Mary Gentry - Vice President, Treasurer, IR Mike Baur - CEO Charlie Mathis - CFO.

Keith Housum - Northcoast Research Chris McGinnis - Sidoti & Company Andrew Spinola - Wells Fargo Securities.

Good day ladies and gentlemen, and welcome to the ScanSource Quarterly Earnings Conference Call. All lines have been placed in a listen-only mode until the question-and-answer session. Today's call is being recorded. If anyone has any objections, you may disconnect at this time.

I would now like to turn the call over to Mary Gentry, Vice President, Treasurer and Investor Relations. Ma'am, you may begin..

Thank you, and welcome to ScanSource's earnings conference call for the quarter ended March 31, 2015. With me today are Mike Baur, our CEO; and Charlie Mathis, our CFO. We will review operating results for the quarter and then take your questions.

A slide presentation that accompanies our comments and webcast is posted in the Investor Relations section of our website. Certain statements made on this call will be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from such statements. These risks and uncertainties include, but are not limited to, those factors identified in the release and in ScanSource's SEC filings.

Any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. ScanSource undertakes no duty to update any forward-looking statements to actual results or changes in expectations.

We will be discussing both GAAP and non-GAAP results during our call and have provided reconciliations between these amounts in our slide presentation and in our press release. These reconciliations can be found on our website and also have been filed on our Form 8-K. Mike Baur will now begin our discussion with an overview of our results..

Thanks, Mary, and thank you for joining us today. Let's start with the highlights for third quarter on Slide 3. We reported a net sales of $763 million and non-GAAP EPS of $0.52 both below our expected range principally due to foreign exchange impacts and strengthening of the U.S. dollar.

Overall net sales increased 12% year-over-year, worldwide barcode and security sales declined 7% from lower big deals for our POS and barcode business units. Worldwide communications and services sales increased 50% year-over-year with growth in each business unit and the completed acquisitions of Imago and Network1.

In January we completed the acquisition of Network1, the largest communications of value added distributor in Brazil and throughout Latin America. This acquisition is consistent with our strategic plan to grow our communications business outside North America.

Network1 also complements our existing successful POS and barcode business in Brazil and we will provide scale to our back office operations there over time. This was our first full year quarter of results with Network1 and we are excited about the potential for this business.

In February as planned, we began using our SAP ERP system in Europe and are very pleased to have a new IT system that meets the needs of our employees, vendors and customers as we grow our business. What we have learned with our successful Europe implementation provides us a solid foundation for our North American implementation plan for July 2015.

The SAP ERP system will provide a platform for growth and for simpler and faster integration of future acquisitions. With that, I will now turn the call over to Charlie to discuss our financial results in more details and our outlook for fourth quarter fiscal year 2015..

Thanks Mike. The financial information I will be discussing can be found on Slides 4 through 10 of our presentation. As I reminder, our non-GAAP measures exclude the amortization of intangible assets, the change in fair value of contingent considerations and acquisition costs.

Before I dive into the numbers, let me point out some overarching things in the presentation. First, since the beginning of our fiscal year and pursuant to our business plan, we've closed on two international acquisitions Imago and Network1.

In the presentation when we referenced excluding acquisitions in the year-to-year comparison, we are referring to both Network1 and Imago.

Second, due to the stronger dollar as well as the higher percentage of our business in international market, the foreign currency impacts both foreign currency translation and the cost associated with hedging are more noticeable. However, when I referenced the excluding the foreign exchange impact, I'm referring only to the translation impact.

And third, because our SAP ERP system is a global design, following our successful February 2015 implementation in Europe, we are no longer able to capitalize the expenses associated with the implementation of the North America business.

I talked about this last time, and I have included a slide in the presentation for the project and we’ll talk more about that later. Now let me dive into the details of our financial results. Net sales for the third quarter totaled $763 million, a 12% increase over the prior year quarter or a 16% increase excluding the impact of foreign exchange.

The year-over-year change in foreign currency - exchange rates negatively impacted sales by approximately $28 million with most of the impact in the worldwide barcode and security segment. Net sales increased 4% year-over-year excluding our acquisitions and the foreign exchange impact.

Our worldwide barcode and security segment sales decreased 7% year-over-year or 2% excluding the impact of foreign exchange while our worldwide communications and services segment sales grew 50% which includes the acquisitions of Imago and Network1 for the full quarter.

Excluding the acquisitions and FX impact, worldwide communications and services sales increased 17% year-over-year. Turning to profitability, our mix of business led to a 10.5% gross profit margin for the third quarter of 2015.

