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Black Box Corporation (NASDAQ:BBOX)

F2Q08 (Qtr End 9/29/07) Earnings Call

October 30, 2007 5:00 pm ET

Executives

Terry Blakemore - President and CEO

Mike McAndrew - Vice President and CFO

Analysts

Joe Gagnon - Atlantic Equity Research

Liam Burke- Ferris, Baker Watts

Novell Bill - Stifel Nicolaus

Operator

Ladies and Gentlemen thank you for standing by, and welcome to the Second Quarter Fiscal 2008 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 be given at that time. (Operator Instructions).

I would now like to turn the conference over to your host, President and CEO of Black Box Corporation, Mr. Terry Blakemore. Please go ahead.

Terry Blakemore

Good evening from Pittsburg, Pennsylvania. As you heard my name is Terry Blakemore, President and CEO of Black Box Corporation. With me today is Mr. Mike McAndrew, our Vice President and Chief Financial Officer.

Earlier today we announced our second quarter fiscal year 2008 results by issuing a press release, and furnishing it to the Securities & Exchange Commission on our Form 8-K. We also posted this press release on our website at www.blackbox.com.

We'll start today's call with a brief overview of our results and certain additional supplemental information. Following this, we will fill questions as time permits.

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 change 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 a press release included in our ongoing SEC investigation and shareholder derivative lawsuit.

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 comparisons. We will limit any non-GAAP financial discussions today to these specific measures.

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 schedules that accompany the press release for a reconciliation of non-GAAP financial measurements to the most directly comparative GAAP financial measurement and other supplemental information.

With that, let’s take a look at our results. Our second quarter revenues were $261 million, a 4% decrease from last years' $271 million, and a 3% increase over last quarters' $252 million. The year-over-year decrease is driven by expected post-transaction revenue attrition from the next Tier 1 acquisition.

Looking more deeply at our second quarter, revenues by the two segments will report, the highlights are as follows. First from a service type segment perspective, our second quarter revenues were comprised of 58% or $151 million of Voice Services, 23% or $60 million of Hotline Services, and 19% or $50 million of Data Services.

From a year-over-year perspective, for the quarter we are pleased with a 5% organic growth we achieved in the second quarter of 2008. By organic growth, we mean revenues excluding the effects of acquisitions in both periods. All excluded revenues relate to our North America Voice Service segments.

By service segment, we had 1% organic growth in our Worldwide Voice Services, 8% organic growth in our Worldwide Hotline Services, and 8% organic growth in our [Wireline] Data Services.

Secondly, from a geographic segment perspective, our second quarter revenues were comprised of 83% or $217 million from North America, 13% or $34 million from Europe, and 4% or $10 million from what we call all others, which is primarily the Pac Rim and Latin America.

Also, we are especially pleased with 4% organic growth in our North American operations and 9% year-over-year organic growth in our international operations. Total revenues for the first half totaled $513 million; this represents a 2% increase from last year's $502 million.

Moving on to profits; our second quarter operating earnings per share were $0.87, a $0.04 decrease from last years' $0.91 and a $0.14 increase over last quarters' $0.73.

As noted in our press release, operating earnings per share does exclude amortization of intangible assets on acquisitions, stock-based compensation expense, asset write-up depreciation expense on acquisitions, historical stock options granting practices and investigation cost, restructuring, severance and other acquisition integration cost, and the change in fair market value of our interest rate swap.

Further details of these expenses can be found in today's press release. In total these excluded items represent $0.23 and $0.25 per share for our second quarter of '08 and the second quarter of '07 respectively. GAAP diluted earnings per share for second quarter of '08 was $0.64, a $0.02 decrease from last year's $0.66, and an $0.18 increase over the last quarter's $0.46.

First half operating earnings per share were $1.60, an increase of 6% from last years' $1.51. In total excluded items represented $0.50 and $0.47 per share for the first half of fiscal 2008 and fiscal 2007 respectively.

