Mary Gentry - Vice President, Treasurer and Investor Relations Michael Baur - Chief Executive Officer and Director Charles Mathis - Chief Financial Officer and Executive Vice President.

Ryan Rackley - Raymond James Keith Housum - Northcoast Research Chris McGinnis - Sidoti & Company.

Welcome to the ScanSource quarterly earnings conference call. [Operator Instructions] 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 December 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 have also been filed with 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. As you can see on Slide number 3 of our presentation, we delivered exceptional results this quarter led by strong demand across our business.

Our teams executed very well on our strategic objectives with record net sales of $994 million and record non-GAAP diluted earnings per share of $0.88 per share, both above the high-end of our expected range. We increased net sales 23% year-over-year and grew our bottomline even faster with 29% year-over-year growth for non-GAAP EPS.

We were pleased with a return on invested capital of 17.5%. We were pleased with our strong sales growth led by large deals in our Barcode and Security segment. These large deals came primarily from enterprise mobility, our retail channels, and a seasonally strong KBZ government quarter.

Our strong quarterly results were driven by the acquisitions we completed during the past 16 months, Imago, Network1 and most recently KBZ. A key part of our strategic plan was to combine these acquisitions with our existing business.

This combination of excellent operations and strong balance sheet has led to accelerated growth and profitability in the markets where we compete. With the success of our SAP ERP implementation, we now have invested in a platform to support our organic growth and future acquisitions.

The robust IT platform we have implemented will allow us to develop new digital tools to help our customers grow their business. We believe our customers are interested in ScanSource, providing more than just boxes of products. That is why our company is evolving from just a product distributor to a technology solutions provider.

With that, I'll turn the call over to Charlie to discuss our financial results in more detail and our outlook for next quarter..

Thanks, Mike. And as you can see on Slide 4 and as Mike said, we had an exceptional quarter. Net sales increased 23% year-over-year, non-GAAP EPS grew 29% year-over-year to a record $0.88 per share, GAAP EPS grew 33% year-over-year, gross margins were 10.1% and non-GAAP operating margins were 3.7%, and return on invested capital was 17.5%.

Our results were stronger than expected across our core businesses as well as recently acquired companies. Large deals led to higher than forecasted sales.

Our gross profit margins were higher from better vendor program recognition in North America POS and barcode, improvements in profitability in Latin America and Europe communications, and a higher services mix in our communications business in North America.

Recently acquired KBZ performed better than expected due to the combination of the two companies, and we had a $38 million government deal that generated strong ROIC, but at a low gross margin.

We are excited about the investments we have made in our networking businesses to build on the growing demand for networking solutions and connectivity throughout all of our business units. As of October 1, 2015, we branded ScanSource Security as ScanSource Networking and Security.

With this organizational change and the acquisition of KBZ, we moved some business operations from our Communications and Services segment to our Barcode and Security segment. We've reclassified prior period results to provide comparable financial information. This information is available in tables in our press release.

As you can see on Slide 5, net sales totaled $994 million compared to $807 million, which is a 5.1% organic growth rate. The dollar impact on sales, due to foreign currency translation, was a negative $35 million.

Our presentation includes a summary of constant currency growth, excluding acquisitions, by segment for the current quarter and year-to-date period. Our second quarter 2016 gross profit was $100.6 million or 10.1% of net sales compared to $78.1 million or 9.7% of net sales a year ago. This reflects a favorable mix in better vendor program recognition.

SG&A expenses, excluding amortization of intangible assets and acquisition costs, were $64.4 million or 6.48% of net sales compared to $48.7 million or 6% of net sales in the prior-year quarter. SG&A expenses were higher year-over-year due to increased employee-related expenses, primarily from acquisitions and bad debt expense.

Our second quarter 2016 non-GAAP operating income was $36.3 million or 3.7% of net sales compared to $29.4 million or 3.6% in the prior-year quarter. Our effective tax rate was 34.7% for second quarter 2016 and 35.1% for the prior-year period. Our estimated annual effective tax rate for the full fiscal year is 34.5% to 35%.

Second quarter 2016 non-GAAP net income was $23.7 million or $0.88 per diluted share compared to $19.7 million or $0.68 per diluted share for the second quarter of 2015. Foreign currency translation had an estimated $0.04 negative impact when compared to last year.

Total shares outstanding as of December 31, 2015, were 26.4 million, a decrease of approximately 8% from a year ago from share repurchases. Average diluted shares for second quarter 2016 totaled 26.9 million, down 7% from the year-earlier period as a result of share repurchases.

