Mary M. Gentry - VP of IR & Treasurer Gerald Lyons - CFO Michael L. Baur - Founder, CEO & Executive Director.

Adam Tindle - Raymond James & Associates, Inc Keith Housum - Northcoast Research Chris McGinnis - Sidoti & Company.

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 and fiscal year ended June 30, 2018. With me today are Mike Baur, our CEO; and Gerry Lyons, our CFO. We will review our operating results for the quarter and full year and then take your questions.

A CFO commentary 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 sales, earnings, tax rates and interest expense for our first quarter of fiscal year 2019 are 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 Form 10-K for the year ended June 30, 2018, as filed with the SEC today.

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 change, 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 the CFO commentary 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. I am pleased to report excellent fourth quarter results and a year of strong financial performance and strategic progress. For the fourth quarter we delivered 8% net sales growth, 12% gross profit growth, and 11% non-GAAP operating income growth.

For the full year we had record net sales of $3.85 billion and record non-GAAP EPS of $3.11. We delivered strong net sales growth across our business with year-over-year organic growth for both of our worldwide segments and for all of our geographic regions. Throughout the year we executed very well on our six key opportunities for growth.

I'll walk through each and describe how it contributed to our growth this year. First, strong demand from mobile computing solutions continued across all geographies reflecting an operating system transition to Android and a big market refresh opportunity.

Year-over-year mobile computing solutions grew double-digits and were a key driver for the organic growth in our worldwide barcode, networking and security segment. Secondly, we achieved double-digit growth in video surveillance from opportunities to provide customized programs and offerings driven by the E-Rate funding for education.

This business also included strong performance from our networking vendors, a business which has stabilized for us following vendor consolidations in recent years. Our networking and security business in North America had a record sales quarter. Third, for POS Portal we added a new large customer in our contract deployment business this quarter.

This customer selected our team to provide value added services including payment terminal, replacement services, kitting, and customized configuration services. Since the acquisition a year ago we are pleased that POS Portal has exceeded our expectation for EBITDA contribution.

Our fourth growth area is our communications channel opportunity that we described last March when we announced an expanded relationship with Mitel for their premise based products in United States. This opportunity continued to grow in the fourth quarter.

We have recruited new customers and expanded our offerings to include both premise based and cloud products and services. Our fifth growth opportunity is continuing to grow Intelisys our recurring revenue business.

We had another record quarter for Intelisys up 26% year-over-year growth with the fastest growth coming from our excellent line card of cloud suppliers.

Approximately 60% of the cloud growth is from unified communications as a service known as you UCaaS and contact center as a service called CCaaS and in August to expand our UCaaS and connectivity offerings in Europe we have acquired the Intelisys global business based in the UK.

And our sixth opportunity, our Network1 business in Brazil also had strong performance across all of our technologies. The Network1 team had a record sales quarter and year-over-year sales growth in each quarter of fiscal year 2018.

Throughout the year Network1 did a great job increasing our addressable market opportunity by recruiting new resellers, adding sales team members, and expanding our business with new vendors. Just last week we completed the acquisition of Canpango, a high growth, high margin professional services business.

Canpango was a global sales force implementation and consulting partner with deep knowledge of CRM and integration with telecom systems. We expect Canpango to continue to work closely with the sales force field team to continue to drive demand.

Canpango's professional services are an enabler for our cloud services offerings and we like the strategic fit for our channel partners in two ways. First, channel partners gain capabilities to build out their CRM solution offerings by leveraging professional services from the Canpango team.

And second, with Canpango's expertise and relationships channel partners can discover and develop new and add on revenue opportunities including CCaaS and UCaaS. Like ScanSource Canpango has built a strong business based on execution and trusted relationships. We're excited to have CEO, Matt Lautz and the Canpango team join the ScanSource family.

Canpango is a great example of our acquisition that focuses on higher margins and adjacent markets to help our customers offer more products and services while building recurring revenue opportunities. With that I'll turn the call over to Gerry to discuss our financial results in more detail and our outlook for next quarter. .

Thanks Mike. We are pleased with our strong finish to fiscal year 2018. For the quarter our operating results included 5% organic sales growth and 11.4% gross margin. Our non-GAAP operating income grew 11% year-over-year outpacing our net sales growth of 8%.

Both net sales of 994 million and non-GAAP of EPS of $0.77 were within our forecast range while GAAP EPS of $0.40 was below our forecasted range. GAAP EPS includes a higher than expected expense for the change in fair value of contingent consideration as a result of better than expected results for Network1 in Brazil.