First half GAAP diluted earnings per share was $1.10, an increase from $1.04 of last year. Management believes that presenting operating earnings per share is useful to investors because it provides a meaningful comparison of the ongoing operations of the company.

Looking at cash flow, GAAP cash provided by operating activities for the quarter was $5 million, compared to $9 million for the same period last year. Second quarter free cash flow was $8 million, compared to $12 million last year.

The second quarter's free cash flow of $8 million was used towards the following items. $5 million to fund debt reduction, $1 million for dividend payments, $1 million to fund capital expenditures, and $1 million related to an increase in our cash positions.

Management believes that free cash flow defined by the company, as cash provided by operating activities less net capital expenditures plus proceeds from option exercises, plus or minus foreign currency translation adjustments is an important measurement of liquidity, as it represents the total cash available to the company.

GAAP cash provided by operating activities for the six months was $12 million, compared to $22 million last year. Free cash flow was $15 million, compared to $26 million last year. This free cash flow of $15 million was used towards the following items. $8 million was used to fund debt reduction, $3 million to fund prior period acquisition payments, $2 million for dividend payments, $1 million to fund capital expenditures, and $1 million related to an increase in our cash position.

EBITDA for the second quarter of '08 was $28 million, compared to $29 million for the same period last year. Adjusted EBITDA for the quarter was $29 million, down $2 million from $31 million for the same period last year. EBITDA for the first half of fiscal 2008 was $50 million, compared to the $47 million for the same period last year. Adjusted EBITDA for the first half of both fiscal 2008 and 2007 was $53 million.

Management believes that EBITDA, defined as income before income taxes plus interest, depreciation, and amortization is a widely accepted measure of profitability that we believe may be used to measure the company's ability to service its debt. Adjusted EBITDA defined a EBITDA plus non-cash stock compensations expense may also be used to measure the company's ability to service its debt.

For fiscal year 2008, we continue to target reported revenues of approximately $1 billion, corresponding operating earnings per share in the range of $3.30 to $3.50, and cash provided by operating activities in the range of 80% to 90% of operating net income.

Further in connection with the results of the internal investigation of our historical stock option granting practices, the company is in the process of implementing a corrective action plan related to the adverse tax consequences under section 409A of the U.S. Internal Revenue Code for certain stock options granted below fair market value to U.S. team members.

The financial statement impact of these remedial actions will not be known until the corrective plan has been executed and completed, which is expected to occur during our third quarter of 2008. Our targets for fiscal 2008 do exclude these charges as well as other items listed in the press release.

I will now turn the call over to Mike to review some of our key metrics for our company.

Mike McAndrew

Thanks Terry. We'll give those metrics. At the end of the second quarter, we had cash and cash equivalents of $18 million and total debt of $231 million for a net debt position of $213 million. This is a $7 million reduction from a net debt of $220 million at the end of the first quarter.

Currently our interest borrowing rate is 6.6%. Companywide DSOs were 58 days, and this is up 5 days from the first quarters' 53 days. While we typically see an increase in AR from 1Q to 2Q, our established goal for DSOs remains to 50 days, and as such we look to improve in this area throughout the balance of the fiscal year.

As a reminder, each DSO day is currently worth approximately $3 million in cash flow, plus an [8] day improvement's potential is $24 million of incremental cash flow.

Accounts receivable reserve was $14.1 million or 7.0% of the gross AR balance. This compares to the first quarter's AR reserves of $13.7 million or 7.8% of the gross AR balance.

Moving to inventory, our net inventory was $69.8 million, and we are pleased to report inventory turns of 7.9 or 46 days, this compares to the first quarter's net inventory of $69.7 million and 7.5 turns. We are very close to achieving our established goal of 8 turns, and we look to continue making incremental progress on this metric over the balance of fiscal 2008.

Inventory reserves were $21.7 million or 23.7% of gross inventory. This compares to the first quarter's inventory reserves of $22.0 million or 24% of gross inventory. This decrease in reserve is a result of the disposal of fully reserved inventory during the quarter.

