Earnings Call Transcript - SCSC Q1 2021

Operator, Operator

Welcome to the ScanSource Quarterly Earnings Conference Call. I would like to turn the call over to Mary Gentry, Vice President, Treasurer, and Investor Relations. You may begin.

Mary Gentry, Vice President, Treasurer and Investor Relations

Good afternoon and thank you for joining us. Joining me on the call today are Mike Bauer, our Chairman and CEO; John Eldh, our Chief Revenue Officer; and Gerry Lyons, our Chief Financial Officer. We will review our operating results for the quarter and then take your questions. We posted a CFO commentary that accompanies our comments and webcast in the Investor Relations section of our website. Let me remind you that certain statements in our press release, in the CFO commentary, and on this call are forward-looking statements. These statements are subject to risks and uncertainties that could cause such 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 we put out today and in ScanSource's Form 10-K for the year ended June 30, 2020 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 any forward-looking statement to reflect actual results or changes in expectations except as required by law. During our call, we will discuss both GAAP and non-GAAP results and have provided reconciliations between these amounts in the CFO commentary and in our press release. These reconciliations also can be found on our website and have been filed with our Form 8-K. I'll now turn the call over to Mike.

Michael Bauer, Chairman and CEO

Thanks, Mary, and thanks for joining us today. I am incredibly proud of our ScanSource team and our strong execution in an unprecedented operating environment. We achieved better than expected results and net sales grew 19% quarter-over-quarter. This is much stronger than our typical June to September sequential quarter growth of around 4%. In addition, we had strong operating cash flow driven by working capital efficiency gains. These results demonstrate the strength of our people, our offerings, and our market growth opportunities. ScanSource is uniquely positioned to help channel partners drive growth by providing customers with industry-leading endpoints and cloud solutions, leveraging successful cloud companies in the channel with our acquisition four years ago of Intelisys. We are a leader in sales of UCaaS, CCaaS, infrastructure as a service, and SD-WAN solutions, and ScanSource remains after 28 years, the largest and most successful endpoint distributor in our industry. We remain the leader in video and voice endpoints, mobile computing and barcode printers, IP-enabled high-definition cameras, payment terminals, receipt printers, network access points, and much, much more. I will now turn the call over to John to discuss our sales performance for the quarter.

John Eldh, Chief Revenue Officer

Thanks, Mike. I'm very excited about this quarter's sales performance and our focused strategy for growth. We saw a continued adoption of our SaaS and subscription business growing at 46% year-over-year. In our Barcode, Networking & Security segment, net sales increased 17% quarter-over-quarter, led by significant growth in large deals across our mobility, self-checkout solutions, and video surveillance technologies, and we also saw continued strength in networking and access points enabling the remote working trend accelerated by the COVID-19 virus. For Communications & Services, we saw a 24% quarter-over-quarter increase in net sales driven largely by cloud-enabled video endpoints, headsets, and phone provisioning to support UCaaS service providers. Our Intelisys business had another record quarter driven by the continued market shift to cloud-based solutions. Our team in Brazil achieved the highest quarterly sales results in Brazil's history in local currency while also driving impressive working capital efficiency gains. In addition to their success across hardware solutions, Brazil continues to build momentum in its recurring revenue businesses, including SaaS and our master agency. We're also excited about our newly formed cloud partnerships with both Oracle and IBM. This quarter, our supplier services team made significant progress in our working capital management. We're delighted with the work we did to increase inventory turns to 6.2x, the best level we've had in close to 3 years while also delivering on time for our customers and maintaining excellent service levels. I'm pleased with this quarter's positive results and really inspired by our workforce who continue to primarily work remotely due to the pandemic. We are also very proud of the success we had with our 2 virtual partner conferences with over 3,000 combined attendees. The first, our Intelisys Channel Connect event helped our partners to re-imagine the new next together exploring opportunities across cloud and connectivity, and our virtual VAR partner conference focused on the power of connections and enabling our partners on opportunities across our portfolio including recurring revenue, SaaS, and verticals. We received huge accolades from our partners and suppliers on our ability to deliver world-class digital events. Now, Gerry, will take you through our financial results.

