ScanSource - Q4 2024

Transcript

Operator (participant)

Welcome to the ScanSource Quarterly Earnings Conference Call. All lines have been placed in a listen-only mode until the Q&A session. Today's call is being recorded. If anyone has objections, you may disconnect at this time. I would now like to turn the call over to Mary Gentry, Senior Vice President, Treasurer, Investor Relations. Ma'am, you may begin.

Mary Gentry (SVP of Treasurer & Head of Investor Relations)

Good morning, and thank you for joining us. Our call will include prepared remarks from Mike Baur, our Chair and CEO, and Steve Jones, our Chief Financial Officer. We will review our operating results for the quarter and the year, and then take your questions. We posted an earnings infographic that accompanies our comments and webcast in the Investor Relations section of our website. As you know, certain statements in our press release, infographic, and on this call are forward-looking statements and subject to risks and uncertainties that could cause actual results to differ materially from expectations. These risks and uncertainties include the factors identified in our earnings release and in our Form 10-K for the year ended June thirtieth, twenty twenty-four. Forward-looking statements represent our views only as of today, and ScanSource disclaims any duty to update these statements except as required by law.

During our call, we will discuss both GAAP and non-GAAP results and have provided reconciliations on our website and in our Form 8-K. I'll now turn the call over to Mike.

Mike Baur (Chairman and CEO)

Thanks, Mary, and thanks, everyone, for joining us today. As we start our new FY, we are seeing accelerated adoption of our hybrid distribution strategy, which we believe will drive more demand. Last week, we hosted 800 attendees at our Partner First conference, where we challenged our sales partners to get out of their comfort zones and embrace new opportunities for growth. Our hybrid distribution strategy enables our sales partners to sell more of the technology stack to meet end user customers' IT requirements. As our channel partners expand their technology stack offerings, ScanSource expands our total addressable market. In July, Ken Mills joined us as President of Intelisys, with a background most recently as CEO of Epic iO, a supplier to all the TSDs in the channel, where he led a private equity-funded company through four years of double-digit growth.

Ken has many years of channel experience dealing with agents, VARs, MSPs, OEMs, and end user customers when he worked previously at Cisco and Dell EMC. At Intelisys, Ken is leading our next phase of growth for the channel, as we are making investments in advanced technologies such as AI and private 5G. We also see partner segmentation as a strategy to demonstrate our differentiated value to partners who require a customized set of services. Our focus will be on the fastest-growing partners, including IT VARs, advanced technology partners, and telco agents. Earlier in August, we announced two acquisitions in different segments of our business for the next phase of our hybrid distribution strategy. Both acquisitions are high margin, recurring revenue businesses that are working capital light.

As we previewed on last quarter's earnings call, our advisory channel business came to life with our acquisition of Resorsive, which closed on August eighth. Starting with Resorsive, ScanSource is creating the advisory channel model of the future, developing best practices that we can share with the Intelisys partner community. Also in August, we announced the launch of our Integrated Solutions Group. This new group is focused on specialty technology VARs and will provide them with new solutions to deliver more value with their hardware. On August fifteenth, we closed the acquisition of Advantix, a connectivity provider of 5G for mobility solutions. Advantix enables mobility VARs to sell hybrid solutions by combining the recurring revenue stream from the connectivity with the hardware mobility devices. We are executing well on investments to accelerate our hybrid distribution strategy and the expanded high-margin growth opportunities ahead.

As we said last quarter, we will continue to use our balance sheet to invest in the growth opportunities that are part of our strategic plan. I'll now turn the call over to Steve to take you through our financial results and outlook for FY 2025.

Steve Jones (CFO)

Thanks, Mike. As we close our FY, I'm proud of how our teams have executed. As reported by many channel companies and suppliers, we are experiencing soft demand for many of our technologies in both of our segments. However, we did see some technologies that experienced good growth in Q4, including physical security in our Specialty Technology Solutions segment and UCaaS and CCaaS in our Modern Communication and Cloud segment. While it was a challenging year, our teams stayed focused and were able to deliver strong profitability and significant free cash flow for the full year, including the Q4. For the quarter, our business delivered strong gross profit margins, Adjusted EBITDA margins, and free cash flow of $53 million. In our Specialty Technology Solutions segment, net sales declined 14% year on year, while gross profit declined 10% year on year.