Now, shifting to the balance sheet and capital allocation plan, our working capital measures are referenced on Slide 8 in our presentation and are in line with our normal trends. We continue to execute our capital allocation plan and remain disciplined and focused on acquisition opportunities that are strategic, accretive to EPS, and increase ROIC.

The acquisitions we completed during the last 16 months were in keeping with our strategic business plan, our value-added model, and focus on growing our bottomline profitability. Turning to Slide 9. At December 31, 2015, we had cash and cash equivalents of $39 million and debt of $150 million for net debt of $76 million.

During the quarter, cash from operations generated $17 million. We used $30 million of cash for share repurchases during the quarter ended December 31, 2015. Consistent with our overall financial plan objectives, leverage increased approximately 0.61x trailing 12 months EBITDA. Our return on invested capital totaled 17.5% for the quarter.

This was our highest quarterly ROIC since fiscal year 2013 due to our stronger profitability for the quarter. At December 31, 2015, we have repurchased over 2.4 million shares for approximately $90 million and executed 75% of our authorization as part of the planned capital allocation strategy.

We have now repurchased over 9% of our current outstanding shares. Now, turning to our forecast on Slide 10. As a reminder, the quarter ending March 31, 2016, is our seasonally slowest sales quarter.

We expect net sales for the quarter ending March 31, 2016, to range from $850 million to $900 million and non-GAAP diluted earnings per share to range from $0.62 to $0.70 per share. Foreign currency translation negatively impact sales by approximately $30 million, assuming stronger dollar compared to the previous quarter a year ago.

The foreign exchange rates used in our forecast are summarized in presentation slides. I'd like to now turn the call back over to Mike..

Thanks, Charlie. We have two reporting segments and I'll start with Worldwide Barcode and Security. Net sales of $690 million increased 26% year-over-year over or 8% growth in constant currency, excluding acquisitions. Our POS and barcode businesses in North America and Latin America had record sales quarter in local currency.

It was a strong quarter for big deals for our POS and barcode units across our geographies. In North America, we had a strong big deal quarter in enterprise mobility and retail technology solutions. We had another record quarter for our payments initiative, more than double over the prior-year quarter.

The EMV Chip and Pin opportunity is still gearing up, with many in the industry estimating that we are 35% to 45% through the upgrade cycle. We are seeing great returns from our investment to support this fast growing business opportunity. In Europe, our team executed very well and beat their sales plan.

Large deals led to the higher than expected sales. However, we see the opportunity to grow our business in certain customer segments and we're going to be investing more in those areas.

In addition, we are providing our customers some innovative digital tools such as our PartnerPAD, which we believe will help our customers grow their business in Europe. We have successfully completed the integration of our Latin America POS and barcode business, due to the strong efforts of our local management teams in Brazil, Miami and Mexico.

The sales and support teams have generated profits for the last three quarters after several years of unprofitable operations in this Latin America business. We now have achieved the scale and critical mass necessary to achieve sustained profitable operations in the region and meet customer demand with value-added services.

In Brazil, we had another record quarter in local currency. Net sales in Brazil increased 33% year-over-year in local currency, but declined 12% when translated in U.S. dollars. Our customer channels grew and our strong financial position continues to be a competitive advantage.

We had growth across all product categories and the receipt printer transition business is still driving growth. Our networking and security business in North America had excellent growth in our video surveillance, wireless and networking business.

A number of factors are driving the wireless growth, including product upgrades and eRate spending for schools. KBZ had outstanding results this quarter. With over half of its business in the federal government sector, the quarter was seasonally strong, following the end of the government's September 30 fiscal year.

Now to our second segment, Worldwide Communications and Services, which had net sales of $304 million. Net sales increased 17% from a year-ago or a decrease of 0.5% in constant currency, excluding acquisitions. However, this team did exceed their plan for profits and return on working capital.

In North America we had good year-over-year growth from many of our unified communications vendors and a better mix of services. This was offset by lower enterprise sales and fewer big deals.

During the March quarter, we are working to gain momentum with new unified communication vendors Mitel and Unify, who will also be expanding our services offerings. For the 12th year in row, Polycom named ScanSource as Distributor of the Year for North America and EMEA.

In Europe, we had better results from the integration of our Europe communications business and our Imago business. This led to record sales results in local currency. The combination of the businesses allows us to achieve critical mass and growing profitability, as we expand our business to meet customer demand.

Network1 had a record quarter in local currency, with strong growth in SMB and service providers. In Latin America, Network1 made solid progress with UC vendors and also had record sales with our physical security vendors in Mexico.

