ScanSource, Inc. (NASDAQ:SCSC) Q3 2024 Earnings Convention Name Could 7, 2024 10:30 AM ET
Firm Members
Mary Gentry – Senior Vice President, Treasurer and Investor Relations
Mike Baur – Chair and Chief Govt Officer
Steve Jones – Senior Govt Vice President, Chief Monetary Officer
Tony Sorrentino – President for Specialty Expertise
Convention Name Members
Greg Burns – Sidoti
Keith Housum – Northcoast Analysis
Michael Latimore – Northland Capital Markets
Operator
Welcome to the ScanSource Quarterly Earnings Convention Name. All traces have been positioned in a listen-only mode till the question-and-answer session. Immediately’s name is being recorded. If anybody has any objections, chances are you’ll now disconnect.
I want to flip the decision over to Mary Gentry, Senior Vice President, Treasurer and Investor Relations. Ma’am, chances are you’ll start.
Mary Gentry
Good morning and thanks for becoming a member of us. Our name will embody ready remarks from Mike Baur, our Chair and CEO; and Steve Jones, our Chief Monetary Officer. Tony Sorrentino, our President for Specialty Expertise, can be becoming a member of us. We’ll assessment our working outcomes for the quarter after which take your questions. We have posted an earnings infographic that accompanies our feedback and webcast within the Investor Relations part of our web site.
As , sure statements in our press launch, infographic and on this name are forward-looking statements and topic to dangers and uncertainties that might trigger precise outcomes to vary materially from expectations. These dangers and uncertainties embody the elements recognized in our earnings launch and in our Type 10-Ok for the yr ended June 30, 2023. Ahead-looking statements characterize our views solely as of immediately and ScanSource disclaims any obligation to replace these statements, besides as required by legislation. Throughout our name, we are going to focus on each GAAP and non-GAAP outcomes and have supplied reconciliations on our web site and in our Type 8-Ok.
I am going to now flip the decision over to Mike.
Mike Baur
Thanks, Mary. Thanks, everybody, for becoming a member of us immediately. Within the third quarter, our individuals responded effectively in a difficult demand setting. Nonetheless, we have been stunned at our lower-than-expected web gross sales for our {hardware} enterprise. Third quarter web gross sales declined 15% attributable to decrease demand from our channel companions throughout our portfolio of applied sciences. Our robust margins and sturdy free money move replicate the energy of our enterprise fundamentals.
We function in extremely specialised know-how markets with value-added revenue margins due to our experience. ScanSource advantages from this deep information of our gross sales and provider providers groups, particular value-added instruments and dealing capital funding that’s countercyclical with gross sales volumes. With our hybrid distribution technique, we’re dedicated to serving to our channel companions execute on the expanded alternative to promote units and recurring revenues.
For our fiscal yr 2024, we recognized robust free money move and concentrate on Intelisys as essential to administration and our shareholders. Once more, this quarter, we achieved this goal with free money move of $158 million and Intelisys progress of 4% year-over-year. Q3 finish person billings for Intelisys elevated 7% year-over-year and totaled $2.68 billion annualized. This contains billings progress in Contact Heart as a Service, or CCaaS, of 33% progress and UCaaS of 11%. We’re increasing our investments in expertise, coaching and instruments to extend our worth and drive progress as a know-how providers distributor.
As reported by many channel corporations and suppliers, we’re experiencing softer demand. Our gross sales companions inform us that they’re seeing a extra cautious IT spending setting from finish prospects accompanied by longer gross sales cycles. For our third quarter, we anticipated broad-based declines throughout our {hardware} applied sciences. What stunned us, and what induced our income shortfall in opposition to our plan, was the numerous decline in income from our networking merchandise throughout the board, together with Cisco networking.
Our {hardware} portfolio is comprised of a various set of business-critical applied sciences. Proper now, they’re at totally different levels of their finish buyer demand cycles following the final 2 years of provide chain and pandemic disruption. We consider we’re on a path to return to progress and believe in our group’s means to navigate the demand cycles with the assist of our channel companions. Within the close to time period, we see each macro uncertainty and the persevering with normalization of provide and demand, making a difficult forecasting setting.
We generated one other quarter of robust free money move and have a disciplined capital allocation plan of share repurchases and M&A. Our most popular use of free money move is to fund progress of excessive margin, recurring income companies which might be working capital gentle.