From a capital expenditure standpoint, we had new capital expenditures of approximately $1 million for the quarter and $2 million for the six months period. We are currently targeting capital expenditures for FY '08 of approximately $4 million to $5 million.

Excluding the non-cash impact of the interest rate swap discussed in today's press release, interest expense is currently running about 1.7% of revenues. As I've mentioned earlier, our current borrowing rate is 6.6%.

Our projected tax rate for fiscal 2008 is 37.2%. This is an increase from the first quarter’s 36.8%, and it is related to the expected rate of the deferred tax assets related to non-cash book stock-based compensation expense.

There were minimal stock repurchases during the quarter, and at the end of the second quarter, the weighted average common and common equivalent shares stood at 17,752,000. For the beginning 3Q '08 period, this number is approximately 17.9 million shares.

Our six months order backlog now stands at a $166 million. This is a slight increase over both the first quarter of ’08 and 2Q '07 backlog which were at $165 million.

And our team members staffing stands at approximately 4400. Although our team moves between DV&H, somewhat, for perspective, our Black Box team breaks down approximately as follows: 2700 are mostly V that is Voice; 900 are mostly D that is Data; and 800 are mostly H that is Hotline. And as I mentioned, the team does move around a bit, particularly from a DVH marketing perspective.

I'd like to now turn the call back to Terry to conclude our comments.

Terry Blakemore

Okay. Thank you, Mike. In closing we’re very pleased with our overall results for the second quarter. Our Black Box team has delivered strong revenues, operating EPS, and operating cash flow over the first six months of the fiscal year, which are consistent with achieving our targeted ranges for fiscal year 2008.

Similar to the organic growth achieved in the first quarter, we are particularly pleased with a 5% organic revenue growth realized in the second quarter, as well as improved profit margins. The progress in the next Tier 1 integration is continuing to drive the improved operating profitably.

We have a clear strategy with well-defined priorities, as we continue to focus on leveraging our financial strength to add high quality service provider via merges and acquisitions, while continuing to implement programs to deliver strong organic growth. The results we have achieved are evidence that our strategy is working.

In summary, our expectations for Black Box in fiscal year 2008 remained high. We remain committed to delivering the highest quality technical DV&H services to our global client base, while executing a business model that is delivering strong and substantial operating results, which we believe will translate increased shareholder value.

We'll now open up the call for your questions as time permits.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line [Joe Gagnon] of Atlantic Equity Research. Please go ahead.

Joe Gagnon - Atlantic Equity Research

Hi guys, how are you doing?

Terry Blakemore

Fine, Joe. How are you?

Joe Gagnon - Atlantic Equity Research

Good. I have a few questions, on the deferred revenues is that made up of maintenance contracts or what exactly is in there?

Mike McAndrew

Hi Joe, this Mike, yeah that it is maintenance contracts that we have built for and receive payment for expected payment for moving forward.

Joe Gagnon - Atlantic Equity Research

Okay. So, it's all maintenance contracts?

Mike McAndrew

Yes Sir.

Joe Gagnon - Atlantic Equity Research

So, why I guess, why was it jumped from like 20 something million to $52 million after the NextiraOne acquisition? Why did NextiraOne have so much more in maintenance contract compared to the size of its overall business, compared to your previous voice business?

Mike McAndrew

That was driven by the composition of business that they had relative to projects, maintenance in MAC business that was one of the, candidly one of the attractive parts of that transaction that we found interest in.

Joe Gagnon - Atlantic Equity Research

Yeah, that they had so much in maintenance contract revenue compared to normal voice companies?

Mike McAndrew

Yes sir.

Joe Gagnon - Atlantic Equity Research

Okay.

Terry Blakemore

They have bought in larger contracts as well.

