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Black Box Corporation (NASDAQ:BBOX)

F3Q08 (Qtr End 12/29/07) Earnings Call

January 29, 2008 5:00 pm ET

Executives

Terry Blakemore - President and CEO

Mike McAndrew- VP and CFO

Analysts

Jeff Beach - Stifel Nicolaus

Ed Brea - Sterling Capital

Liam Burke - Ferris Baker Watts

Operator

Welcome to the Third 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 with instructions being given at that time (Operator Instructions)

As a reminder, this conference is being recorded. 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 Pittsburgh, Pennsylvania. As you heard, my name is Terry Blakemore, President and CEO of Black Box Corporation. With me today is Mike McAndrew, our Vice President and Chief Financial Officer. Earlier today, we announced our third quarter fiscal year 2008 results by issuing a press release and furnishing it to the Securities and Exchange Commission on Form 8-K.

We also posted the press release on our website at www.blackbox.com. We will start today's call with a brief overview of our results and certain additional supplemental information. Following this, we will field all questions if time allows.

Before we begin, and as a reminder, matters discussed in this call may contain forward-looking statements that involve risks and uncertainties concerning Black Box's expected financial performance. Actual results may differ materially from expected results, and reported results should not be considered as an indication of future performance.

Potential factors that could affect our business and financial results include 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 the press release, including the 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 comparable GAAP financial measurement and other supplemental information.

With that, let's take a look at our results. Third quarter revenues were $258 million, a 2% decrease from last year's $265 million and a 1% decrease over the last quarter's $261 million. The year-over-year decrease is driven by expected post transaction revenue attrition from the NextiraOne acquisition.

We are pleased with the 5% organic growth achieved in our third quarter of '08. 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. Excluding the year-to-year currency impact, we achieved 2% organic growth in the quarter.

Looking more deeply at our third quarter revenues by the two segments, we report the highlights as follows. First, from a service type segment perspective, our third quarter revenues comprised of 58% or $149 million of voice services, 23% or $59 million of hot lines services, and 19% or $50 million of data services.

Secondly, from a geographic segment perspective our third quarter revenues were comprised of 82% or $211 million from North America, 14% or $37 million from Europe and 4% or $10 million from what we call all other which is primarily the Pac Rim and Latin America.

Total revenues for the first nine months totaled $771 million. This represents a 1% increase from last year's $767 million. This translates to 5% organic growth on a year-to-date basis and a 3% growth excluding currency impact.

Moving on to profits. Our third quarter operating earnings per share were $0.84, a $0.06 increase from last year's $0.78 and a $0.03 decrease over last quarter's $0.87. It should be noted that primarily as a result of the 409A Stock Option Remediation program effective during the third quarter, the company's current effective tax rate for fiscal 2008 is now 38% resulting in an effective tax rate of 39.7% in our third quarter. This increases in the effective tax rate impacted operating EPS during the third quarter by $0.03.

As noted in our press release, operating earnings per share does exclude restructuring, severance and other acquisition integration cost. Amortization of intangible assets on acquisitions, stock-based compensation expense, asset write-up depreciation expense on acquisitions, historical stock options granting practices, investigation costs, the change in fair market value of our interest rate swap and 409A expenses. Further details of these expenses can be found, however, in today's press release. In total, these excluded items represent $0.37 and $0.19 per share for third quarter '08 and third quarter '07 respectively.

GAAP diluted earnings per share for the third quarter of '08 were $0.47, a $0.12 decrease from last year's $0.59 and a $0.17 decrease over last quarter's $0.64. We are very pleased to report adjusted operating income as a percentage of revenue of 11.2% for our third quarter, an increase from last year's 9.5%. This is the fourth consecutive quarter of increased adjusted operating margin, which we can attribute primarily to the successful execution of our integration efforts related to the NextiraOne acquisition.