The worldwide barcode and security gross margin decreased to 9.2% from 9.4% for the year ago quarter, largely due to the sales mix and the impact of foreign currency changes which lowered the overall mix of international business.

For worldwide communications and services, the gross margin was 12.1% compared to 13.3% in the prior year quarter due to customer and product mix. Third quarter 2015 non-GAAP SG&A expenses were $55.8 million versus $45.8 million in the prior year quarter.

This also included $2.6 million of non-recurring SAP related ERP cost that go away once we are live with North America and the SG&A expenses associated with the recent acquisitions. Our recent acquisitions include earn-out payments as part of the purchase price.

Each quarter we remeasured the fair value of estimated future earn-out payments, which is expected to be in expense each quarter. These fair value adjustments can fluctuate based on changes in the assumed discount rate, actual versus forecasted operating results, foreign exchange and other factors.

In the third quarter of 2015, we recorded a fair value adjustment expense of $285,000 compared to an expense of 981,000 in the prior year quarter. For the fourth quarter 2015, we expect the fair value adjustment to total approximately $1.2 million principally from the higher adjustment for Network1.

Given the size of the acquisitions and potential variability fair value adjustments on operating results, we exclude the change in fair value of contingent considerations from our non-GAAP results including ROIC. Our third quarter 2015 non-GAAP operating income was $24.2 million compared to $27.6 million in the prior year quarter.

Our non-GAAP operating income includes the non-recurring $2.6 million for SAP related ERP cost and a $1.3 million impact from the foreign currency translation compared to prior year. For the worldwide barcode and security segment on Slide 6, the non-GAAP operating margin was 2.6% for third quarter 2015.

For the worldwide communications and services segment on Slide 7, the non-GAAP operating margin was 3.9% for the third quarter 2015. These margins include higher SG&A expenses for the SAP related ERP cost discussed earlier and the impact from the foreign currency changes which lowers the mix of international businesses.

The foreign exchange loss increased to $1.6 million during the March quarter principally from higher cost related to hedging U.S. dollar denominated accounts payable for Network1, as well as other foreign exchange losses for Network1. With the integration of Network1, we anticipate the foreign exchange losses to be reduced going forward.

Our effective tax rate was 34.7% for the third quarter of 2015 and 34.8% for the third quarter 2014. We estimate the effective tax rate for the fiscal year 2015 at approximately 34.5% to 35%. Third quarter 2015 non-GAAP net income was $14.9 million or $0.52 per diluted share compared to $18.2 million or $0.63 per diluted share for third quarter 2014.

On a GAAP basis, net income for the third quarter 2015 totaled $12.9 million or $0.45 per diluted share. Now shifting to the balance sheet and some key metrics.

Cash and cash equivalents at March 31, 2015 were $93.6 million, down from the previous quarter, principally from the initial cash payment and repayment of debt for Network1 partially offset by positive cash generated from operations of $33.8 million for the quarter.

At March 31, 2015, we had $11.9 million debt, up from a year ago for debt assumed with the Network1 acquisition. We assume $34.7 million in net debt from Network1 and repaid $28.3 million during the March quarter. Outstanding debt includes tax favorable $5.4 million for an industrial development revenue bond for a distribution facility in Mississippi.

Days sales outstanding at March 31, 2015 increased to 57 days with the acquisition of Network1. Inventory levels, inventory turns and paid for inventory days as depicted on Slide 8 of our presentation, are within our normal ranges and consistent with our current operating environment.

During the nine months ended March 31, 2015 capital expenditures totaled $19.9 million, primarily for our ERP project. Capitalized costs for ERP project totaled approximately $28 million and we began depreciating these costs over a 10-year live starting in February with European implementation.

On February 2, 2015 we successfully implemented our SAP ERP in Europe, our first go-live date. We expect North America to go-live in July. The project remains on schedule and on budget. Now turning to Slide 9, we incurred $2.6 million of SAP related cost for the quarter.

In addition, we expect SAP related cost of another $1.9 million in the June quarter, and $1.5 million in the first quarter fiscal year 2016. These expenses are primarily for outside services, related to SAP implementation cost and training after the first go-live that can no longer be capitalized for the project.

Again these costs will not be ongoing expenses for the Company after our North America go-live. In addition, as I mentioned last time and show on Slide 9, we estimate ongoing incremental ERP cost at $1.5 million per quarter which includes $0.7 million for depreciation.

These costs are additional SG&A expenses that are incremental to our legacy systems. On Slide 8, our return on invested capital, which excludes the change in fair value of contingent consideration and acquisition cost, totaled 12.1% for the quarter compared to 15.3% in the prior year quarter.