I am going to now flip the decision over to Steve to take you thru our monetary outcomes for the quarter and our outlook for fiscal yr 2024.
Steve Jones
Sure. Thanks, Mike. Q3 demand was weaker than we anticipated. Whereas gross sales have been decrease, our enterprise delivered robust gross revenue and adjusted EBITDA margins. Free money move exceeded our projections for the quarter. Q3 web gross sales of $753 million declined 15% year-over-year, whereas our gross revenue margin of 12.6% is increased than we anticipated, benefiting from a better mixture of recurring revenues.
We anticipated softer demand throughout applied sciences in our Specialty Expertise Options section. For our networking enterprise, we noticed sharper declines than we anticipated. Phase web gross sales declined 14% year-over-year and our gross earnings declined 22% year-over-year as we’re seeing decrease advantages from provider value will increase as in comparison with final yr.
In our Trendy Communications & Cloud section, revenues declined 16% year-over-year. Cisco networking gross sales declined as massive offers stalled and demand adjusted for provide chain normalizing. Intelisys revenues grew 4% year-over-year. And our gross revenue margins in Trendy Communications & Cloud section declined solely 9% year-over-year, reflecting a positive combine, together with increased concentrations of recurring revenues from our Intelisys progress.
For the quarter, we delivered $158 million in free money move. This displays decrease working capital wanted when gross sales declined and our concentrate on balancing lasting enhancements in our working capital effectivity, with out sacrificing worthwhile progress alternatives.
As we glance to shut our fiscal yr, the corporate expects a difficult demand setting to proceed, and we’re updating our steerage to replicate our present views of near-term demand. As a reminder, we’ve little or no backlog to offer us indication of demand as we ship every day from our inventories primarily based on orders acquired that day.
We’re managing our SG&A spending to match our income expectations for FY ’24 and past by redirecting sources and investing in our Intelisys recurring income enterprise.
We frequently assessment our useful resource investments. In January, we executed a workforce discount plan to align our sources with our strategic plans. Q3 GAAP outcomes embody restructuring bills associated to worker separation and profit bills of $3.9 million. These actions are anticipated to end in annualized expense financial savings of roughly $10 million.
For FY ’24, we now consider that our web gross sales will probably be not less than $3.3 billion, and our adjusted EBITDA will probably be not less than $140 million, which displays an EBITDA margin of roughly 4.25%. We’re rising our free money move outlook to not less than $275 million. Our steerage displays our expectations of the near-term demand setting. We stay assured in our progress alternatives, the resilience of our enterprise mannequin and the energy of our hybrid distribution technique.
Now going a bit deeper into the steadiness sheet and money flows. We’re happy with the progress that we’re making with working capital enchancment plans. Our purpose is to enhance our working capital effectivity whereas sustaining acceptable stock ranges to satisfy channel associate demand. Q3 stock turns of 4.8x have been negatively impacted by the shortfall in income. Stock ranges have decreased $224 million and our paid for stock days improved to 11.2. Days gross sales excellent, DSO, of 71 days is a slight enhance quarter-over-quarter, reflecting gross sales timing on the finish of the quarter.
Our steadiness sheet could be very robust. We ended Q3 with $159 million in money and web debt leverage ratio under zero on a trailing 12-month adjusted EBITDA foundation. Our capital allocation plans, balanced acquisitions and share repurchases, whereas sustaining a robust steadiness sheet with modest ranges of leverage.
For Q3, share repurchases totaled $20 million. Immediately, we introduced a brand new share repurchase authorization of $100 million. That is along with the $45 million of present authorization remaining as of the March quarter finish. Our new repurchase program licensed by our Board of Administrators displays our confidence in ScanSource’s enterprise and the energy of our long-term free money move era.
I am going to now flip the decision again over to Mike.
Mike Baur
Just lately, after a lot analysis and market evaluation, we recognized a number of key developments affecting the longer term progress alternatives in our Intelisys enterprise. Since ScanSource acquired Intelisys in 2016, the aggressive panorama for our distribution enterprise has been altering. Throughout this time, consolidation lowered the variety of TSD rivals from 16 down to five immediately. As we’ve mentioned, we’ve skilled margin stress in our Intelisys enterprise, which lowers our Intelisys income progress outcomes. Nonetheless, even with the consolidation, Intelisys stays the most important know-how providers distributor within the enterprise.
