Welcome to the ScanSource Quarterly Earnings Conference Call. [Operator Instructions] 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 September 30, 2016..

With me today are Mike Baur, our CEO; Charlie Mathis, our CFO; and Gerry Lyons, our Principal Accounting Officer. We will review our 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, including our expectations for the second quarter and full year, will be forward-looking statements.

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 earnings release that we put out today and in ScanSource's 10-K for the year as filed with the SEC..

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 disclaims any duty to update forward-looking statements to reflect actual results or changes in expectations, except as required by law.

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 also be found on our website and have 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. We are pleased to report solid results for our first quarter, with net sales of $933 million that grew 7% and exceeded our forecast range, led by more big deals in our Barcode segment and growth in our business in North America.

This additional sales volume led to GAAP EPS and non-GAAP EPS above our forecast midpoint. At the end of August, we successfully completed our acquisition of Intelisys, the industry-leading technology services distributor for telecommunications and cloud services.

Intelisys sells services for the world's leading telecom carriers and cable companies such as Centurylink,, Level 3, XO, Comcast, Windstream and others, as well as many cloud services providers. .

The Intelisys acquisition broadens our growth opportunity in several important ways. The Intelisys suppliers need to expand their indirect channel capacity to be able to serve the growing demand from SMB customers. These suppliers are excited to have access to the ScanSource VAR base of over 30,000 potential reseller customers.

And we have been pleased to learn that many of the over 2,000 Intelisys sales partners are very interested in selling hardware and software from ScanSource or partnering with ScanSource VARs to provide complete solutions to their end-user customers. .

Importantly, with Intelisys, we have a remarkable combination of strategies, views and cultures. This great strategic fit began to crystallize during events held over the past 2 months, including internal team-building, ScanSource partner conferences and the Intelisys Channel Connect partner event.

ScanSource was especially well-received at this event, with more than 1,000 sales partners, supplier partners and guests. As summed up in a quote from one of the partners, "The best thing to come out of Channel Connect this year is that every doubt, every fear about the ScanSource acquisition has been eradicated.".

Our strategic plan for the full year of fiscal 2017 indicates strong growth in adjusted EBITDA compared to fiscal 2016. We expected that this adjusted EBITDA growth will lead to an improved ROIC for full year fiscal 2017.

Our balance sheet remains very strong and provides us with the ability to execute our capital allocation plan, which includes organic growth, strategic acquisitions and share repurchases..

Today, we announced that Charlie will be leading ScanSource to join a company in the defense industry. Charlie has been a great partner to me and the ScanSource management team, and we truly wish him and his family well in the future. .

With that, I will turn the call over to Charlie to discuss our financial results in more detail. .

Thanks, Mike, and let me say that I am most appreciative to you and the Board of Directors for the opportunity over the last 4 years. ScanSource is a truly exciting growth company, and I am confident in its long-term success and the strategic initiatives that we have executed on. .

As Mike indicated, first quarter financial results exceeded expectations. On Slide 6, net sales for the first quarter increased 7%, $930 million, and includes acquisitions. Net sales rebounded strongly from the June quarter, up $55 million and 6% quarter-over-quarter. .

Our first quarter 2017 gross profit margin was 9.8% compared to 9.4% for the sequential quarter and 10.1% for the year-ago quarter, reflects the sales mix for more big deals and lower international margins.

This can be seen more clearly in the segment financial charts on Slide 7 and 8, where the Worldwide Barcode, Networking and Security segment gross margins declined to 7.9% compared to 8.1% for the sequential quarter and 8.4% in the prior year quarter.

The gross margin for the Worldwide Communications & Services segment of 13.9%, which includes Intelisys, reflects an improvement from 12.1% for the sequential quarter and 13.3% for the prior year quarter..

SG&A expenses, excluding amortization of intangible assets and acquisition costs, were $65 million or 7% of net sales compared to $59 million or 6.8% of net sales in the prior year quarter. This year-over-year increase includes expenses from the KBZ and Intelisys not in the prior year. .