Our fourth quarter GAAP EPS also included an $0.08 benefit from a favorable tax recovery in Brazil which was a recovery of tax overpayments over the past eight years. Our non-GAAP results exclude this benefit from the favorable tax recovery. Consolidated net sales for the quarter increased 8% to $994 million.

The dollar impact on sales due to foreign currency translation was minimal and the POS Portal acquisition added $31 million to net sales. We had continued strength in our worldwide barcoding, networking, and security segment with net sales up 11% year-over-year or 5% organic growth.

This was led by mobile computing, physical security, networking, and payment solutions. Net sales for our worldwide communications and services segment increased 4% year-over-year or 5% organic growth driven by Network1 in Brazil and record net sales at Intelisys.

Gross profit dollars increased 12% year-over-year from higher sales volumes and the addition of POS Portal. Our fourth quarter fiscal year 2018 gross profit margin was 11.4% up from 11% for the prior year period.

For the worldwide barcode, networking, and security segment the gross margin increased to 9.1% from the addition of our higher margin POS Portal acquisition. And for the worldwide communications and services segment, the gross margin remained relatively consistent at 16.5%.

SG&A expenses increased $5.7 million from the prior year quarter to $77 million for the fourth quarter fiscal year 2018. This increase reflects the addition of POS Portal. We are making investments in our business as we continue to execute our strategic plan.

Our fourth quarter fiscal year 2018 non-GAAP operating income was $30.8 million or 3.1% of net sales compared to $27.8 million or 3% in the prior year quarter. For the worldwide barcode, networking, and security segment the non-GAAP operating margin increased to 2.4% reflecting the addition of our higher margin POS Portal acquisition.

For the worldwide communications and services segment the non-GAAP operating margin decreased slightly to 4.6% reflecting unfavorable performance for our communications business in Europe. We have $108 million contingent consideration liability on our June 30, 2018 balance sheet.

This reflects the present value of expected future earn out payments for Network1 and Intelisys acquisitions. For the fourth quarter fiscal year 2018 we recorded an expense for the increase in fair value of contingent consideration of $8.4 million. Fiscal year 2018 was the final earn out period for the Network1 acquisition.

For our first quarter 2019 in forecast we estimate the change in fair value of contingent consideration to be an expense of approximately $2.4 million related to Intelisys. For the fourth quarter of fiscal year of 2018 the effective tax rate was 42.4% which included one-time tax reform charges. The non-GAAP effective tax rate was 30.1%.

For fiscal year 2019 we estimate the effective tax rate to range from 26% to 27%. Now for a few comments on full-year results. For fiscal 2018 we delivered record net sales of 3.85 billion for an 8% year-over-year increase. We had 4% organic growth with growth in both worldwide segments.

The gross margin for fiscal year 2018 was 11.3% up from 10.8% in the previous fiscal year principally from adding the higher margin POS Portal acquisition and from faster growth or our Intelisys recurring revenue business. Non-GAAP operating income increased 12% year-over-year with a non-GAAP operating margin improving to 3.22%.

Full year net income decreased to 33 million or $1.29 per diluted share principally from much higher expense and the change in fair value of contingent consideration. Non-GAAP net income increased 14% to 80 million or a record $3.11 per share.

Now shifting to the balance sheet, we had $31 million of operating cash flow for the fourth quarter and 28 million for the fiscal year 2018. During the year we made additional working capital investments to support faster growth.

Our inventory returns of six times were comparable to 6.2 times for the prior year quarter and inventory levels increased 12% year-over-year. We believe that our inventory levels are appropriate given our sales forecast for the September quarter. DSO excluding Intelisys came in at 59 days back in line with our recent trends.

Our balance sheet remains very strong and continues to provide us with the ability to execute our capital allocation plan which includes in order organic growth, strategic acquisitions, and share repurchases. At June 30, 2018 we had cash and cash equivalents of $35 million and debt of $249 million.

Our leverage totaled approximately 1.6 times trailing 12 months adjusted EBITDA and ROIC was 12.5% for the fourth quarter of fiscal 2018. While adjusted EBITDA for the fourth quarter increased 14% year-over-year, ROIC decreased due to increased borrowings on our revolving credit facility for the POS Portal acquisition.