Operating earnings per share for the nine months ending were $2.44, an increase of 7% from last year's $2.28. In total, excluding items represented $0.87 and $0.65 per share for the nine months of fiscal 2008 and fiscal 2007 respectively. Third quarter GAAP diluted earnings per share for the nine months ended were $1.57, a decrease from $1.63 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 $25 million compared to $3 million for the same period last year. Third quarter free cash flow was $23 million compared to $7 million last year. The three quarter's free cash flow of $23 million was used toward the following items: $11 million to fund current period acquisition payments, $11 million to fund debt reduction, and $1 million for dividend payments.

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 nine months was $37 million compared to $25 million last year.

Free cash flow was $38 million compared to $33 million last year. For the nine months, free cash flow of $38 million was used toward the following items: $19 million to fund debt reduction, $11 million to fund current period acquisition payments, $3 million for dividend payments, $3 million related to an increase in cash position, and $2 million to fund prior period acquisition payments.

EBITDA for the third quarter '08 was $24 million compared to $26 million for the same period last year. Adjusted EBITDA for the quarter was $28 million equivalent to $28 million reported for third quarter of '07. EBITDA for the nine months of fiscal 2008 was $73 million equal to the same period last year. Adjusted EBITDA for the nine months of fiscal 2008 was $81 million, up $1million, or 1% compared to $80 million in 2007.

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

As a result of the increase in the company's current effective tax rate to 38%, we are updating our current operating EPS target for fiscal 2008 to between $3.25 and $3.35. Our other targets for fiscal 2008 remain the same, with revenues of approximately $1 billion and cash provided by operating activities in the range of 80% to 90% of operating net income.

All of the above ranges exclude acquisition related expenses, stock-based compensation expense, any restructuring, severance, other costs related to the NextiraOne integration plan, historical stock option granting practices, investigation cost, expenses incurred as a result of measures taken by the company to address the application of IRS code section 409A, the impact of changes in fair market value of the company's interest rate swap and or before any new mergers and acquisitions activity that has not been announced.

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

Mike McAndrew

Thanks, Terry. At the end of the third quarter, we had cash and cash equivalents of $20 million and total debt of $221 million for a net debt position of $201 million. This is a $12 million reduction from a net debt position of $213 million at the end of the second quarter. Currently, our interest borrowing rate is 6.3%.

Moving to DSOs, our companywide DSOs were 58 days. This is equal to the second quarter's 58 days. Again, our established goal for DSOs remains at 50 days, and we will look to make improvements in this area over the next six to nine months. And as a reminder, each DSO day is currently worth approximately $3 million in cash flow.

Accounts receivable reserve was $12.7 million or 6.6% of the gross AR balance. This does compare to the second quarter's AR reserve of $14.1 million or 7.8% of the gross AR balance. This decrease in reserves is primarily the result of writing-off fully reserved receivables in the period.

Net inventory stood at $74.2 with inventory turns of 7.9. This compares to the second quarter's net inventory of $69.8 million and 7.9 turns. Our established goal remains at 8 turns and we will look to make progress on this metric as well over the next six to nine months.

Inventory reserves were $21.1 million or 22.2% of gross inventory. This compares to the second quarter's inventory reserve of $21.7 million or 23.7% of gross inventory. This decrease in reserves is the result of the disposal of fully reserved inventory during the quarter.

Relative to capital expenditures, we spent approximately $500,000 for the quarter and we are at $2 million for the nine month period. We are currently targeting capital expenditures for FY '08 of approximately $3 million. Excluding the non-cash impact of the interest rate swap discussed in today's press release, interest expense is currently running about 1.6% of revenues. And, as I mentioned earlier, our current borrowing rate is 6.3%.

Moving to our tax rate, currently, we are projecting 38.0% tax rate for fiscal 2008. This increase from the second quarter's 37.2% is primarily driven by the expected write-off of deferred tax assets that relate to non-cash book, stock-based compensation expense driven by the remediation program for tax code 409A implemented in the third quarter. As Terry mentioned earlier this increase in the effective tax rate did impact operating EPS by approximately $0.03 in the quarter.

There were minimal stock repurchases during the quarter. And at the end of the third quarter, the weighted average common and common equivalent shares stood at 17,742,000, and for the beginning fourth quarter '08 period, this number is an equivalent 17.7 million shares. Our six month order backlog now stands at $165 million, which compares to a $166 million at the end of the second quarter of fiscal '08, and $162 million at the end of our third quarter of fiscal 2007.