Over the past 24 months, we have additionally seen rising consolidation in our company companions. This exercise additionally pressures margins. We’ve not seen these company roll-ups ship innovation or new choices to drive elevated finish buyer demand. As well as, our TSD competitor have launched varied provides to amass books of enterprise and contracts from companies. And in some instances, they acquired the company itself. It’s this final growth that has satisfied us to introduce our personal provide to amass contracts and companies.
Our companions have requested us repeatedly if we have been focused on offering this worth proposition to them. This provide would give our channel companions a solution to take just a few chips off the desk or exit their enterprise utterly because the final stage within the company enterprise life cycle. So we introduced that ScanSource would create a brand new enterprise entity, separate from Intelisys, to be a platform for the channel mannequin of the longer term. We’re evaluating alternatives to amass an present company that has a robust management group and matches with the ScanSource tradition.
Second, we’re evaluating alternatives to amass the digital instruments our channel companions must handle provider and finish person contracts. These contract administration instruments and different greatest practices we’d develop within the new entity will probably be shared with the Intelisys channel. We count on to have extra to share about our investments within the company channel enlargement quickly. We sit up for launching the channel mannequin of the longer term to assist all our companions develop their companies sooner and higher.
We’ll now open it up for questions.
Query-and-Reply Session
Operator
Thanks. At the moment, we are going to conduct the question-and-answer session. [Operator Instructions]. Our first query comes from Greg Burns with Sidoti. Greg, go forward along with your query.
Greg Burns
Good morning. By way of the declines you noticed in networking and from Cisco this quarter, I believe Cisco has talked about a few quarters of backlog of stock at their prospects that also must be deployed. Do you could have a view on that? How lengthy do you see this hangover lasting on the networking aspect of the enterprise?
Tony Sorrentino
Greg, that is Tony Sorrentino. There’s a variety of uncertainty round when this backlog will get labored by means of. It is a mixture of softer demand and dealing by means of that backlog. So I do not know that we’ve a definitive reply on that.
Greg Burns
Okay. After which by way of this new company initiative on the — for Intelisys, is there any danger of, I do not know, so perhaps the business works, however is there a danger of channel battle? Any channel battle there bringing an company in-house versus servicing your broader company companions? And what does that do for the margins for the general Intelisys enterprise?
Mike Baur
Hey Greg, it is Mike. I am going to deal with that one. We completely are conscious of the potential for channel battle and truly, we have been performing some surveys of our channel companions simply to know how are our rivals doing this. As a result of we’ve discovered that our rivals all are doing one thing like this in numerous fashions in numerous flavors. And we have requested that query, hey, are you involved? And because it seems, lots of our companions are nonetheless working with these distributors which have additionally created a considerably aggressive mannequin.
So we checked out what others are doing. We consider we’re creating one thing that has the correct quantity of separation. We’ll separate this NewCo, this new entity from Intelisys, so it can report back to ScanSource not by means of Intelisys. We’ll have a separate administration group. Our purpose is to firewall off any information between Intelisys companions and this new company. And we have shared the thought with our companions earlier than as a result of we acquired a product referred to as RPM that a few of our traders bear in mind again 2017 or ’18, which is — which grew to become an business commonplace commissioning instrument that the majority of our rivals have used.
And on the time, I met with every of our rivals and stated, we’ll firewall off the info, so Intelisys will not see your company’s information. And we have been efficiently ready to do this for a few years. So we have a observe report of separating out the info, that might be the battle.
However we have additionally gone additional. We stated that we are going to be sure that earlier than this new company brings on a brand new — we name it, a brand new emblem, however for instance, a brand new finish buyer that they need to promote to, they’re going to first examine inside the ScanSource construction, and we’ll have somebody on the high who will have a look at the info and say, have we ever had — or do we’ve a present Intelisys companions promoting into that finish buyer? And if we see that we do, we’ll instantly notify this Intelisys associate and allow them to know, hey, your buyer is searching for an answer. Have you ever talked to him recently?