Our first quarter 2017 non-GAAP operating income was $26.7 million or 2.9% of net sales compared to $28.4 million or 3.3% in the prior year quarter. Sequentially, non-GAAP operating income improved from $18.9 million. Non-GAAP operating margins for the Worldwide Barcode & Security segment were basically unchanged from the prior year.

Non-GAAP operating margins for the Worldwide Communications & Services decreased 60 basis points, in part from higher bad debt expense. .

With the acquisition of Intelisys, we recorded a $95 million contingency consideration, reflecting the present value of expected future earn-out payments. For the first quarter 2017, we recorded a change in fair value of contingency consideration of $800,000.

For the second quarter 2017, we expect the change in fair value of contingency consideration to total approximately $3.1 million. .

In addition, we recorded intangible assets of $63 million, with related amortization of $0.5 million in the first quarter of 2017 and $1.6 million expected for the second quarter 2017. These purchase accounting entries will have a significant impact on the GAAP reported financials going forward but not on the non-GAAP.

To illustrate, for the month of September, Intelisys was dilutive to GAAP EPS by less than $0.01 and added $0.03 for the non-GAAP EPS for the quarter. .

Our effective tax rate was 34.8% for the first quarter 2017 and 34.5% for the prior year period. For the fiscal year 2017 forecast, we're using 34.8% effective tax rate. First quarter 2017 GAAP EPS of $0.58 increased $0.02 year-over-year and non-GAAP EPS of $0.68 was unchanged. .

Average diluted shares for the first quarter 2017 totaled 25.8 million, down 8% from the year earlier period as a result of share repurchases..

Now shifting to the balance sheet and capital allocation plan. Our working capital, balance sheet and cash flow measures are referenced in Slides 9 and 10 in our presentation. One of the highlights from Slide 9 is $116.8 million of operating cash flow generated over the last 12 months.

Although some of this relates to timing, the business teams have done an excellent job of improving our working capital by increasing inventory turns and reducing the paid-for inventory days. .

Inventory turns improved to 6x compared to 5.3 turns a year ago. As you may recall in the prior year, we increased our inventory levels to support the SAP go-live implementation in North America. This decrease in inventory levels was part of our plan, and the team has executed well by achieving this.

We expect continued improvements in working capital efficiency for the remainder of fiscal year 2017. The DSO excluding Intelisys came in at 59 days, higher than our typical range and primarily reflects the aging of customer-specific accounts in North America and Brazil. .

One point of clarification relates to the Intelisys working capital model. We have included 2 months of accrued accounts commissions receivable and accrued accounts commissions payable on the balance sheet, as required by U.S. GAAP. These 2 accruals basically offset one another and therefore have no impact on our overall working capital results. .

As Mike said earlier, the balance sheet remains very strong. At September 30, 2016, we had cash and cash equivalents of $45 million and debt of $166 million or net debt of $121 million. Our leverage totaled approximately 1x trailing 12-months adjusted EBITDA from increased debt following our acquisition of Intelisys.

ROIC was 13.1% for the first quarter 2017. And again, as Mike mentioned earlier, regarding the full year, we expect strong growth in adjusted EBITDA and a higher ROIC compared to last year, partially from Intelisys. We paid $83.8 million for the initial cash purchase price of Intelisys and repurchased $17 million of shares.

As of the end of the quarter, we had approximately $103 million remaining on our share authorization. .

I would now like to turn the call back over to Mike. .

Thanks, Charlie. We have 2 reporting segments, and I'll start with Worldwide Barcode, Networking and Security, which represents 68% of overall sales. Net sales of $633 million increased 10% year-over-year. Overall, our business in North America was stronger than our International business.

For the segment, we had higher big deals in all geographies, including a record big deal quarter for our North America POS market business. This includes the benefit from certain big deals we discussed last quarter that were pushed from June into the September quarter.

These big deals were at lower gross margins than we have experienced in the past, and this led to lower segment gross margins. .

Competition in our wireless and networking business continued as a result of vendor consolidation, and this resulted in lower sales and lower gross margins for the quarter. We expect this market condition to provide headwinds for our team again next quarter.