In our Modern Communication and Cloud segment, net sales declined 32% year on year, while Intelisys net sales grew 6% year on year. Q4 end-user billings for Intelisys increased 9% year on year and totaled $2.67 billion in FY 2024. This includes Q4 billings growth in Contact Center as a Service, or CCaaS, of 35% and UCaaS of 13%. Gross profit in our Modern Communication and Cloud segment declined 11% year-on-year, less than the sales decline, reflecting a favorable mix, including higher concentration of recurring revenues from Intelisys. For FY 2024, net sales declined 14%, while gross profits declined 11%. GAAP and non-GAAP net income declined 12.5% and 20.5%, respectively. FY 2024 non-GAAP EPS is $3.08, compared to $3.85 last year.

Free cash flow for the year was $363 million, driven by a significant reduction in working capital from lower sales and our working capital efficiency improvements. For the year, the Specialty Technology and Solutions segment net sales declined 14% year-on-year, while gross profits declined 16%. Modern Communication and Cloud segment net sales declined 13%, while gross profit declined 6%, again, reflecting a higher mix of recurring revenue from our Intelisys business, which saw a 6.6% year-on-year growth in net sales. Recurring revenue represented 27% of the company's consolidated gross profits. Now turning to the balance sheet and cash flow. We are very pleased with the progress we're making on our working capital efficiency. Our goal throughout the year was to improve our working capital efficiency while maintaining appropriate inventory levels to meet channel partner demand.

We saw inventories decrease $245 million year-over-year, and sustainable improvements in our inventory turns. Our accounts receivable balances are in line with our change in revenue, and both our inventory and accounts receivable portfolios are healthy. Our balance sheet is strong. We ended Q4 with $185 million in cash and a net debt leverage ratio below zero on a trailing twelve-month adjusted EBITDA basis. Our capital allocation plans balance acquisitions and share repurchases while maintaining a strong balance sheet with a modest net leverage target of one to two times adjusted EBITDA. Share repurchases totaled $22 million for Q4 and $43 million for FY 2024. For FY 2025, we have an active pipeline of acquisition targets and room to continue to do share repurchases while staying within our targeted net leverage ratio.

As we look to our FY twenty-five annual outlook, the company expects the challenging demand environment to continue in the near term, particularly in the H1 of our FY. As a reminder, we have very little backlog to give us an indication of demand as we ship each day from our inventory based on orders received that day. We continue to manage our SG&A spending to match our revenue growth expectations for FY twenty-five and beyond by redirecting resources and investing in our recurring revenue businesses. We continually review our resource investment and adjust based on market opportunities. For FY twenty-five, we currently believe our net sales will be between $3.1 billion and $3.5 billion, with adjusted EBITDA ranging between $140 million and $160 million.

This reflects an Adjusted EBITDA margin of approximately 4.5%-4.6%. As we reported last year, the company's building a cash culture, as we believe generating predictable Free Cash Flow is a key measure of success. For FY 2025, we believe that we will generate at least $70 million in Free Cash Flow. While this is significantly lower than FY 2024, we believe the majority of our working capital reduction actions are complete and will shift to a continuous working capital efficiency improvement. Our outlook includes our recent acquisitions, and we remain confident in our growth opportunities, the resilience of our business model, and the strength of our Hybrid Distribution strategy. We'll now open it up for questions.

Operator (participant)

Thank you. At this time, we'll conduct the Q&A session. To ask a question, you'll need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Adam Tindle, Raymond James. Your line is now open.

Adam Tyler Tindle (Analyst)

Okay, thanks. Good morning. Mike, you talked earlier in the call about the appointment of Ken Mills as President of Intelisys in July, and I think that's a really interesting turning point for the company. I wonder if you could maybe just double-click on that, maybe a little bit more details on the structure of the organization, how that's changing, the KPIs for that business, and how those might be changing. Thanks.