And finally, looking at our team member population, staffing is at approximately 4500 worldwide team members. And while our team does moves between D, V & H somewhat for perspective, our Black Box team breaks down approximately as follows: 2,600 are mostly V, that is Voice, and 1100 are mostly D, that is Data, and 800 are mostly H that is Hot Line. 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

Thank you, Mike. In closing, our Black Box team has delivered revenues, operating income and operating cash flow over the first nine months of our fiscal year, which are consistent with achieving our targeted ranges for fiscal year 2008. We are particularly please with another quarter of organic same store growth, operating cash flow of approximately $25 million for the quarter and $37 million year-to-date. This reflects our ability to translate our diversified revenue growth into cash, while making strategic investments for the future.

We continue to execute our strategy with well defined priorities, as we remain focused on leveraging our financial strengths to add high quality service providers via mergers and acquisitions, while continuing to implement programs to deliver a strong profitable organic growth.

As we along with the rest of the global community enter into an uncertain economic environment, our expectations for Black Box remain very high. We will continue to focus on the strengths of our business and remain committed to delivering the highest quality technical DVH services to our worldwide client base.

We will now open up the calls for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) We have a question from the line of Jeff Beach of Stifel Nicolaus. Please go ahead.

Jeff Beach - Stifel Nicolaus

Good afternoon, Terry and Mike. Congratulations on the best quarter I can remember in a while.

Terry Blakemore

Thank you, Jeff.

Mike McAndrew

Thanks, Jeff

Jeff Beach - Stifel Nicolaus

Can you comment on the recent trends in data services in each of the different segments. Especially the third quarter, I think, it's a little bit of a seasonal quarter. It didn't seem to show up much here. What do you see in the end markets looking ahead in these businesses, and is basically the pruning and the fixing of the Nextira over, and you would look to the revenue base beginning to turn and move the other way in voice?

Mike McAndrew

I will take that one, Jeff. Relative to the -- let's start with the end there, the Nextira base has kind of flagged out some of that attrition; you can see we put up some pretty consistent quarters from a revenue perspective. So, we worked our way through that and we are getting some reasonable comps on a year-to-year basis. So, that's relative to the three segments. I'd say we had a very strong data service quarter. That segment is much chunkier than perhaps the others. It's more project driven, and so quarters-to-quarters, that's robust.

We've had a good year in the data services. We did take a hit, as we recall, on the second quarter relative to the gross margin and we expected that to rebound. The margins were up over 31% for the quarter, and back to normal. So far, so good there. Relative to voice, again, we put up a couple of quarters in a row relative to organic growth, and we are pleased with that segment's performance, and, as we highlighted, the increased operating margin of the whole business. Clearly, a lot of that is being driven by our integration efforts with Nextira. That's driving that. And again, we saw some increase in the gross margin in that business as well.

So, I'd say that is performing well. The weakest spot, I would say, is Hot Line. We've had probably a year and a half of organic growth in Hot Line, and with the currency impact it's actually down a little bit. And in particular, at the end of the quarter, December month was slower than we had expected.

So, we are keeping a close eye on that, but that’s 20% of our business. The other two seem to be moving along. So we are keeping a close eye on things, but overall Jeff, we are really pleased with this quarter's results that we put up and we hope to replicate that moving forward.

Jeff Beach - Stifel Nicolaus

I was really referring little bit more to what you see ahead from your clients. Whether they are indicating so far? We are hearing a pretty good outlook for '08, what do you see in the pipeline?

Terry Blakemore

Well, Jeff, we are keeping a very close eye on that, as you could imagine, but right now it's -- we are just watching it very closely. We don't see any major blips on the radar screen today, but we will continue to manage that as we move forward.

Jeff Beach - Stifel Nicolaus

All right. Thank you.

Operator

Okay, thank you. And the next question comes from the line of Ed Brea from Sterling Capital. Please go ahead.

Ed Brea - Sterling Capital

Good evening. The first question I had is that if you could just explain a little bit better these 409A expenses that are both cash and non-cash. What are you spending the money on there?