And so we’ll do every part we all know methods to do to tell our companions first earlier than we attempt to go in. So our major purpose right here is to get a administration group, find out how an company can work sooner or later and do some issues, frankly, that we do not see being executed immediately within the channel. After which I am going to let Steve perhaps speak concerning the second a part of that query, which is extra about how does this have an effect on margins.
Steve Jones
Sure. Thanks, Mike. Greg, that is Steve Jones. After we have a look at the margin alternative, what’s occurred in our house is margins have actually began to get compressed on the Intelisys aspect because the agent is taking extra of the margin share. So we predict for ScanSource, it will assist increase our margin alternative on this company channel. In order that’s the best way we’re taking a look at it. That is the best way we’re modeling it.
Greg Burns
Okay. Nice. Thanks.
Operator
Standby for our subsequent query. Our subsequent query comes from Keith Housum with Northcoast Analysis. Please go forward along with your query.
Keith Housum
Nice. Thanks guys. And good morning guys. Simply clearly, need to proceed the road of questioning right here on the company initiative. Mike, are you able to simply give me a bit of perspective about immediately, like what’s the make-up of the company market? Are we primarily speaking individuals, like 1 or 2 individuals and small million-dollar retailers? Are we speaking an finish market that immediately does tens of tens of millions of {dollars} of enormous retailers? What sort of market are you guys stepping into?
Mike Baur
Sure, Keith. Good morning. Simply as a reminder for everyone, we immediately have about, I am going to simply say, about 4,000 Intelisys companions doing enterprise with us, and we’ve it extensively distributed. And I might say the standard associate has 10 workers or much less. And bear in mind, their major operate as an company is promoting. They do have technical sources, however they’ve nearly no again workplace. Most of those companies run off of QuickBooks, simply to be sincere, even the bigger one.
We course of all of the commissions, and the tip customers are billed by the suppliers. And they also do not actually must have a again workplace of any significance. In order that they’re actually gross sales organizations, and that is actually what an company does is that they exit and work with finish prospects on alternatives for brand new.
The place we predict we see a chance, although, to assist the prevailing companions is with renewals. One of many challenges is most companies do not have an environment friendly solution to scale over time renewals of contracts, as applied sciences change, they should be renewed with new applied sciences, and as simply contracts expire. So we predict that is one of many benefits we are able to construct.
If we are able to construct this contract administration instrument set that goes together with individuals, we consider we are able to present the remainder of the Intelisys companions methods to scale and methods to use, frankly, a few of our sources to work their put in base in order that they’ve much less churn. So this is among the challenges with the standard company is they do not have a variety of infrastructure to handle renewals.
Keith Housum
Okay. I respect that. And Steve, clarify a bit of bit extra on the margin query about companies. I assume, I am simply searching for like a margin profile. I imply we all know Intelisys has nice gross margins. And earlier than the aggressive benefit, I imply, I believe your EBITDA margins have been north of 30% or 35%. Clearly, that is modified fairly a bit prior to now a number of years. However how can we take into consideration like an company’s profile? Is it additionally going to be extra gross revenue’s going to be income? After which what sort of EBITDA margins, I assume, may your common company expertise?
Steve Jones
Sure, Keith, thanks. So let me perhaps begin again at the start, as you assume by means of this. So that you talked concerning the Intelisys EBITDA margins being form of within the 40% once we acquired, that is probably not eroded a lot for us till not too long ago as these margins began getting stress and that margin began shifting to the agent as we have been having to surrender extra of a cut up to them by way of the fee construction. So there’s margin setting within the agent that was once within the TSD that we need to go take part again in.
After which if you have a look at their margins, once more, we’re in all probability taking a look at this as an agent form of fee. So it is going to be 100% gross margins from a reported perspective. However as , Keith, once we have a look at our enterprise, that has an issue with our high line progress, proper? As a result of it simply would not develop as quick, or it would not materially affect our $3.5 billion form of high line quantity as a lot.
So we have to do a superb job of actually unpacking how this — how the economics of this are going to work. However we count on this will probably be margin accretive to our total firm, and that is why it is fascinating to us.
Keith Housum
Okay. If I take into consideration just like the barcoding house, the place you bought a era of VARs which might be form of retiring out. Do you could have the identical factor within the company house the place they have been round for lengthy sufficient that you have homeowners which might be in that fifty to 60-year-old teams that wish to get out? Or is that this a comparatively youthful, I assume, make-up of householders immediately?