Steve Jones (CFO)

Adam. You know, for us, as you know, we took quite a while to actually appoint a new president, and at the time, I was acting in that capacity to make sure I understood not only where we were doing things well, but also where we weren't doing things maybe for the future, and it looked to me like we needed more strategy and vision. Execution is something I think that Intelisys has always been very good at, but I think as the competition changed on us over the last couple of years, we need to take a hard look at where our value is and where our value can become in the future.

Ken brings such a strong background in different channel approaches that really resonated with our team as we interviewed Ken and looked at others that might come more directly from the TSD channel community. Ken's background, not only at Cisco and Dell EMC, but also at a supplier to all of the TSDs, really brings a unique approach to the knowledge base that, frankly, I didn't have. So as Ken and I sat and I talked about, you know, where Intelisys is, it became more the conversation about where it can go and what it can become. So we are very bullish on the TSD model and why we believe, going forward, we can create more growth. As a matter of fact, Ken and I discussed, going forward, we believe we can get back to double-digit growth at Intelisys.

Adam Tyler Tindle (Analyst)

Got it. That's helpful. I also heard that he's a Clemson Tiger, too, so I'm sure that was welcome.

Steve Jones (CFO)

You know, we try not to use those things to influence us, but yes, it wasn't a bad thing. Go, Tigers!

Adam Tyler Tindle (Analyst)

Yep, yep. Steve, I wanted to maybe follow up on that. Obviously, this is part of sort of a broader strategy to, you know, also to build up the ISG group, and we've got a couple acquisitions here. Any help that you could maybe provide us in terms of expected contribution from those acquisitions as you built up your FY 2025 guidance? And then separately from that, just, you know, more broadly speaking, as you built up the FY 2025 guidance, I wonder how that process might have been similar or different from entering FY 2024. I know, you know, that whole process was kind of newer to you guys at that time, and I'm sure there's been some learnings since.

If you could maybe just touch on the process to guidance entering FY 2025, how it was different, and then any acquisition contribution color would be helpful. Thanks.

Steve Jones (CFO)

Adam, thanks for the question, and good morning. Let me talk about the first one about our acquisitions. Again, when we talk about our, and we've been thinking about this for a while and working through this. When we think about our acquisition strategy, it's really around acquiring higher margin opportunities that are low in working capital, and this will always be over the context of the right return for the company. So when we think about, are they accretive to our EBITDA? Are they accretive to our overall contribution? Yes, they are. They're small. These are small acquisitions that we're announcing, more of a programmatic approach to our acquisition strategy.

And so they are included in our guidance, but I would say that they're not significant to the consolidated results for FY 2025 that we've got in our guidance. Let me maybe move to the second question on. We learned a lot, and the thing that we learned is, this is a tough time to try to predict the top line growth. You know, when we, when we entered last year, there was a lot of changes going on in the market. We were coming out of the supply chain constraints and our technologies. You know, we, we do have this differentiated portfolio, which helps us, but our technologies all went through different cycles of that portfolio. So what we learned is predicting this thing is hard again.

And, so that kind of guided our decisions as we came into 2025 on how we would guide. We wanted to maintain guidance because we think it's important, but also what's important to us. And one of the things that became crystal clear last year is we needed to focus our whole company on driving free cash flow and making good decisions on our working capital. And so, that gave us confidence that we could guide again this year for free cash flow. But really, I would say the two takeaways is hard to predict the top line as we go through the year, and we gave wider ranges because of that, and keeping everyone laser-focused on the trade-off between expanded top line and the return on free cash flow.

Adam Tyler Tindle (Analyst)

Makes sense. Thank you very much.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Greg Burns with Sidoti. Your line is now open.

Gregory John Burns (Analyst)

Good morning. I guess, I don't know if you characterize it as positive, but maybe improving kind of outlook from some of your supplier partners like Cisco and Zebra, or maybe just more positive comments or green shoots there in terms of maybe demand firming up. Is it just a function of maybe the cycles of the, like you mentioned, the different technologies of, or where you sit in terms of the timing of orders that is, like, maybe clouding demand? I'm just trying to understand, maybe the declines you saw this quarter in both segments and your outlook relative to maybe some of the more positive commentary we're seeing from your supplier partners. Thank you.