Terry Blakemore

Sure. I will definitely take that one. What that is essentially, we completed our investigation stock options. And as we looked at the conclusions we reached there, and looking at the tax code 409A, which is effectively a tax code that relates to deferred compensation programs and the taxation associated with that. An interpretation of that is that options were granted, and the money could begin to have this 409A tax exposure to them.

So, we put together a program to remedy that, in effect for non executive team members who are holding shares. And the remedy of that program is actually outlined through the tender offer process, and is outlined in some files with the SEC. But the net of it is that we had to exchange shares that team members were holding for equivalent shares, so to speak.

And what that did is create a new one 123(NYSE:R) charge, because we effectively reissued some shares. And for some folks, there was actually a cash compensation element that we had to pay to true them up for their holdings. So, that's essentially behind us in the third quarter, and what it did, net of all that, was to remove this tax exposure or true up this tax exposure for team members that were holding shares that could be deemed to fall on to this deferred tax compensation code. Does that make sense?

Ed Brea - Sterling Capital

So I guess, simplistically, this would be the last quarter you think that charge would be in the results?

Terry Blakemore

Yeah. There is a possibility that we would have another small charge in the fourth quarter. We are working through a couple of exceptions for folks that who are not able to participate in the tender offer, but we believe that to be immaterial at this point. At the end of this fiscal year, we plan to have it solved.

Ed Brea - Sterling Capital

Okay

Terry Blakemore

Clearly, by the end of this fiscal year, we plan to have this all behind us.

Ed Brea - Sterling Capital

So, the remaining operating earning adjustments would relate to amortization of intangibles stock based on the FAS 123R charge

Terry Blakemore

Right.

Ed Brea - Sterling Capital

Small, not for asset, write-ups and then the interest rate swap?

Terry Blakemore

That is correct.

Ed Brea - Sterling Capital

Simply would be sort of the remaining numbers. The other question I had is just on the Hotline business. I know, you made a comment about watching the business, and I know it's struggled over the last couple of years, both in terms of top line growth and margins, and there is some sense of competition eating away at the profitability or growth in that business. Maybe you can just share the dynamics around that division. And what you are doing to possibly reaccelerate the growth or cut into the cost structure there a little bit?

Terry Blakemore

Yeah, that is correct. The business is a very competitive business. We are seeing that not only in the US market, but also international markets. We do have some new marketing campaigns underway. We are actually as far as the Hotline business; it's a very profitable business and we were continuing to look at rates, some new products to market, and also getting some of the cost out of the system, as we move forward. So, we are somewhat disappointed with the Hotline business today. But if you look around at competitors, it appears that everyone is having the same issues.

Mike McAndrew

Yeah. Then just one correction there Ed. I think really the last year and a half we've actually seen growth in that business. We've seen a little bit of compression on the TP side tied to some of these competitive characteristics, Terry was just talking about. So, we are extremely pleased with it for the last year. So, this is the first quarter we've actually gotten behind on the organic side, and we will continue to look, as Terry said, to introduce new products and new marketing programs to reignite that business.

Ed Brea - Sterling Capital

Is it fair to say it’s a stable business, or is there something competitively that may cause the fall off or close kind of thing?

Terry Blakemore

Yeah. I don't think we are seeing anything that's going to change it dramatically in any short term. I mean, it's a trendy business. In the early 2000, it was down organically mid single digits year-over-year. In the last year and a half, it's been up mid single digit. So, it bounces around, but we don't expect any dramatic changes in the characteristics of that business in a three, six, nine, twelve month period.

Ed Brea - Sterling Capital

The last question I had is just historically the company has bought back shares pretty consistently, and with a net debt position having fallen some, and with, I think, new acquisitions at least sizable ones maybe being on the backburner. Is the company in a position to, I guess, reaccelerate the share buyback with the stock at pretty accretive buyback levels?

Terry Blakemore

Yeah, clearly at 28 a share and the interest rate levels of where they run, it is an attractive accretive action. We do continue to look at that. We are authorized for a million shares under our buyback currently, a million one, I believe is the number. Obviously, we are balancing that each and every day with our M&A pipeline.