However, we have received assurances from our vendors that ScanSource and our resellers are a very important value-added channel. .

Now to our second segment, Worldwide Communications & Services, which represents 32% of our overall sales. Net sales of $299 million increased 1% from a year ago. Similar to our other segment, we had lower sales in our International business in Latin America and Europe, partially offset by growth in North America.

This growth in North America included a strong end of the quarter for resellers who are focused on enterprise-level, communications businesses. .

We have been working to return to growth for this segment by adding some new vendors. We've added new unified communication vendors in North America and in Europe, but they are still in the early stages for material revenue and profits for the segment.

In Brazil, we are making investments to support some exciting new vendors for Network1, including the recently-signed Cisco, Fortinet and VMware. With these key vendors, we believe we have the best line card of networking, voice, data and security offerings in Brazil and LatAm region. .

In Europe, our Imago team will now be led by James Vickerage, who was recently promoted to President of Europe Communications. We believe the ScanSource and Imago teams in Europe will be able to leverage our key products and services across the region. They have recently launched a provisioning and help desk service offering started in the U.K.

called Impromp2U for our channel partners to sell to their customers. .

In our Communications business, our offerings include hardware, software, and vendor supply and maintenance service contracts plus our own branded contracts, like the Impromp2U and iCare in Europe, and Total Coverage in North America.

Intelisys has been added to the Worldwide Communications & Services segment and was included in our results for the month of September. With Intelisys, we added a business that sells technology services and earns recurring commissions on the sales contracts.

In addition to the telecom carriers and cable companies, we added a growing cloud services business with diversified cloud offerings. Intelisys has a very strong line card and our offerings include Software-as-a-Service, Infrastructure-as-a-Service and managed communications services. .

For the month of September, Intelisys had a record month for net sales. Our forecasted growth in net sales for the December quarter is around 20% year-over-year. .

Now turning to our forecast on Slide 11. We expect net sales in the second quarter fiscal year 2017 to range from $930 million to $980 million, GAAP earnings per share to range from $0.47 to $0.53 and non-GAAP diluted earnings per share to range from $0.67 to $0.73. The forecast includes Intelisys for the full quarter.

And as a reminder, we had record sales and record non-GAAP EPS in our December 2015 quarter last year, and that also included an unusually large $38 million government deal. .

We will now open it up for questions. .

[Operator Instructions] Our first question or comment comes from the line of Adam Tindle from Raymond James. .

Congrats to Charlie. Just wanted to start by asking in prior years, if I look at the first half EPS, it's typically represented over half of the full year EPS number.

Is there something different this year that we should be thinking about, in particular in light of your comments about expecting strong adjusted EBITDA growth for the full year?.

Adam, this is Charlie. One of the variables there is Intelisys that we have this year. That has given us confidence in our full year forecast and the type of comments we made about the growth for the full year. So as you know, we had just one month in the September quarter.

And so, therefore, we believe we will be more back-end loaded this year than in prior years. .

Okay. And then maybe on the December guidance, I think it implies that gross margin is going to remain maybe at or below 10%. Wanted to see if you could confirm that, since you gave us some guidance there last call.

And then lastly, last quarter seemed as if many of the issues were temporary, such as integration costs, vendor incentive timing, things like that.

But I look -- and December should mark the third consecutive quarter of operating income dollar declines on a year-over-year basis, so wanted to understand what is needed to right that trend?.

Yes, Adam, this is Charlie again. So you are correct in that each quarter has somewhat different elements in it. In the September quarter, margins are down due to the large number of big deals and the international mix.

In the December quarter, you are correct that the forecast is for the gross margins to remain in those levels, and that is due mainly to vendor program changes that we are seeing at the end of the year. .

And then perhaps on the operating line, if we look at kind of the operating income dollar declines and gross margins kind of remaining below where they have been historically, that would suggest that perhaps something is needed in terms of the cost structure? Or how do we right the operating income dollar declines?.

And you're talking about the forecast or the September quarter, I guess, to make sure I'm clear on this?.

Both the September quarter and the implied forecast for the December quarter. .