Mike Baur (Chairman and CEO)

Hey, Greg, it's Mike. I'll tackle it. I think, as Steve indicated, the approach we took this year-

... similar to what we've done in many years, is we ask our teams what's their, you know, best estimate of what we're gonna do. And, and I've argued for a long, long time that, for us, as a distributor, who really, we don't control the demand, we don't typically create demand, very hard for us to know what's coming. And as you know as well, we don't maintain a backlog, except for that brief period during the supply chain crisis, where there was no product, and so we did kinda understand what demand was. We're more back to where our business normally operated from a distributor standpoint of hardware, which is we have to depend on our partners to tell us what they think they're gonna need. We then place orders with our suppliers.

Our suppliers, let me tell you, they're asking us constantly, "Hey, are we starting to see," as you indicated, "green shoots?" This idea that we gave for this year, unlike last year, where we had an at least number for the top line, we decided to come up with this wide range because it's the timing question. As Steve indicated in his prepared remarks, we believe right now that there's a H1, H2 dynamic that should play out. That's based on all the information we have. That may or may not be true, meaning, I think the H1 of our FY is gonna be very hard to forecast. We believe the H2 will be easier, but we also said that last year.

So, so we're doing the best we can and bounding it by what we continue to hear as well from the suppliers that you've referenced. But as you know, we've got a lot of suppliers, and we indicated that some actually did better last year than others. Our physical security business, as an example, really was very strong and resilient, yet we had some other parts of our business, even beside the Cisco and the Zebras, that did not do well, and so we're trying to figure out where we should make an investment decision for 2025 and 2026 right now, but we're mindful of the fact that, as Steve indicated as well, we wanna be mindful of managing our balance sheet appropriately, not getting into the position where we're using our balance sheet to drive opportunistic purchases.

That's something we used to do. We're gonna make sure we're very, conservative in our use of the balance sheet to drive working capital.

Gregory John Burns (Analyst)

All right, thanks. And then, in terms of Resorsive, why was that the right, I guess, first acquisition in the advisory space? Maybe what was unique about them that attracted you to that business?

Mike Baur (Chairman and CEO)

When we started talking about this idea of creating a new business group, the two key messages we started talking about was, we believed that we needed a management team, a leadership team, that we could acquire, that would be the people that are staying, not the people exiting. In this particular case, the founder and CEO, president of this company, is leaving, but the team that he recruited has been there for about seven years, and they're staying. They're on board, they're staying, and we're excited about their ability to build, really, a team that can continue to perform well going forward. So we believe this is the kind of starting point for this leadership team.

The second thing we talked about that we were gonna need was some kind of technology tool to help this particular company, Resorsive, and others like them that buy from us on the Intelisys side of the fence, manage their contracts, manage renewals, manage selling advanced technologies, and we believe we still need to find that other piece of the puzzle. We need to find a technology tool rather than us building ourselves, and so for us, if we had to choose between acquiring a technology, a tool, if you will, or a leadership team first, our preference was the leadership team first, and that's where Resorsive really shines, so we're excited. This team is excited to be part of ScanSource.

And Mark Morgan, who, many of our investors and certainly folks in the community know Mark, he led the discovery of the potential targets and led the acquisition. And so Mark leading this gives us a lot of confidence that we picked the right team, and that we will be able to get started very quickly to generating the kind of business that we expect Resorsive to become.

Gregory John Burns (Analyst)

Oh, great, thank you.

Mike Baur (Chairman and CEO)

Yep.

Operator (participant)

Thank you. Our next question comes from the line of Keith Housum of North Coast Research. Your line is now open.

Keith Michael Housum (Analyst)

Good morning, guys. Hey, Steve, perhaps you can provide some color in terms of the scalability of the companies that you just acquired. Were they limited more into some geographies there, or you have advantage of taking them, you know, countrywide now? But how scalable are the businesses, and how quickly can you guys scale them up?