Gerald Lyons, Chief Financial Officer

Thank you, John. We made excellent progress this quarter, 19% sequential quarter net sales growth, disciplined cost management, strong cash flow generation, and lower working capital. Unless otherwise indicated, this discussion reflects our results for continuing operations only. For the first quarter, our net sales were $757 million, down 10% year-over-year or down 7% year-over-year organically. Foreign currency translation negatively impacted non-GAAP sales by approximately $25 million. As expected, the year-over-year reduction in net sales was primarily due to the impact of the COVID-19 pandemic. Our gross profits were $81 million, down 18% year-over-year. Gross profit margin of 10.7% is down from 11.7% for the prior year quarter. As John said earlier, this quarter's sales reflected a higher mix of large deals compared to last quarter as well as lower supplier program recognition, impacting gross profits. Our non-GAAP SG&A expenses for the quarter of $61.6 million, declined 9% year-over-year and declined 2% quarter-over-quarter. At the end of July, we implemented a $30 million annualized expense reduction program. Our lower non-GAAP SG&A expenses reflect a partial quarter impact and we are on track to achieve the $30 million in cost reductions. In the first quarter of fiscal year 2021, we recorded a restructuring charge of $8.3 million for severance and related benefits. We have experienced higher costs from COVID-related expenses which totaled approximately $310,000 in the September quarter. For fiscal year 2021, we estimate the effective tax rate to range from 28.5% to 29.5%. Now turning to the balance sheet and cash flow. We generated strong operating cash flow of $71 million for our first quarter and $226 million for the trailing 12-month period. Working capital investment declined 34% year-over-year and 13% quarter-over-quarter. We continue to strengthen our balance sheet and our liquidity position. Our DSO came in at 61 days remaining relatively stable with recent trends. We decreased our inventory levels, down 29% year-over-year and down 7% quarter-over-quarter and we increased our turns to 6.2x as John referenced. On September 30, 2020, we had cash and cash equivalents of $56 million and debt of $169 million including discontinued operations. Our net leverage totaled approximately 1.3x trailing 12-month adjusted EBITDA. On October 30, we completed the sale of our products business in Latin America, outside of Brazil to Intermacs. We are actively working on sales opportunities to divest our products business in Europe and the U.K. Both of these divestitures were classified as held for sale and discontinued operations in our first quarter fiscal year 2021 financial statements. And now I'd like to turn the call back over to Mike for closing comments.

Michael Bauer, Chairman and CEO

Thanks, Gerry. Before we close, I want to take this opportunity to welcome our new Director, Frank Emory, to our ScanSource Board of Directors. Frank currently serves as Executive Vice President and Chief Administrative Officer for Novant Health. Frank's perspectives as a legal expert and executive, as well as his many years of public service and deep community involvement bring valuable insight to the Board and ScanSource. The progress we made this quarter gives me confidence in the strategic direction we are taking. We are very excited about the growth opportunities for our channel partners. And with that, we will now open it up for questions.

Operator, Operator

Your first question comes from Adam Tindle with Raymond James.

Madison Suhr, Analyst

Good afternoon, this is Madison on for Adam, and thanks for taking my questions. I wanted to drill down a bit on the Barcode, Network and Security operating margin. So revenue was up pretty significantly quarter-over-quarter, but margins were flat. So can you just touch on what drove the quarter-over-quarter margin headwind in Q1 and then historically, this segment has operated above a 2% operating margin. So, do you still think this is the right way to think about margins in this segment longer-term?

Gerald Lyons, Chief Financial Officer

Hi Madison, this is Gerry. Let me begin by addressing the income statement. Within that segment, we experienced some sizable deals that impacted our gross profit margin. Last year, it was 8.7%, but for the current quarter, it dropped to 7.8%. These larger deals, along with some supplier program recognition, contributed to the decrease in gross profits. This is the primary factor affecting the decline in operating profit.

Madison Suhr, Analyst

Okay, and kind of longer-term outlook for that segment in particular, do you still think that 2% range is achievable over the kind of intermediate longer-term?

Gerald Lyons, Chief Financial Officer

Yes.

Madison Suhr, Analyst

Okay, great. And then wanted to ask quickly on Q2, obviously, normally a budget flush quarter. Just wondering if you can give some initial color on what you're seeing into Q2 and maybe how you're expecting this year to be different or similar relative to prior years?

Michael Bauer, Chairman and CEO

Hey, Matt, this is Mike. I'll take that one. We're not providing any guidance for this quarter, but if you consider our historical performance, there are a lot of variables in the December quarter, and we’ve never been a company with excessive budgets during this time. Over the past four to five years, however, this quarter has often involved federal business, where we typically saw federal deals happening on time or sometimes getting delayed until the March quarter. This period is usually marked by significant federal deals, which we used to label as federal/Cisco transactions. So, the question for this upcoming quarter is uncertain, and overall, we would love to experience another quarter like we just had.

Madison Suhr, Analyst

Got it. Yes, that would definitely look nice. Thanks for taking my questions, guys.

Michael Bauer, Chairman and CEO

Sure.

Operator, Operator

Your next question comes from Keith Housum with Northcoast Research.

Keith Housum, Analyst

Good morning, everyone. I noticed that there wasn't much mentioned about the performance of the on-prem business. Last quarter was obviously challenging, and I expected to see more pressure this time around. However, based on the results, it appears that the pressure is not as significant as it was previously. Additionally, regarding the strength seen from remote work, do we anticipate that continuing into the second quarter, possibly for the upcoming fiscal year '22? I meant to say '21.