Our year-to-date ROI fee is 14.5% compared to 16.5% in the prior year-to-date. The lower ROI fee is impacted by the addition of SAP related expenses as I discussed previously.

We will continue to pursue strategic opportunities to invest and grow our business including through additional acquisitions and keeping with our business plan and value added distribution model.

We successfully completed our acquisition and Network1 in January 2015 with a cash payment and a fixed amount of assumed debt for initial purchase price of approximately $60 million.

The Network1 acquisition is structured to include additional annual earn-out payments over the next four years that are based on an adjusted EBITDA multiple and payable in Brazilian reais. In August, our Board of Directors authorized that three year 120 million share repurchase program.

We repurchased approximately 2.7 million of shares during the March quarter. We have a strong balance sheet, which provides us with additional opportunities to grow. Over the long-term, we believe moving from a positive cash balance and almost no debt to an EBITDA ratio of at least one time improves our capital structure and results in better returns.

Turning now to our next fiscal quarter and let me add some additional color here. The forecast assumes a stronger dollar and includes the assumption of a go-live of our SAP ERP project in North America in July. This includes approximately $1.9 million in the quarter or a non-GAAP EPS impact of $0.04 for the SAP related cost.

In addition, this forecast reflects average U.S. dollar exchange rates of 1.08 for the euro, and 1.51 for the British pound, and in average Brazilian reais exchange rate 2.98 per US dollar.

The FX translation negatively impacts our forecast versus the prior year by about $38 million for sales and $1.8 million for non-GAAP operating income or a non-GAAP EPS impact of $0.04. This does not include the FX translation impact on Network1 and Imago, which was not in the prior year.

Due to the volatility of foreign exchange and our recent acquisitions we’re increasing our forecast range. We expect net sales for the quarter ended June 30, 2015 to range from $800 million to $850 million and non-GAAP diluted earnings per share to range from $0.56 to $0.62. I’d now like to turn the call back over to Mike..

Thanks Charlie. We have two reporting segments, and I’ll start with worldwide barcode and security summarized on Slide 11, which represents 55% of overall sales for the quarter. Worldwide barcode and security sales of $422 million decreased 7% year-over-year or down 2% excluding foreign exchange.

We have fewer big deals this quarter across all geographies as some projects were delayed. In North America our payment process in hardware business was 47% year-over-year and our key injection services more than doubled.

We expect demand for EMV enabled terminals to continue as we approach the October 2015 date for merchants to install compliant equipment. Our physical security business North America grew 9% year-over-year with strong growth in wireless and networking.

This business unit began selling caballing and connectivity products from Hitachi, General Cable and Signamax, and also lost an outdoor wireless networking initiative. During the quarter, we expanded key vendor relationships into additional geographies including Ruckus Networks in Europe, and Intermec by Honeywell in Brazil.

Now to our second segment worldwide communications and services on Slide 12. With the completion of two international communications acquisitions, Imago in September and Network1 in January this segment is 45% of overall sales this quarter.

Worldwide communications and services net sales of $341 million increased 50% from a year ago or 17% increase excluding the acquisitions in foreign exchange. This reflects year-over-year sales growth for all of our business units in this segment.

A key element of the growth strategy for this business has been to expand or been to relationships across other geographies and be a worldwide leader in communications distribution. A great example of this is Polycom, a key vendor of ours that named ScanSource its global distributor of the year in February for the 11th year.

Imago is Polycom's largest distributor in Europe and Network1 also distributes Polycom in Brazil and Latin America. This was our first quarter with Network1. Network1 has over 60 vendors and 7,000 new customers. Our team reported good growth in network security and in the SMB customer segment.

Similar to our POS and barcode team in Brazil, Network1 had some projects postponed due to foreign exchange volatility. In North America we launched total coverage, a value added service for our Cisco collaboration business and we now have a full suite of services offerings for Cisco.

Near the end of the quarter, our North America communications team launched Mitel as new vendor in the U.S. and Canada. Mitel offers a full line of communication solutions including business phones, unified to communications, collaboration and contact center.

We also announced additional cloud offerings developed with our key vendor partners, such as the recently announced offering of Shoretel Sky. With these offerings we’re able to offer both premises and as a service cloud based solutions giving customers greater flexibility in the unified communications offerings.

Our ScanSource services group works closely with our business units to support hardware sales. We continue to see increased custom configuration activity led by our key injection services and we’re also seeing increases in the number of our reseller partners using our ScanSource's services offerings.