Steve Jones (CFO)

Hey, Keith, good morning. You know, the way we are thinking about both of these companies is, they are scalable plays. They are smaller companies that we think have unique capabilities, unique management styles, and those would then be what we would build on. Advantix, that we announced, that's an interesting one because it does two things for us. First of all, it gives us some advanced capabilities and some value-added capabilities, much like what we did with POS Portal years ago, but it also then should help us sell more hardware. And that's an exciting thing for us as well, is this will help our VAR partners sell more of the technology stack.

... and that, that's a good thing in that channel for us. We think that'll help differentiate our offerings, again, around the technologies that we know very well, and we've been in for a long time. So in terms of the scale, yes, both of these are scalable acquisitions, both small as we start out. But the right, to Mike's point, Resorsive, the right management team to get that opportunity off the ground, and with Advantix, very established, they know their stuff, they're in a very exciting and interesting space in that hardware technology stack that we're really excited about.

Keith Michael Housum (Analyst)

Yep, appreciate that. And I know that you guys said they are higher margin. Do I assume that these are 100% gross margin businesses as well as, you know, much better on the bottom line as well?

Steve Jones (CFO)

They're primarily recurring revenue businesses, Resorsive more so than Advantix, but Advantix also has recurring revenue. But if you think about Advantix, there'll be a little bit more services around that too, but higher margin for sure, and Resorsive, you know, with the net reporting would be close to 100%. Advantix is gonna be very high as well. Just the mix of services in there might bring it down a bit.

Keith Michael Housum (Analyst)

Okay. Got it. Got it. Switching over to the hardware, in terms of the hardware portfolio, you know, historically, there's been issues, obviously, as the on-prem hardware systems, communication systems were declining. I guess what I'm trying to understand, is there anything in their product portfolio that perhaps we're seeing, like, you know, just the evolution of technology where there's naturally under pressure from, you know, being able to grow going forward? Can you perhaps give me an idea of your portfolio, if you've got any challenges there that perhaps will be hurting hardware growth sales going forward?

Mike Baur (Chairman and CEO)

Hey, Keith, it's Mike, and you're talking about our comms business and whether it, there's any new challenges? 'Cause that's certainly been a story for, you know, seven or eight years. Is that, is that really your question? Is there anything new there?

Keith Michael Housum (Analyst)

I'm looking for new challenges.

Mike Baur (Chairman and CEO)

Yeah.

Keith Michael Housum (Analyst)

If it's, you know, comms or specialty group, either one.

Mike Baur (Chairman and CEO)

Got it.I don't think there. Well, on the specialty itself, no new news there. I think we expect that business to return to growth. We believe the technologies that customers want to develop and use, they're gonna need to refresh their products. And so that, we believe we're in an opportunity where that'll become the story. We don't know yet, again, is that H1, H2, when's that gonna start to become apparent? But going over to the comms side, that business, as we said, and again, we got to remember, in our comms segment, we have Cisco, which confuses sometimes our story, right?

So Cisco being challenged affects that comms segment more than normal, so that's probably why there's maybe some, it maybe look different than it did a year ago, is because of the Cisco emphasis there. But the traditional other business in the comms segment, outside of Cisco, I would say it's operating, as our other hardware businesses are. They're challenged, but we expect them to start doing better, not necessarily, some of them still declining, but they will do better going forward into FY 2025.

Keith Michael Housum (Analyst)

Just touching on that networking business, if I remember right, last year, the, obviously, a lot of tough comparisons because you guys were flushing through the supply chain, Cisco-wise. Those tough compares are just about ending here after the first FY quarter, correct?

Mike Baur (Chairman and CEO)

That's right. Yep.

Keith Michael Housum (Analyst)

Okay.

Mike Baur (Chairman and CEO)

Yep.

Keith Michael Housum (Analyst)

Got it. Got it.

Mike Baur (Chairman and CEO)

Like you said, it was, they were the last technologies for us to come out of the supply chain problems.

Keith Michael Housum (Analyst)

Yep, absolutely. So last question for me, I'll turn it back over. Capital allocation strategy, obviously $185 million, a lot of cash to work with. You guys bought back more shares the past, you know, two quarters, you probably have historically. Obviously, acquisition pipeline is, you know, large. What's your strategy going forward in terms of mixing your capital allocation between M&A and share buyback?

