performed throughout the year and really the larger analysts that were projecting the year that is a flat to modestly down market.
Clearly we are down more than that operating over the last nine months and then taking into our projections into fourth quarter 12 months, we're going to be down 8% or so. Some of that is Fed has its own characteristics, but on the commercial side, we will be down around 6% organically.
We -- so from that standpoint Greg it isn't really a market issue and these are large markets combined $30 billion. So I don't think we can look to the market as being the reason we're down, it really comes down to sales execution. As you know we've gone from a product centric branch based approach to the market to a broader solution selling to our clients bringing that portfolio lining under a common sales process. I think that when you look at that in a broader scheme, we're trying to move upstream, right, we're trying to get beyond our initial contacts to higher up in the chain and may be even broader within the client decision making tree and really bringing our broader portfolio to those clients leveraging the relationships we've had in place. Really thought that was the first place to go, the lowest hanging fruit.
We had established credibility under one of our solution sets and really leveraging that. We do have sales team members that are executing very well in that environment and growing year-to-year and expanding wallet share within the client base. And I think others have either through reluctance to adopt the process, or inability to embrace and use the process and the tools we put in place unable to perform.
I think if we were to take the premise of working back to -- reverting back to, if you will, older sales patterns, we would clearly not be in the position we need to be in as it relates to adding additional services and really building on our managed services opportunity and we really see that longer-term that is -- that's what we need to be doing. So I think that addresses the second part of your question.
Okay. And last call you had talked about the pipeline and kind of give a breakdown of the size, the percent that was in kind of late stages --
Could you just maybe give an update there?
Sure. Yes. So we have, I would say we had market improvement from our first quarter to the end of the second. What I talked about at that time, Greg, is a reminder o everyone on the call, and I'll talk commercial services, and then I'll hit the Fed side.
We had about a $1 billion pipeline in aggregate and what we were calling late-stage or active pipeline out of that $1 billion, it was about $550 million. As we move into the third quarter, our pipeline still is at about $1 billion and our late-stage is at about $525 million, so modestly down. Similar characteristics I would say at a macro level similar characteristics to what we saw as we came out of September what we're seeing coming out of December.
On the Fed side, the pipeline is large; it's almost hard to put that math in here. But if you look at late stage on the Fed side that number has also been increasing went from $75 million in Q1 to $100 million in 2Q and it's now north of $200 million, again funding decisions need to be made around that and has its own characteristics. But in aggregate we feel like we have a solid pipeline, a significant amount of opportunities in the active stages, and again, as we've pointed out last quarter around converting those wins and accelerating where we can the process to move that into backlog and then ultimately into revenue.
Okay. What percent of revenue is Fed currently and may be on an absolute dollar basis if you could let us know where you are at now and may be where you were historically before that kind of market fell apart just to give a sense of where we are in the cycle?
Yes, sure. And these are we're not as clean on the Fed piece because there is some mixing and matching clients, but this is materially correct, Greg, and I'm talking on the services side now not on the products business. Our federal business was roughly running about $120 million per year in FY '14 and also in FY '13. I'm sorry FY '14 and FY '15. In the current year, we're looking at an approximate $90 million of revenue there. So it's come down 25% from $120 million to $90 million.
Okay. And in terms of the cash flow, do you still expect to get to that kind of $13 million still range for the year?
Yes, we're comfortable with that. We talked on the last call of our confidence as it related to generation lot of cash here in the December quarter. I would say that we have a high confidence that we will be able to hit our annual targets of low to mid-30s cash from operations number with what we're seeing going on here into fourth quarter just on the balance sheet we saw unbilled come down pretty dramatically moving to AR. Again there is -- we're pretty consistent once we get those invoices out to the clients, whether they be federal or commercial turning those around. And so and we've had a pretty good progress even in the first month of this quarter. So we're looking for something in the mid-teens, upper teens as far as cash from ops in our fourth quarter.
Okay. And in terms of the refinancing the revolver where you're at on that and kind of what are the rates or how you're feeling about the pricing on what you're seeing?
So we're engaged with our bank group as it looks on that as you know we had a pretty attractive, I would say better to market deal that we've been running with here for a while. It is slightly out of market, we're in the middle of negotiating, I don't think looks a material change. But I think that we would be surprised if we could replicate the terms we have today. So still in progress, there is a lot of moving parts there Greg, but I don't think anything material as it relates to changes in the pricing grid and the terms.
Okay. And lastly the Fed project that was delayed, could you just give us a little color on that may be what the size of it is and do you expect that to close in the first quarter?
Yes, so it was an approximate $4.5 million, $5 million project. We actually started it in the tail end of the December quarter and internally in the government it was determined that the funding that was allocated to that did not go to that contract vehicle. And so there is an internal process going on in the Fed side to reallocate funding to reengage that project.
So it caused us, we got a little bit of revenue in it, in the third quarter, it's currently on hold and like many of the mechanics within the Fed side it's very difficult for us to predict when that funding will get properly allocated to reengage on that project. Currently we do not have it in our projection for any incremental revenue in our March quarter. But looks that resolved itself we are still the awardee, the project is still on the books, it's a matter of getting funding to it. So timing would be difficult for me to predict at this point.
Okay. And in terms of the OpEx run rate going forward still $59 million or $59 million or is it going down?
Yes, we got that benefit, as we talked about that $59 million goal. We made progress. We saw some of the -- Tim mentioned that we eliminated some costs within the quarter, we got partial benefit in 3Q, we will have additional benefit in 4Q. So I think $59 million give or take a 100, 200 K is the right number, Greg.
Thank you. [Operator Instructions].
And that concludes our Q&A session for today. I would now like to turn the call back to Ron Basso for any further remarks.
Thank you. We want to thank you all for your time today. As a reminder, our press release has been filed on Form 8-K and is available on blackbox.com. This concludes today's conference call. Thank you and have a good evening.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.
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