We repurchased no shares for the fiscal quarter and for the fiscal year and have approximately $100 million remaining under our share repurchase authorization. Now turning to our forecast, we expect net sales for the first quarter fiscal year 2019 to range from $950 million to $1.01 billion.

GAAP diluted earnings per share to range from $0.56 per share to $0.62 per share and non-GAAP diluted earnings per share to range from $0.83 per share to $0.89 per share. The midpoint of our forecast range reflects organic sales growth of somewhere between 6% to 7% for both segments and a gross profit margin that's a little over 11%.

For the first quarter of fiscal 2019 we assume approximately $2.8 million for interest expense. In July we restructured our communications business in Europe to be appropriate for the size of the business and to take advantage of growth opportunities.

And in Latin America outside of Brazil we are integrating our business units and moving positions in country to be closer to our customers and to achieve cost savings. As a result we included approximately $1.7 million for restructuring cost reflected in the forecast as a non-GAAP item.

For the first quarter fiscal 2019 we estimate the tax range -- tax rate to be in the range of 26% to 27%. In August we announced the acquisitions of Intelisys Global and Canpango for a combined purchase price of approximately 14.7 million.

We expect these acquisitions to be accretive to earnings per share excluding the intangible amortization expense for the fiscal year. Now I'd like to turn the call back over to Mike for our closing comments. .

Thanks Gerry. For the quarter and the full year we delivered strong sales and non-GAAP profitability growth. We head into fiscal year 2019 excited about our momentum and the excellent opportunities ahead to invest in and grow our business, expand our operating margins, and deliver strong EPS growth. With that we will now open up for questions..

[Operator Instructions]. Our first question comes from Adam Tindle with Raymond James..

Okay, thanks and good evening.

Mike I just wanted to start on results in the quarter, you mentioned gross profit grew faster than sales and that's probably the right metric to focus on but just wondering if you could maybe talk about the competitive landscape in the quarter, were there deals that were lower profitability that you walked away from to drive that trend because some of the other distributors had a little bit more robust revenue growth rates so just trying to understand the dynamics between those two things?.

Sure Adam, good afternoon. You know for us this wasn't one of those quarters that we typically have talked about where we had a lot of large deals which generally would drive down our gross margin. And as we reflected on the quarter we had a much more balanced contribution especially from some of our higher margin areas.

So we always know that we have competition. I would say the competitive landscape is pretty much the same as it has been. I think what's changing and helping us and we think the growth rate we achieved was still very good.

We're not -- we don't believe we lost market share to our direct competitors but we do believe that our focus on higher margin opportunities leads us to a more sustainable margin profile going forward..

Okay, that makes sense and I think you alluded to some of this at the very end in your comments but just wanted to ask were there any particular key goals into fiscal 2019.

I know coming into fiscal 2018 you had kind of goals for a 3.5% operating margin to improve ROIC, anything more specific as we head into fiscal 2019 that is top of mind?.

Yeah, that's a great comment because we had a discussion about that just right before the call we pulled out the guidance we gave a year ago just to take a look at that again and we believe that when you look back over the last even seven, eight, nine years ScanSource was a company that was always delivering 3.5% to 4% operating margin.

And as we look back to why that changed a few years ago we believe part of that was we had a growth problem and we had invested in some new business opportunities.

So as we look forward now into 2019 we believe we can get to that 3.5% and we hope we'll go higher than that because we believe we are in a position if we continue to grow our top line that we will gain leverage on our SG&A and we'll see the increased contribution of our higher margin businesses that we've acquired such as Intelisys and POS Portal.

I mean the POS Portal margin story is one that's just now becoming more obvious in our financials. As we talked about earlier today it is a business that is similar to a traditional ScanSource distribution business but very focused with key customers driving a higher percentage of higher margin services that go along with selling hardware.

And so we do believe that will result in operating margin expansion over time. So we believe for 2019 as we look ahead that we should get back to that 3.5% number, yes. .

Okay, great that's really helpful.

If I could just ask one last one for Gerry, cash flow was somewhat suppressed in fiscal 2018, I just wanted to ask kind of moving forward did some of that normalize and might the average of fiscal 2018 and fiscal 2019 be closer to the 70 plus million of operating cash we've seen in the past, I am sure it is somewhat growth dependent but just any color on how we can think about a reversal or uptick in cash flow in fiscal 2019 would be helpful? Thank you.

.