Mike Baur
Sure, Keith, it is Mike once more. Precisely proper evaluation. So the rationale that these roll-ups have been taking place, there have been traders, let’s name all of them just about non-public fairness traders which have are available in and purchased companies or acquired simply their contracts as a result of lots of these company leaders are — frankly, they’re on the finish of their cycle. They’re able to exit. They usually’ve requested us for the previous few years. And we truly stated for the final two years, no, we won’t do this. It isn’t in our DNA to promote to the tip person and personal an company.
So it is a massive change for us. And — however the company homeowners, they’re truly very . And we have been nervous about simply even speaking about it, but it surely grew to become apparent to us that a part of the rationale we’re getting stress on our margins from our rivals is as a result of they’re already doing this. They’re already benefiting from that, and it is as a result of the brokers, as soon as they know that there’s a purchaser on the market like, hey, choose me, choose me. And a few of them are saying, we do not need to promote the entire enterprise. However as I stated in my ready remarks, they need to take some chips off the desk.
And in contrast to the VAR enterprise, you may’t simply purchase simply part of a VAR enterprise. You possibly can’t simply purchase as a result of it is not recurring. It is deal by deal. Right here, these are contracts that we are going to have an outlined time period with, outlined quantity of profitability, and we’ll be capable to fairly easy, make a suggestion to only purchase, for instance, $1 million annualized of recurring income from a associate, and so they do not must promote the entire enterprise. And in order that has gotten a variety of curiosity out there. So once more, we’re responding to what the market is doing.
Keith Housum
And you’ve got introduced this a number of months in the past at one in all your conferences, and you have had these conversations. So I am assuming that your M&A technique is you need to purchase a extra established company with some digital instruments perhaps — to make use of your phrases, in establishing good administration group. Is it secure to say that you just’re having these conversations now? And I assume for those who’re not, is the choice to go organically and to construct it your self?
Mike Baur
For us, we have talked about acquisitions as a result of we need to go sooner than we’ve been, that means we’re catching up. And once more, listening to our rivals who’ve all come out publicly and dodged the query, frankly of are they doing this, they’ve already began. We’re catching up. So we are going to completely need to do it by means of acquisition. However then we are going to develop it with the steadiness sheet that we’ve. Which means including headcount, individuals, instruments, and we consider then we are able to turn out to be the participant of curiosity.
And what I imply by that’s we’re not trying to make this company the most important. It may occur. That is not our purpose. Our purpose is to create one of the best company in order that this has one of the best practices, one of the best applications in order that we are able to nonetheless recruit new and albeit, youthful companions within the Intelisys channel who need to perhaps do one thing with their enterprise 10 years from now or 5 years from now. And so we’re attempting to create, as I stated in my opening remarks, a unique mannequin. So we’re calling it the channel mannequin of the longer term, the place you may come to your distributor and take some chips off the desk or probably promote the entire enterprise.
And once more, these are once more, comparatively, and perhaps the purpose could be, these are all small companies. These should not the scale of Intelisys was. Now having stated that, a few of them have already been rolled up. These entities have gotten massive. One in every of our companions immediately has already rolled up about 30 companies. And they also’ve acquired vital EBITDA by rolling them up.
Keith Housum
Bought it. And I respect that you just’re not going to let time dictate your schedule right here. However do you could have a purpose in your thoughts about if you need to have the ability to have an company below your roof and be operating with the technique?
Mike Baur
Sure. I believe I stated earlier, we count on to have extra to share about our funding — channel enlargement quickly.
Keith Housum
All proper. I can respect that. I’ll change gears on you right here and simply speaking about extra conventional enterprise, the {hardware} enterprise. A few of your bigger barcoding companions have expressed some optimism for an enchancment within the second half of the calendar yr. I am unsure I am listening to that out of your dialog right here immediately. And I respect the truth that your backlog is someday, two days, it’s extremely brief. However are you listening to any constructive conversations that might provide you with optimism for the second half of the calendar yr?
Mike Baur
Sure. Let me have — I’ll have Tony touch upon that as a result of he can discuss we’ve totally different applied sciences and never all of these suppliers have been public. And so perhaps Tony can simply form of provide you with a bit of abstract of the place we’re.