We're very pleased to have completed our two acquisitions this fiscal year and accelerate the growth of our international communications business in attractive markets with higher margin opportunities. As we enter the fourth quarter, we will continue to execute our strategic plan for growth across our worldwide markets.

We will now open it up for questions..

[Operator Instructions] Our first question comes from the line of Keith Housum with Northcoast Research. Your line is now open. Your question please..

Thanks for taking my questions guys and thank you again.

Mike as you guys implemented the ERP this quarter, did you guys notice any impact on demand or do you guys have any type of operational issues with so ever that would have - international sales?.

Hi Keith good afternoon. When we implemented our new system in Europe, we were prepared that we might delay some shipping in the first couple of days. We even notified our customer's, couple of week in advance and asked them to get some of their orders in early.

And so I think we did a very good job of preparing for some slowness or difficulties in the first few days. And so we probably had less orders to have to deal with in the first few days.

But by the end of the first two weeks of our go-live, we felt very good that we didn’t have any interruption in services, we talked to our vendors to see if they were having any concerns from their perspective, and we believe it went very well.

So, we don’t believe there were any material impacts from our sales side in our ERP implementation in Europe..

I appreciate it. As we talk to a lot of those vendors and the borrowers out there, there is a lot of discussion regarding the vendor's raising prices over in Europe to offset the strengthening dollar.

What’s your thought in terms of demand it’s going to have on your impact as your vendors are doing that? Are you guys expected to absorb any of those price increases and are you seeing or hearing anything in terms of the borrowers and what their expectations are for the impact on demand?.

Well what's happened so far is the vendors have notified the channel that the increases were coming and some of them were affected in the beginning of April and some during the month of April. And so far as of today, we have not seen a negative impact on our business and what we expected to do for this quarter.

So I would say right now, we feel pretty good about the impact of the increases certainly the vendors spend time talking through the partner community, making sure they understood the magnitude of the increases so that they could better test the potential impact on demand.

So I believe that our vendors have done a very good job of making sure they've measured the potential impact.

Our conversations with customers and with the vendors has been that we believe that this increase will happen, will not impact demand materially and that certainly if there is any impact, we'll be sitting down with our vendors and discussing what we can do to mitigate that.

But right now, we don’t expect to absorb the price increases and we don’t expect our borrowers, we think borrower can raise the prices to their end customers because most of the times our components are part of the total solution and the end customers will expect this to come from any vendors that are selling in U.S. dollars in Europe for sure..

So what’s driving some of your customers than the first time these projects that you referred to in Brazil?.

In Brazil it's little different than in Europe. So the price increases were in Europe. And what we found there in Brazil is that, there is so much volatility and it was in the short period of time that I don't believe the markets were prepared for that. And we've got problems with some large projects, but not in the run rate business.

So our team in Brazil is saying, customers are wondering and nervous about as the volatility settled out to where they can, price the customer a project and be able to support that price when it's actually installed, delivered and invoiced. So that was a Brazil issue..

Okay. And then if I can just follow-up I guess back on into Europe, it seems like dropped - your European sales dropped a lot more that I would have expected even with FX, was there anything else it was happening in Europe that impacted your demand there.

And you guys buy in local currency right, so you guys are competitive with local distributors correct?.

We buy locally in most cases. Remember that you have the Pound Sterling there, as well as the Euros so there are some differences but you’re right, in most cases we’re buying locally selling locally. So it’s not an impact on demand in Europe that really wasn't the point there.

I think in general, we saw a weaker March quarter there than we had originally planned..

Okay. I'll jump back –.

And we've had - in the past we’ve had quarters where large deals come in, and sometimes they don’t happen. And I think in this case, we had some specific large deals that did not happen in the March quarter that we had forecasted and we do believe most of those deals will happen and they are in our June forecast..

Okay, I’ll jump back in the queue..

[Operator Instructions] Our next question comes from the line Chris McGinnis with Sidoti & Company. Your line is now open. Your question please..

Good afternoon thanks for taking my questions.

I guess just on the communication side organic strength that you saw, can you maybe just dig into that what was behind that a little bit more - was it new vendors or maybe demand for certain products or?.

I think the main message and without getting into specific vendor names Chris, because we try to be careful around trying to tell our vendor story as you know we don't want to get ahead of them but we saw a very good strength in our wireless and networking business and that's been something we’ve been talking about for a few quarters.

We certainly have as you know a strong legacy premises based own business, UC business and that business hasn't changed significantly from standpoint of growth. I think that business has been a slower growth business as you know.