With our point-of-sale and barcode business, we are the largest HP distributor in Brazil, and both teams won the HP Distributor of the Year awards for Brazil. We are very pleased with the execution of our strategic plan and the strong demand across our business.

We delivered record second quarter results both for sales and for non-GAAP earnings per share. Looking ahead, we will continue our focus on profitable growth. We will now open it up for questions..

[Operator Instructions] And our first question comes from Ryan Rackley from Raymond James..

I was wondering you guys have had two real solid quarters with KBZ.

I was wondering how that is measuring up to your original expectations? And these government contracts are something we can expect to continue or has it just been an especially strong first half?.

For us, it's still new, for us with their business. As you know, our ScanSource traditional business in U.S. was not a strong player in the government space. We've always had some of our businesses and our vendors doing business with the government.

But that was something that we weren't sure when we acquired KBZ, how much that would happen in these first quarters and basically a little over a quarter. We do believe though that it is a seasonal business and that certainly is reflected in our expectations for them for the March quarter. But we were very pleased with their success.

And for that company itself, this was an all-time record quarter for their sales..

So is it fair to say they did better than expected this quarter, probably still on track for the year in terms of what you originally thought?.

Yes, it was extremely positive. When we go back and look at the valuation we put in the business, and we look at what we expected from a contribution margin and EBITDA, they are ahead of plan for the year. So we're very pleased with that.

The team really has done a great job working with the ScanSource team to combine the strengths of ScanSource and the strength of KBZ, and we believe that's how they were able to perform better than they would have if they were on their own..

And then looking at the balance sheet, it looks like you had a little further inventory growth there in inventory build.

Can you talk about the progress with the ERP rollout in North America and where you're at with that?.

Yes. So we've made great progress with ERP and that wasn't really what was driving the inventory. We wanted to make sure, because of this increased demand that we're seeing that we had sufficient inventory there to be able to meet the demand. And issues related to the ERP, we believe are pretty much behind us..

So there wasn't any customer loss or vendor loss or disruption with the delays we saw last quarter?.

No, we do not see any of that..

Our next question comes from Keith Housum from Northcoast Research..

Mike, obviously, the markets been in a turmoil over the past six weeks or so, and probably even going back a little bit further, can you just talk about like the competitive environment in the different geographies in which you play and how is that impacting your guidance?.

Well, if you look at, let's start with North America, we believe that after we went live with our system back in July, we had certainly some bumpy times in that September quarter that we acknowledged last quarter that we wanted to make sure we could certainly get through that successfully and we did.

And so we were very pleased that our customer competitiveness is still very strong. And a way I would characterize that in North America would be that our best customers, our largest customers are growing their business, and they are still preferring ScanSource as their distributor. So we believe from a market share perspective in the U.S.

that we're in a very strong position, and we haven't given up any ground to our competitors as of the end of December.

When I look at all of our other regions, I would say in even stronger comment that in Latin America, because that not only have we continued to see competitors in Brazil struggle financially, but now that we have kind of, I'll call it, repaired some of the challenges and problems that we had in Mexico and Miami, we're seeing market share gains there as well.

So we believe that that is allowing us to bring in new customers who may not have worked with us in the past in that region.

And quickly over to Europe, again, I think we're starting to see much better operation after three quarters there with SAP, and when we combine that with our acquisition of Imago, which again has really improved our go-to-market with our European comps business, we believe the strategic plan that we had laid out where we're going to grow our communication business across our other two geographies is now starting to pay off for us..

And how about if we talk about more from the demand side, obviously the retailers had a little bit tougher year and they were expecting retail sales to kind of drop off.

As the year was ending, did you see any tail-off at any of the orders or in the pipeline that would suggest that perhaps FY 2016 is going to start off some demand challenges?.

Well, I would say, no. We were actually pleased with the demand that we got in the December quarter, and as we look at what we would face going into 2016, there are several key areas that continue to look strong.

The payments program that we talked about, we described our success with large deals with what we called retail technology, which is our larger resellers reselling solutions in the retail that was very strong.

Even our mobile computing business continued to be very strong for us, and we believe that that's not short-lived, that wasn't just a December phenomenon. So feedback from our customers is that they believe they have a strong demand continuing into 2016..

Turning back over to the acquisition, so it looks like KBZ clearly outperformed your expectations, and you referenced that $38 million deal.

As we look at I guess modeling out next year, should we kind of think that $38 million was a one-time hit, one-time benefit I should say?.