Yeah, Adam so you have hit the nail on the head, right. As we grow and we grow at faster rates that's consumer working capital. And so we were expecting a little more cash flow but again we're happy to trade off of cash flow with increased growth. So, I think that's a good trade off for us..

Is it something that end of fiscal 2019 that working capital releases itself and really upticks or is it just too early to tell at this point?.

Well, I mean I think we're expecting that we're still going to have fairly high growth rates. We just indicated that on the for the first quarter. But as those growth rates come back down yes, you'll see working capital decrease as well..

Got it, thank you..

Thank you. Our next question comes from Keith Housum with Northcoast Research. .

Good afternoon everyone. Appreciate the opportunity here.

Gerry, as you were talking about the acquisitions, I believe you said you expect them to be accretive for the full year, any guidance in terms of your thoughts are for the first quarter?.

For the first quarter Keith? Sorry you got -- your last word got kind of cut off..

Yeah Gerry, I am actually having a trouble with the entire call so it might be my line here. .

Okay, alright, so we think it's going to be accretive Keith but you can tell by the size of these acquisitions that they're not material, meaning that it's going to be accretive but it will be small. I don’t know if that helps you or not. .

Gerry, okay, I am sorry my line is cutting out. So I will try and get these questions in if I can, I have to call back in a moment.

Moving out to next question, the restructuring benefits from Europe and Brazil, or I should ask you guys foresee in those efforts?.

Yes, so the restructuring Keith just to be clear it is Europe and Latin America outside of Brazil and we do expect those to have -- obviously have a favorable impact to us..

But you are not going to quantify at this time. .

No, I don't think so. I mean we gave guidance on what the amount was, of the 1.7 million. So….

Okay, got it. A question for you on the video surveillance recently the U.S.

government banned [indiscernible] from selling into U.S., is that favorable for your guys or is that negative for you guys or any impact at all for your business?.

I don't think there was any impact for our business right now. I mean I think we always are looking to see what our key customers expect and if our customers find the right products to fit the solution we will sell those to them. And for us we have been fortunate to have really strong supplier relationships in video surveillance for many, many years.

So we believe that we have the right line up and we'll see what happens. But there's no -- we've not got any indication Keith that there's any problem with that or planning to take any advantage at this point, too early. .

Okay, got you. I mean obviously I am going to ask some questions on Canpango here if I may, Mike you guys draw your high growth and high margin professional services business, obviously I think some of us are having a tough time kind of interpreting exactly what that means.

Can you provide any additional color on that, I mean we're talking growth rate you expect in Intelisys here or margins in the 15% to 20% range or how can we perhaps wrap our hands around that?.

Yeah, so when we say high margins that would be margins much higher than ScanSource traditional margins, so it would be much higher than 15% to 20% and that's why that's attractive to us because even on a smaller base it is -- it can be a big, very favorable to our margin profile.

It's also a business that is high growth because there's this big opportunity to work with Salesforce's sales team around the world.

Canpango is one of less than 40 partners that's managed by Salesforce directly and so they're brought into opportunities where they have a specific expertise and knowledge and it's been exciting to and I had a call with some of the Salesforce executives understanding better why they're excited for Canpango to be acquired by ScanSource as we will give them the ability to add more resources as appropriate to fit the growth profile.

But our business plan for them is keep doing what you're doing which will also drive demand for UCaaS and CCaaS opportunities as they are deploying Salesforce CRM. CRM we believe is a key piece of providing the solution that includes UC and context centers of service.

So that's why the margins are going to be much higher than a typical ScanSource 11% margin and the growth rate is at least as high as the Intelisys if not higher, that's the answer..

I appreciate that color.

So do you foresee Intelisys and Canpango giving referrals to each other or is it more of a one way street?.

No, it's a two way street so as Canpango is brought in to opportunities by the Salesforce field team which is massive by the way, that will be an opportunity for Canpango to qualify in end-user opportunity and then bring in a partner to help sell additional capabilities again, if it's a UC or CCaaS for sure.

But more importantly if we can bring to Canpango through the channel one opportunity or two opportunities we think that channel gets more than that from Canpango through Salesforce. So it is a definitely a two way street.

And Canpango as you know has been working with Intelisys for about six months prior to the acquisition and we have closed transactions for Canpango with Intelisys sales partners.

But also we expect that ScanSource telecom bars will also be referral partners with Canpango because Canpango can integrate telecom solutions not only for UC and contact center as a service but also for a prem based on solutions from Mitel and Avaya and Cisco.