Joe Gagnon - Atlantic Equity Research

Okay. And then, I have a question on the [Cadec], on the line item versus cost in excess of billings or uncompleted contracts, and then say billings in excess of cost estimates on earnings on uncompleted contracts. What specifically are those two line items?

Mike McAndrew

Sure. The asset cost in estimated earnings in excessive billings?

Joe Gagnon - Atlantic Equity Research

Right.

Mike McAndrew

That's essentially revenues that we have recognized from a percent completion standpoint.

Joe Gagnon - Atlantic Equity Research

Right.

Mike McAndrew

Where we have not yet invoiced the client.

Joe Gagnon - Atlantic Equity Research

Okay.

Mike McAndrew

And down on the liability section that is invoices to clients that we have not yet executed the work from, a work in process percent complete standpoint. So, it's essentially a sort of a pre-billing.

Joe Gagnon - Atlantic Equity Research

Okay.

Mike McAndrew

Alright.

Joe Gagnon - Atlantic Equity Research

Now, on the acquisition that you made, I guess, was in Washington State, that was like sometime in October that that going revenues in the third quarter or was that do they the commence after third quarter ended?

Terry Blakemore

The deal out in Washington, we closed that, I think, it was about three weeks ago.

Joe Gagnon - Atlantic Equity Research

Right.

Terry Blakemore

So, it did not contribute to our second quarter, our second quarter ended in September.

Joe Gagnon - Atlantic Equity Research

Okay.

Terry Blakemore

So, it did not contribute to the results you are seeing here today but upon conclusion that deal they will contribute to our performance in our third quarter which is the December ended quarter.

Joe Gagnon - Atlantic Equity Research

Okay. Now, do you know why the deferred revenues fell from like $52 million to $35 million, going from your second fiscal quarter to, second fiscal quarter of '07 to your first fiscal quarter of '08?

Mike McAndrew

Yes sir, we had a part of that approximately $60 million was made up of a contract that we picked up after Nextira acquisition that we subsequently relieved post acquisition with a deal we made with that client.

Joe Gagnon - Atlantic Equity Research

So, in other words that went into revenues and earnings?

Terry Blakemore

Right and that was...

Mike McAndrew

Yeah that actually got eliminated against some receivables that were due from that client and the relationship was terminated.

Joe Gagnon - Atlantic Equity Research

But did that going to revenues and earnings during that time period, did right, I mean, when you reduced deferred revenues, it goes on the income statement, right?

Mike McAndrew

Ultimately, in that particular case, it was a sizeable situation that we did not take that to revenue because it was a closure to a contract issue that we were working for with that particular client.

Joe Gagnon - Atlantic Equity Research

Okay. So, none of that during that time period from 52 to 35 were into revenues or earnings?

Mike McAndrew

Yes some said, because not of that $60 million but some of the AR that was used to relieve that?

Joe Gagnon - Atlantic Equity Research

Yeah.

Mike McAndrew

Was recognized as revenue approximately half of that.

Joe Gagnon - Atlantic Equity Research

So, half of the $70 million went into revenues and earnings?

Mike McAndrew

That is correct.

Joe Gagnon - Atlantic Equity Research

And where do you see this deferred revenues like going from here? I mean, I guess, from my perspective, normally what happens is that you sell new maintenance contracts and that adds to the deferred revenue. And then, as you move on some of the maintenance the deferred revenue goes down, because you are using up what you already having there. Do you think it's going to be flattest or continue to go down?

Mike McAndrew

Yeah, I think, if you look at our last couple of quarters that number has been roughly around the $32 million to $35 million.

Joe Gagnon - Atlantic Equity Research

Right.

Mike McAndrew

So, obviously, we are relieving some of that maintenance revenue, but we're also signing up new maintenance contract. So, we expect that to be barely stable.

Joe Gagnon - Atlantic Equity Research

Okay, alright. Thank you very much.

Mike McAndrew

Yes Sir.

Operator

Thank you. And our next question comes from the line of Liam Burke of Ferris, Baker Watts. Please go ahead.