I would think so. We certainly had a strong performance in KBZ without that. And so if you look at that one transaction, we would hope that by next year we're continuing to grow that government business. But I would say, right now, it's certainly a bluebird that was not in our forecast..

Keith, I'd just add on to that that was a low gross margin business that we took at very high ROIC, and that's why we took it, so I don't want you to think that our quarter happened just because of KBZ and what happened there, that was just part of the story and our core business is performing very, very well..

And I guess, the last question I have for you, as we look at the EPS guidance here for next quarter, are we assuming that some of those vendor incentives go away or is this a more matter of just because of the third quarter, you'll have great visibility to what's outstanding because the beginning of the year?.

Well, Keith, I think most of on the third quarter has to do with the seasonality of the sales. The fact that the sales are going down is really what's happening on the guidance there. We believe it's still a strong year-over-year performance, when you look at it. And we're pretty excited about the March quarter and the full year..

And our next question comes from Chris McGinnis from Sidoti & Company..

I guess, to follow-up a little bit after Keith, but maybe when you look at the guidance you have out, maybe what's the biggest risk you see in kind of the market right now to kind of meeting that?.

I think from the guidance, Chris, the March quarter has always been our toughest quarter to forecast. And so when you go back and look historically, seasonally it's slower weaker. And so it's always one that has some more risk to the forecast.

And so that's why for us, we always go into this, and say, all right, how much of the demand do we take from December and feel good about that through March. And it requires to spent a lot of time with not only our customers, but also our key suppliers coming out with what we believe is a reasonable number.

But again, we've got what we believe is the right operators in place, so that we can take advantage of whatever demand is out there and take more market share as possible..

And I guess, I know we've talked about this before but, and that's a small piece of the business, but you just talk about the Chip and Pin, there's still maybe 50% or little bit over that remaining to go through.

Have you seen that rate pick up over time? And maybe is that helping to the growth little bit?.

Yes. This past quarter we doubled the business, Chris. This was the December quarter, which followed the October liability shift date. I think when you think about typical channels, what we're selling into is not the Tier 1 retailers, right. It's not the Walmart's, and all the big retailers.

So really it's the big guys that make these kind of moves first. So I would say that the market that our customers are going after probably is even less penetrated than that. And so it's a question of the economics for that retailer as to when they'll make that decision.

What we believe that this should last frankly for a couple of years, that it won't happen all in a quarter or two or even when you're at the multiyear cycle, because of the size of the retailers that we cater to it would be a long time..

And then maybe transition that to the Brazil and the print business there, can you maybe just talk about how -- I guess, very strong quarter up 33% backing out the currency.

Can you just like dig into what is actually driving that growth, is it the strong balance sheet and you're taking business or is it more of maybe the print business is doing well for the cards?.

Yes. We've had this printer business we called out for a probably couple of years now. And it's really driven by the government of each state trying to enforce the tax collections of the retailers.

And over time, the printers that we were selling two years ago that we called fiscal printers, they kind of run their course and the government decided that they would accept a different type of printer technology now.

So there is actually really a replacement or a refresh of the technology that was sold before and it's happening on a state-by-state basis. So it happens over time and we see this as an ongoing business, and every quarter we continue to see that business doing well. And frankly, the vendors we're working with down there are the right vendors.

So we have the key couple of vendors that are producing the technology, and these are very specially designed printers for that market and we're the dominant distributor for that business. So as long as there is demand, we will have an unusually large market share in that market.

And what we're finding is this new printer technology replacing this older fiscal printer technology is really a lower cost printer, but it requires other components, so it's more of a solution sell, and so we're seeing still good revenues associated with that, but it's coming from more than one vendor as we're selling that product..

Charlie, just a quick, on the reclassification in the two segments.

The gross margins obviously changed a little bit, and I guess, just kind on a year-over-year basis, if you look out just for modeling purposes, is there anything that sticks out in the quarterly as for either of the divisions, gross margins that were may be beneficial or not and maybe is that rate kind of the thought process going forward, does it still gets you to that 10% range?.

I mean, it still gets you to that range. We haven't broken out the gross margin that went with the revenue, but I think you can pretty much figure that out from what we've done. And again, we tried to disclose all that information in quite a bit of details, so it's easy for you guys to follow.

And if you have any questions on that just follow-up with me, and I'll try to walk you through it and hope that will make sense to you..

Thank you. And I'm showing no further questions from our phone lines. I would now like to turn the conference back over to Mike Baur for any closing remarks. End of Q&A.

Thanks for joining us today. We expect to hold our next conference call to discuss the March 31 quarterly earnings results on Tuesday, May 10, 2016. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day..