So the forecast number that you're looking at, again, it is very difficult to compare that to the prior year because that was a record quarter last December, which included very large deals, including this $38 million deal for the government.

If you look at the forecast versus the September quarter, you'll see what we're forecasting is sequential sales growth that is in line with what we historically see, it's around 2%, 2.5%. And that is also reflected in the margins that I just spoke about, the gross margins and the reasons for that, excluding Intelisys.

But if you look at the combined company of Intelisys and our current legacy business, we believe that the operating income number is going to be slightly increased from there, or is increasing because the guidance we gave are higher than the September quarter. .

Understood. I was looking at a year-over-year basis, but it makes sense to perhaps look at it on a sequential, based on the fact that... .

I think it makes more sense in this forecast to look at it sequentially rather than versus prior year because of the record December quarter that we had. The December quarter had year-over-year last year, year-over-year growth of 9%, something like that. It was an extraordinary quarter in there.

Part of it had to do with the large deals, part of it had to do with vendor programs that are very favorable. So I think it's better to look at the sequential and then look at the full year of where the company is going to be with the expected growth in the adjusted EBITDA on a full year basis. .

Our next question or comment comes from the line of Keith Housum from Northcoast Research. .

Charlie, congratulations on the new, hate to see you go. Guys, can you help me understand the acquisition revenue that you guys highlighted in barcoding of -- segment, roughly $99 million.

Was that all to KBZ in the last month of the quarter?.

I'm sorry. So what we're talking about in the September quarter, Keith, is last year there was only one month of KBZ, if this is what you're referring to. There was only one month of KBZ last year, and this year, we have 3 months. So there is a [indiscernible] on the acquisition related to KBZ.

And it's approximately $50 million to $60 million of additional revenue. .

Okay. So for KBZ for the entire quarter, it did roughly $99 million.

Is that what you're saying?.

Yes. .

Okay.

So excluding KBZ, then the barcoding segment was down -- was down a bit, correct?.

Yes, excluding KBZ, the organic growth was down 1.5%. .

Okay. .

And that was better than our plan. .

Got you, okay. Changing gears over to the accounts receivable increasing, obviously, since last quarter. I know you said in your script that was due to I think Brazil and perhaps North America.

Is this a one-time item? Or do you expect the receivables to be higher here for several quarters?.

No, we would expect this to come back down to the normal levels. The company has run into this 55 to 60 days DSOs for many, many years, and the business is built on a model of the DSO in that range. And due to the couple of specific accounts there, the DSO has gone up, but we would expect this over time to come back down.

And we would expect the company to continue on a full year to generate excellent operating cash flow. .

Okay, but the elevated levels where it's at now, you're saying is due to just several specific accounts, it's more of a timing item than anything else.

Is that what you're saying?.

I'm saying, it's due more to the specific accounts, 2 specific accounts, North America and Brazil. .

Okay, got you. So if I look at your forecast sequentially, revenue $930 million to $980 million is higher than what we had this quarter, and then the midpoint of your guidance is $0.70. If we take away the differential from Intelisys, that would be your guidance of $0.64, excluding the Intelisys difference.

So is the difference really the vendor incentive programs here next quarter are expected to just be, I guess, worse than they were this quarter?.

No, the margins are fairly close to where they were in the September quarter. We're expecting higher volume in the December quarter, and flat to slightly lower gross margins in the quarter. And that's excluding the Intelisys acquisition, as you know. .

Our next question or comment comes from the line of Chris McGinnis from Sidoti & Company. .

Congratulations, Charlie. I as well hate to see you go. I guess, just digging into -- can you just restate the comments about the EBITDA for the full year, what you would expect? I must have missed that. .

Yes, so we're expecting solid growth in the adjusted EBITDA compared to the fiscal 2016 year. .

And is that largely driven by the Intelisys transaction? Or is there also organic in there as well?.

Intelisys is a primary factor in that forecast. .

Okay, great. Just on the competitive landscape, can you maybe just touch on how you're -- maybe it sounds like it still remains tough.