John Eldh, Chief Revenue Officer

This is John Eldh and I appreciate your question. We experienced significant strength in Q2, with positive results across North America, including the U.S. and Canada, as well as in Brazil across all segments. Overall, it was a good quarter, and we are optimistic about maintaining similar trends as we transition into Q3. Regarding the work-from-home situation, we also observed a lot of strength in Q2 and believe this momentum will continue as we move from Q1 to Q2.

Keith Housum, Analyst

Got you, got you. So do I assume here the pressure for the on-prem hardware was not nearly as bad as we saw last quarter?

John Eldh, Chief Revenue Officer

It was not, and I think it's important to remember that this business is going to continue to shift to the cloud and we were in great position to deliver on both fronts this quarter and we foresee that happening as we move forward.

Keith Housum, Analyst

Great. Gerry, in terms of the workforce reduction, can you provide a little bit color in terms of how much of that was completed and you saw the benefit in this quarter versus yet to be seen here in the second quarter?

Gerald Lyons, Chief Financial Officer

Sure, Keith. So I mean we announced that late in July and so really, we probably had about a month and a half of benefit in the quarter. So as we move forward, you'll obviously get full quarters, but we're on track as I said.

Keith Housum, Analyst

Okay, the sale of the Latin America business, that's closed already, correct?

Gerald Lyons, Chief Financial Officer

Yes, it closed on the 30th.

Keith Housum, Analyst

Right, can you provide any color in terms of the sales proceeds and how much of working capital reduction you guys are seeing?

Gerald Lyons, Chief Financial Officer

We didn't announce any of that, Keith.

Keith Housum, Analyst

Okay, got it. Okay, that's all I got. Thank you.

Gerald Lyons, Chief Financial Officer

Thank you.

Operator, Operator

Your next question comes from Chris McGinnis with Sidoti & Company.

Chris McGinnis, Analyst

Thanks for taking my questions. Nice quarter, I was just wondering if you can maybe just comment around maybe some pent-up demand and are you seeing continued strength in the sense of maybe on a monthly basis. I know that larger orders play into that somewhat but maybe more volatility in the quarter base but just when you're looking at the business, it sounds like you feel pretty good at this point.

John Eldh, Chief Revenue Officer

This is John again. We definitely coming out of Q4 saw some pent-up demand clearly as a result of COVID and I think that helped us and will also help us as we move into Q2 especially in light of projects that were on hold and actual physical locations of our customers' customers that were closed that are beginning to open up, which are enabling more installations, things like physical surveillance technology and other things, and so as we see more of the economy open up, we should see continued benefit from this.

Chris McGinnis, Analyst

Great and a little surprised by the strength in Brazil. Can you just talk about given their reaction to the pandemic, how are you succeeding down there and how has that performed. I think a little bit better than expected?

John Eldh, Chief Revenue Officer

We are very proud of our Brazil team and their performance. We observed widespread success across both small and medium-sized businesses and the enterprise sector, affecting all areas of our operations, including communications and the POS barcode business. Additionally, we experienced achievements in hardware as well as in our recurring revenue streams. Overall, significant deals performed well this quarter, and we anticipate another strong quarter ahead.

Michael Bauer, Chairman and CEO

And Chris, this is Mike. If I can just add one thing to that, one of the things we heard when we reviewed the quarter was that employees who work for us in Brazil are extremely happy that we've taken the actions to allow them to work from home. The employee satisfaction that we measure in Brazil regularly is at one of the highest it's ever been and our executive team there attributed the morale and loyalty of our employees as a difference.

Chris McGinnis, Analyst

Makes a lot of sense. Thank you. Regarding the long-term target, I believe a 3% operating margin is in sight. Do you think there's a way to achieve that this year, or what changes would need to occur in the environment? Would you require a bit more demand, or could the cost savings help you reach that by year-end, under a normal pace of recovery from this point?

Michael Bauer, Chairman and CEO

Yeah, Chris, this is Mike again. I'll take it. We talked about it last quarter too. We have a plan for the year that we believe based on our cost savings plan that we've already announced of $30 million and based on growth returning that we can get leverage on that SG&A at certain volumes and certain mix of volume and get back to 3.5% at a point in time. We're not going to say we're done once we get there either, but we do believe that there is a path to get back to 3.5%.

Chris McGinnis, Analyst

Yes. That's all I have for now. Thank you very much for taking my questions and good luck in Q2.

Michael Bauer, Chairman and CEO

Thanks, Chris.

John Eldh, Chief Revenue Officer

Thanks, Chris.

Operator, Operator

I'm showing no further questions at this time, I would now like to turn the conference back to Mike.

Michael Bauer, Chairman and CEO

Thank you for joining us today. We expect to hold our next conference call to discuss December 31 quarterly results on Tuesday, February 2, 2021.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and have a wonderful day. You may all disconnect.