But if think the real emphasis that we’re trying to share with you guys today is that our wireless and networking part of that business is doing very well..

Okay.

And you mentioned maybe some larger deals being pushed out on the barcode side, is it more just kind of a temporary market itself or do you have some confidence that maybe those deals fall through within the next say next quarter or few quarters out?.

Well, what we decided to do was clear enough, to put a reasonable estimate of which ones would continue to be delivered in the quarter and so our forecast would reflect that. We certainly don't anticipate all of them would.

We put some - again measured experience against that from prior years, but we believe that most of that business will happen in June quarter, yes..

And then Charlie, just on Slide 9, with the ERP table, is the incremental 1.5 on top of the 2.2, or should we see some cost benefits and then this kind of mask it, if I look at it, say Q3 of 2016, you have the $2.2 million and then is there an additional $1.5, I just want -.

If you are looking out, we are really talking about the $1.5 million per quarter. The $2.2 million is really cost of our internal people that are going to the project and are being trained on the project. So that incremental that you see above the $1.5 million will go away so we go-live as well..

And then any cost savings benefits that – I think last quarter we talked - little hesitant but maybe anything – I know its still early in the implementation..

We have not factored that in but as Mike mentioned it's a global design and it's meant to gain efficiencies and putting future acquisitions on quickly. So, we are very pleased with the product and the platform that we got..

Okay. And then one other comment just on the leverage ratio possibly going out for 1, can you maybe just talk a little bit more about that, I think - I must say I mistaken, maybe the first time I heard it, bringing that up, that will be more on the acquisition side.

Would you ever be that aggressive on a share repurchase although you probably can’t disclose that?.

Probably wouldn't say other than we have a plan that we’re trying too execute on and the idea is to get to at least one times leverage in the long term..

Thank you very much. I appreciate taking my questions..

Appreciate it. Thank you..

Thank you. Our next question comes from the line of Andrew Spinola with Wells Fargo. Your line is now open. Your question please..

Thank you. I apologize if I missed some of the call, but I heard your comments in the last few minutes, but on the barcode business Mike, it doesn’t sound like you’re particularly concerned about the result in the March quarter, it sounds like there were most in push-outs.

Can you say was the run rate business up in that quarter or has there been a change in trend in the run rate business?.

I think you understood it right is that, it's the largest projects or big deals we call them different names depending on region but the point would be with those larger transactions that got pushed out and we had that happen in other quarters too.

The last few quarters we've had such strong success with our larger - on sale deals, our larger mobility barcode deals, so we had a nice run of large project large deal quarters, we anticipated the same in the March quarter.

So I mentioned earlier that there was some specific reasons in Brazil around the tremendous volatility and the currency, our guys saying that cost people delay. In Europe I think it was other issues and some of those we expect will be recoverable again in the June quarter based on talking to our teams.

I don't think the run rate business was effected or we would have called that out. We didn't want to go down each vendor discussion but we have a good quarter but it's certainly was less than we expected and so we were disappointed but we do believe that is recoverable..

Interesting, okay. And I guess just I'm going to ask the same question a different way, the last four quarter's is it sort of - you had this [indiscernible] up, the double digit growth in June and September the last year, then that stepped down to 5 in December and minus 2 I guess on constant currency in March.

We’ve been talking over the last year call it about, trying to understand the progression of this particular upgrade cycle in this business and it looks like it maybe we are reaching the end of that.

And I maybe making too much of it or is it just we're reaching a more normal run rate?.

We, we're still talking about barcode right. If I go back and look at history, the March quarter has always been our toughest quarter to predict.

You take that and layer on a lot of changes going on in this space, relative to vendor consolidation, changing- now the Europe changing prices coming everybody knew that was going to happen but not sure when in the March quarter, but a lot disruption along how do we you do business and what's going to happen and but this time the year the March quarter's when every one of our key vendors just about, has a partner conference to talk about new initiatives for the year, it's always a tough quarter for us to predict because when there is a lot of change, things slow down as the channel tries to digest these changes and decide how do they need to execute their business.

So, on one hand I'm disappointed, on the other hand I'm not shocked or surprised that this can happen in the March quarter..

Makes sense. Thank you very much..

Thank you. I'm showing no further questions in the phone queue. At this time, I would like to hand the call back over to Mr. Mike Baur, for any further remarks..

Thank you for joining us today. We expect to hold our next conference call to discuss our June 30 quarterly and our year end earnings results on August 20, 2015..

Ladies and gentlemen, thank you very much for your participation. This does conclude the program. You may now disconnect..