So the channel opportunity for Canpango to operate in at ScanSource and Intelisys is huge, so they are excited about that..

Okay, well I have got some more final questions, but I don’t want to dominate the call, so I will go back in the queue. .

Okay, good. .

Thank you and our next question comes from Chris McGinnis with Sidoti and Company..

Good afternoon, thanks for taking my questions and nice quarter and nice guidance.

I guess just thinking about the strength in Q1 when you look at the six areas for growth is there anything that's more that is stronger or performing better than expected to drive that or is it just stronger trend that we're seeing overall?.

Yeah, thanks Chris this is Mike. Each one of those and we've been talking about them for over a year, each one of them were very impressive and clearly maybe the no surprise one was Intelisys because it's much more of a predictable growth business.

I think the -- I'll call it the resurgence in video surveillance was a little more surprising at how strong that became. And on the call we referenced the fact that not only is the video part of that solution growing well but also the networking products that are there to support video have done very well this year.

Whereas a year ago there were acquisitions of Aruba and Ruckus, some of our key vendor acquisitions really slowed down some of the opportunities in those markets. And so I think that's what also changes. That video surveillance growth did do better than expected.

And then I think the other kind of dark horse out of the acquisitions that was really pleasant surprise was the growth in POS Portal.

Some of that growth came later in the fiscal year than maybe we originally thought and we referenced on the call that there was a large customer that we finally closed last quarter, well that customer opportunity POS Portal has been working on for about four years just to give you an idea.

And so we didn't -- we weren't sure when it would happen but everyone thought for sure it would and it's an example of a large customer, large opportunity that rolls out over a long period of time but that's very good margins for the company.

So it's not a large project at low margins, it's a large project at higher margins because we're providing a higher level of services. It's not just we go pick a box and ship a box and charge a customer. So I think that's an exciting growth opportunity that maybe a year ago I don't think it was as obvious to especially to our investors. .

Good thanks for that. And then just to double check, did you say that you can reach the 3.5% operating margin by year end or for the year.

I just want to make sure I heard that correctly?.

Yeah, Chris this is Gerry. I think that's still our target. I don't think we gave an exact are we going to hit there by year-end or not but yeah, that's certainly our target and should be within our reach..

Alright, and I guess just one last question maybe on following the Canpango acquisition, how many I guess are the pieces that you need to add to make this stronger -- the service part of the story stronger for you and what would those be if you don’t mind giving maybe just -- giving a little insight on what you think on the M&A outlook for the year? Thanks.

.

Sure, yeah I'll try to handle that. We have not disclosed all of the targets and target areas that we're looking at but in general we believe that part of our strategy of providing more of the solution when an end user needs a technology solution, they need more from their channel than we have been providing the channel.

So we believe as we did our research which led to the acquisition of Intelisys, the end user is saying I want fewer partners because I want less confusion, less I want to simplify our life and make it easier for the end user to buy a more complete solution.

Which means hardware which we have been doing for a long time, connectivity which is Intelisys' software which we've done some of but I would suggest that there are pieces in the software arena that our customers and the end user asking us to provide as part of the solution.

And then services, in the services as a broad category would include Canpango and more other services like them.

And so yes, the answer is yes, we would expect our strategic acquisitions to include more services type companies but unlike services from five years ago at ScanSource where they were primarily provided for two reasons; one was to help us sell more hardware which meant it was sold at breakeven or a loss these are all because the services on their own will make very strong margins.

Secondly, in the past we had a lot of services that were provided to us by our hardware vendors and these services are all service companies who understand how to compete and provide a service across multiple vendors, hardware, and software products.

To me that gives us more leverage for those services across a larger, much bigger opportunity including taking the services as you heard from Canpango outside the U.S.

So, Canpango operates globally and we would expect additional services to also give us that reach into Latin America and Europe where we need to build more profitability frankly into those programs.

And that was one of the reasons we went through this restructuring is we didn't believe we were structured for the profitability that we're achieving in the U.S. And we believe that we're now in a position to do that, well to do that successfully we need to add additional capabilities which are more to come. .

Great, thanks for the additional color and good luck in Q1. .

Thank you Chris..

Thank you. [Operator Instructions]. Speakers I am showing no further questions in the queue. I will turn the call back over to you for any closing remarks. .

Great, thank you very much this afternoon. We appreciate you joining us and we expect to hold our next conference call to discuss September 30th quarterly results on Tuesday, November 6, 2018..

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