Tony Sorrentino
Sure, Keith. Hey it is Tony. So there is definitely nonetheless a variety of uncertainty within the near-term. However I might say we’re seeing inexperienced shoots of alternative for progress in our bodily safety, barcode and mobility companies for certain. That stated, there’s some optimism there, however there’s additionally a variety of concern as effectively. So I’ve spent a variety of time with our high prospects over the previous month and so they’re cautiously optimistic, however actually all of the uncertainty within the macro setting is creating concern for them.
Keith Housum
All proper. Thanks guys. I am going to flip over.
Operator
Please standby for our subsequent query. Our subsequent query comes from Mike Latimore with NCM. Mike, go forward along with your questions.
Michael Latimore
All proper, nice. Thanks. It seems like one other good quarter of CCaaS and UCaaS billings progress. I assume, are you able to simply speak a bit of bit concerning the gross sales cycles you are seeing there? Has there been any change in gross sales cycles for both one or each these classes?
Mike Baur
Hey Mike, it is Mike Baur. No actual change in that, however what I might say is we’re doing a variety of instructional seminars across the nation, as you in all probability know. And no shock, the massive story is about how is AI going to have an effect on our enterprise, and the place that everybody is wanting to listen to about is AI and get in touch with heart. So we’re getting a variety of traction with curiosity. We’ll see how that impacts actually outcomes, however the contact heart story and the contact heart house stays very enticing to our brokers. They need to study extra.
We’re having — once more, we’re having large consideration and attendance at these occasions. And we’re persevering with to ensure we’re constructing our group out, in order that we study extra about how contact heart might be one of the best instance can make the most of AI to drive future revenues. However I believe, once more, the thought is we see an extended gross sales cycle when this know-how change occurs, for certain, as a result of now there could be some hesitation of do I purchase what’s out there immediately? Or do I wait one other six months or 12 months?
And so I would not be stunned to see a few of the transactions decelerate. However as we simply reported, it was nonetheless a really robust progress with our companions. And that is the fantastic thing about this Intelisys recurring income mannequin is we’re constructing off of that base each quarter and that is why we’re very interested in this house.
Michael Latimore
Sure. Sure. How concerning the pipeline? Any touch upon simply pipeline progress in UCaaS and CCaaS?
Mike Baur
Properly, we do not usually give out the pipelines. However once more, if I simply take into consideration the general alternative, and that is one motive that we’re enthusiastic about this new entity and being nearer to the tip person, Mike, is we consider we’ll profit from understanding higher what the tip customers are desirous about relative to CCaaS and UCaaS and I believe that may assist inform us for a few of our choices concerning the future. And what I hope will occur is we’ll develop some greatest practices to assist our Intelisys channel shut enterprise truly sooner. And that will probably be one in all our targets with a few of the instruments.
Michael Latimore
Nice. And simply lastly, you talked about some pricing stress maybe associated to consolidation within the business. I assume, are you able to discuss pricing on the finish person? Are you seeing pricing stress for the software program distributors themselves and how much their charging within the UCaaS, CCaaS market?
Mike Baur
Normally, I might say there may be completely stress on the seat costs persevering with to go down. Important stress there. Brokers must determine — and let’s simply return to the apparent, a few years in the past, UCaaS was rising on the fee CCaaS is rising now. So we are able to see that the unit value, the seat value taking place, makes it tougher to develop off the bottom.
And I believe that is critically essential as a result of the channel must know the way are they going to promote extra sooner or later. They must promote extra seats for a similar quantity of income that they received two years in the past. So undoubtedly stress on the seats, extra on the UCaaS immediately, however CCaaS can be seeing that stress on the finish person.
Michael Latimore
Bought it, received it. Okay, thanks.
Mike Baur
Thanks.
Operator
[Operator Instructions] At the moment, seeing no additional questions, I would now like to show it again over to Steve Jones for closing remarks.
Steve Jones
Properly, thanks for becoming a member of us immediately. We count on to carry our subsequent convention name to debate June 30 quarterly and full fiscal yr outcomes on Tuesday, August 22 — 27 at roughly 10:30 a.m.
Operator
Thanks to your participation in immediately’s convention. This does conclude this system. You could now disconnect.