And I think that's really the balancing act we have, utilizing our debt facility in our cash flow relative to investments in our M&A. So, we continue to evaluate that, but no doubt at $28 a share, it's a more attractive proposition than at $42, $44. So, just note that we are looking at that, and we will continue to evaluate that relative to providing benefit to the shareholders.

Ed Brea - Sterling Capital

Okay, thanks very much.

Terry Blakemore

Sure

Operator

Okay, thank you. And we have a question from the line of Liam Burke of Ferris Baker Watts. Please go ahead.

Liam Burke - Ferris Baker Watts

Terry and Mike how are you?

Terry Blakemore

How are you?

Liam Burke - Ferris Baker Watts

Mike, if I am looking at your one time charges of $10.9 million?

Mike McAndrew

Yeah.

Liam Burke - Ferris Baker Watts

Roughly, if I do the arithmetic, $7.5 million would be in restructuring 409A and related charges. Those won't be recurring over the next several quarter, is that right?

Mike McAndrew

Yeah. I think here is what we -- the restructuring we will -- we've just a tad left this quarter, but moving into FY '09 you will not see that as a call out. That is really driven on the last stages of our two year plan on the Nextira integration. So, that will stop at the end of the next quarter. The historical stock option gaining practice is winding down, but until we conclude some of the derivates and SEC investigations, I won't try to be hanging out there. 409A expenses will go away and but also we've there -- I think, it was one other we mentioned.

Liam Burke - Ferris Baker Watts

It was basically just a 409A and the restructuring, but my point is that, if I'm looking at G&A in the next year, it is roughly $7 million plus charges that are being run through there that I shouldn't see next year more on a quarterly -- on this particular quarter?

Mike McAndrew

That is correct.

Liam Burke - Ferris Baker Watts

Okay.

Mike McAndrew

Yes sir.

Liam Burke - Ferris Baker Watts

Okay. And on the voice services 2% organic growth is great, considering the reorganization of next year and what you had in the front of you. But are you seeing any increase in Voice Over IP demand on the equipment side that would step up the growth rate there. And if so, is it large customers or is it -- how does that end market look?

Terry Blakemore

We are seeing some activity there, Liam. Some of the larger customers going to migrating to Voice over IP, really with all the different technology partners that we have. So, that's been talked about for several years now and we are just starting to see some activity there.

Liam Burke - Ferris Baker Watts

Okay. Thank you.

Operator

Thank you. And we have a follow-up question from the line of Jeff Beach of Stifel Nicolaus. Please go ahead.

Jeff Beach - Stifel Nicolaus

Yes. I'm looking at the gross margin in voice over the last seven quarters, and it seems to be, I’ll call it relatively stable. Do you have a gross margin target or a range of where you think you can get that in the voice services over the next couple of years? And if you don't have a target or don't have one to share, can you talk about the initiatives, what you would do to drive that gross margin higher?

Terry Blakemore

The margins there that we are experiencing is pretty competitive business out there. But as far as the gross margins, we think that it's pretty much in line with competitors out there and we are trying to get another half a point to a point in gross margins over the next six months or so. But right now that's pretty much what the market will bear and we'll continue to monitor that. We are pretty satisfied with it overall.

Jeff Beach - Stifel Nicolaus

All right. Thank you.

Operator

Okay. Thank you. And that was our final question back to you gentlemen.

Terry Blakemore

Okay. We thank you for your time tonight and as a reminder our press release has been filed on Form 8-K and on our website www.blackbox.com. In addition, we are planning on filing our quarterly report on Form 10-Q with the SEC on Thursday, February 7th. This concludes the conference call. Thank you.

Operator

Okay, thank you. And ladies and gentlemen, this conference will be made available for replay after 7: 00 p.m. today until February 12 at midnight. You may access AT&T executive playback service at anytime by dialing 1-320-365-3844, entering access code 904687. Again that number is 1-320-365-3844, access code 904687. And that does conclude our conference for today. Thank you for participation and for using AT&T executive teleconference service. You may now disconnect.

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