How are you reacting to that? Maybe is it better dealing with vendors or maybe competing in a different capacity in the regions that you're being impacted? Can you maybe just discuss that a little bit?.

Chris, this is Mike. I'll take it. Yes, I think what we're seeing is in a slower-growth environment, the deals that we have, and we reference this in the call, for example, the big deals that we compete in, actually, we saw more competition from a margin perspective on big deals than historical.

And big deals always come with lower gross margins, they came with even lower gross margins now. And as you know as well, a lot of that is driven by the vendors competing for deals. And we've always been somewhat at the mercy of the vendors to manage our margins, frankly, on those transactions.

They are very concerned about not losing business on a large deal in a slow growth environment for them. And so we are definitely seeing that. And of course, our strategy is to make sure that our partner, our reseller partner and ScanSource are positioned with the vendor as driving more value than our competitor so that we can realize a fair margin.

But that's what we're experiencing right now, is more pressure on the gross margin, primarily in the big deals. And that is a -- and that's kind of an across-the-board statement, across both segments and also geographically, and that's causing us to have more pressure than we had, say, a year ago. .

Sure.

And did you just say that you, in your prepared, Mike, that you're going -- they promised that in time, they'll come back? Or could you maybe just clear up those comments that you made about -- I think it was around the vendors supporting you a little bit more, like maybe on pricing?.

Yes, that was specifically on the networking vendors, Chris, is that -- we've had some consolidation, you've had the Aruba acquisition, Ruckus acquisition, Zebra selling their wireless LAN business, we've got a lot of consolidation, if you will, in our wireless and networking business.

And along with that comes some new competitors, in some cases, that we've already experienced for the last 2 or 3 quarters.

And those new competitors come in, not because the vendor thinks we're not doing a good job, and of course, they always promise us, "Hey, this won't affect you guys, we'll do everything we can to help you." And once we see an effect, it takes a quarter or so for the vendor to construct a program that will help us get compensated appropriately.

And so these are not, "Hey, we're going to give you an extra discount point." These are more programmatic, that they have to be able to rationalize internally with their management team. So that was why my message was we don't believe they have given up, that we are stuck with the margins we have.

But it is a headwind to us right now, and at least through the next quarter. .

Okay, great.

And then just lastly, I know we're past the implementation of it, but maybe any gains you're seeing from the ERP? Can you maybe just talk about where that's at, how it's been implemented? But any gains that you're seeing across the board from that?.

Well, I think one of the key areas is that we expect, that we've seen and expect to continue to see, is in our back office, is we're getting much more, much -- we have the ability now to handle more business with the back-office team that we have.

So I believe what we're going to see is leverage on our cost structure as ScanSource continues to grow, whether that's through acquisition or organically. We now have a world-class platform that allows us to not only leverage our existing business but additional businesses that come along, whether they are integrated or not into our back office.

With SAP, we have a system that any other system we acquire can plug into. And we're able to do that very quickly and more efficiently than we could in the past. And that's a huge advantage, plus the other piece of that is our IT team is now much more scalable because we have more knowledge about our system than ever before.

In the past, we had the knowledge of our IT system, frankly, constrained to a few people in our company, because it was a very, very old, custom-built system. And now we have a much more talented group, a team that can help us with our IT needs in the future. So we think some of that we're seeing now, and more to come. .

Great.

And I guess, just last, with Charlie leaving, maybe your outlook for a new CFO and maybe timing of that?.

Well, we've got Gerry Lyons with us today. Gerry has been with us now 9-plus years, and he has been managing all of our financial teams as our Principal Accounting Officer and been doing a fantastic job. And Gerry is going to be our Interim CFO until we decide what we're going to do long term.

But Charlie and I discussed it with our board, and everyone felt very confident that we're in good hands, and we're not in any hurry to make a decision. And look forward to you meeting Gerry in the near future. .

[Operator Instructions] I'm showing no additional audio questions in the queue at this time. I'd like to turn the conference back over to management for any closing remarks. .

Great. Thanks for joining us today. We expect to hold our next conference call to discuss the December 31 quarterly earnings results on Tuesday, February 7, 2017. .

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