Liam Burke- Ferris, Baker Watts

Thank you. Terry, could you talk about the competitive environment on the voice services business, particularly pricing or if there is any particularly aggressive competitor out there?

Terry Blakemore

Liam, its pretty much standard, I mean, let say it is a competitive environment for sure. There is lot of manufacturers that are actually directly competing with channel partners these days, as you are aware of, but it's nothing, we're not seeing any thing as ordinary, we continue to compete in the market. There is lot of opportunities, as you know; the market here is fragmented. So, there is a lot of channel partners in the area. We're focusing on not only the local base but also the national accounts. And we're also working in some subcontract role supporting a lot of the larger system integrators as well.

Liam Burke- Ferris, Baker Watts

On the voice services in particular between I know that Nextira had some business in there, though wasn't as profitable but I would think that as you work through that business and attract new contracts voice services gross margins would begin to move directionally up and it looks like a down both sequentially in year-over-year. Is there something particularly unique to the quarter or is that a trend do you expect and to stabilize at a certain level or?

Terry Blakemore

We did have something that was unique in the quarter, we had a couple of strategic clients that we're very competitive large projects that we won after and win after aggressively that have a multi-year of services behind it. So, we did have some GP pressures for the second quarter but that was like a one-time event.

Liam Burke- Ferris, Baker Watts

Alright, thank you.

Terry Blakemore

Thank you.

Operator

Okay, thank you. Our next question comes from the line of [Novell Bill] of Stifel Nicolaus. Go ahead.

Novell Bill - Stifel Nicolaus

Hi guys.

Terry Blakemore

Hello.

Novell Bill - Stifel Nicolaus

Just looking at your interesting expense kind of from the second quarter versus the first quarter, it looks like there is a pretty big jump there. First quarter, it looks like there is $3.28 million and then now we are looking at ground $6.1 million. And I was wondering on more borrowing how that happened, it looks like that wasn't fully accounted by the change of the value and interest rates volume?

Mike McAndrew

Yeah, that actually, what is driving that Novell is the interest rate swap. The interest swap in the first quarter, let me get there actually showed up as a helper of $1.3 million, so if you normalize that interest on the 3280 and that 1.32 to it the true interest…

Novell Bill - Stifel Nicolaus

Okay.

Mike McAndrew

Interest rate without that was about $4.5 million. Okay? In the second quarter, we're showing 6.1 and 1.7 of that is the interest rate swap going the other way, and so if you back that out it's actually about $4.4 million. So, first quarter was 4.5, second quarter is about 4.4.

Novell Bill - Stifel Nicolaus

Okay.

Mike McAndrew

Okay.

Novell Bill - Stifel Nicolaus

And then, could you just talk about some of your verticals where you're seeing strength versus either if you know, may be where you are seeing some weakness?

Terry Blakemore

Yes, we've had pretty good luck in the second quarter Novell in the hospitality and also in the University of Education vertical, also in the government we have done quite well in the government with some large contracts that we've won that are multi-year contracts.

Novell Bill - Stifel Nicolaus

And anything, where you are seeing weakness?

Terry Blakemore

Not necessarily. Not across the board, no.

Novell Bill - Stifel Nicolaus

Okay. Alright, thanks.

Operator

Okay, thank you. There are no more questions in queue. Please continue.

Terry Blakemore

Okay. We thank you for your time today and as a reminder our press release has been filed on our Form 8-K and it's also on our Black Box website at www.blackbox.com. In addition, we are planning on filing our quarterly report on Form 10-Q with the SEC on Thursday, November 8. Again, we thank you for your time this afternoon and this does conclude our conference call. Thank you.

Operator

Ladies and gentlemen this conference will be available for replay after 8:30 pm today through midnight on November 13. You may access the AT&T teleconference replay system at any time by dialing 320-365-3844, entering access code 889-657, and number again 320-365-3844, access code 889-657.

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

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