Steve Jones (CFO)

Hey, Keith, this is Steve again. I'll tackle that one. You know, it really goes back to what we generate free cash flow and the focus on our free cash flow that then allows us to do our capital allocation strategy. And we think there's room to do both. We think we were, you know, we had some of these opportunities coming out of the, you know, in August to close some of these deals. But we think that there's room to do both, particularly to your point, we have cash on the balance sheet, so we're not concerned about where our leverage ratio would go for twenty-five.

So in the near, you know, the near view that we have, you know, it's to do both, take advantage of the opportunities of the acquisitions that are out there, but be disciplined in those to make sure they fit our strategy and fit our profile. And then return the shareholder wealth through share repurchases, return that capital back to our shareholders through a disciplined share repurchase program.

Keith Michael Housum (Analyst)

Great. Thank you.

Operator (participant)

Thank you. One moment for our next question. Again, as a reminder, to ask a question, you'll need to press star one one on your telephone. Our next question comes from the line of Matthew Harrigan of The Benchmark Company. Your line is now open.

Matthew Harrigan (Analyst)

Thank you. Two questions, one more or less derivative of some of the prior questions. When you look at the M&A market right now, is there any loosening up on multiples given the economic uncertainty? And I know you're not gonna talk about the EV to sales multiples on the two acquisitions you just did, Resorsive and Advantix, but where do you see what's the broad color for multiples that you're seeing? I know you've got a nice arb between the operating contributions between what you see and the perceived, you know, sellers multiple, but just any general thoughts on where that's going, since it seems like you got a lot of Pac-Man opportunities to, you know, roll up more smaller companies in the same genre of the two recent acquisitions.

And then secondly, fairly encouraging noises out of Zebra. And what are you seeing in terms of kind of the equilibrium between, you know, secular decline and innovation on the barcode market right now? Thank you.

Mike Baur (Chairman and CEO)

Hey, this is Mike. I'll take part of the first question, and I'll come back to the second after Steve answers, but you know, when I think about our acquisition strategy, we've got a history of acquiring companies that want to be part of ScanSource, and that's always allowed us to frankly make very, I think, good acquisitions from a multiple standpoint, from a return standpoint. Because these companies see that if they join with ScanSource, their employees and even their founders and sellers do better, especially 'cause many of our acquisitions over the years have included earn-out, so we actually are a generally well-received acquirer, and I think that helps us make smart decisions.

And to the earlier question that was being asked about acquisitions, you know, I think what we'll see in 2025 is a result of the work we did in 2024, working on a target list. So we certainly believe that a year ago, we didn't have the targets aligned like we do today. And I'll leave it to Steve to answer some more about the acquisitions, and anything else, Steve, on that.

Steve Jones (CFO)

The only thing I would add to that, Mike, I think you covered it really well, is that, when you talk about acquiring recurring revenue businesses with higher margins, they come naturally with a higher multiple. But, we're not seeing any big shift yet in the multiples that are out there. We just think that we're doing a better job of getting them queued up and fitting them to our strategy, so that we can then bring them in and make them, to Mike's point, happy ScanSource family members.

Mike Baur (Chairman and CEO)

That's right. And, and then to the Zebra question or the barcode question, if you will. You know, one of the things that we really are excited about is this idea of creating this group now that we're calling ISG, and led with this Advantix acquisition, this is going to actually drive demand for hardware. We know that, and we've experienced this over the last few years. We've had experience with Advantix for about, I think four or five years, and so this has been kind of, we were dating these guys for a long time, not really understanding whether we should own this business or not. But as we looked at how do we participate as the market comes back, we felt like we need to create a stronger value proposition for our partners.

We believe having recurring revenue and being able to sell mobility devices gives us a stronger position in the market as it comes back. We believe that a year from now, we'll actually do much better than our competitors in these competitive barcode spaces because of an acquisition like Advantix.

Matthew Harrigan (Analyst)

Great. Thank you.

Operator (participant)

Thank you. I'm showing no further questions at this time. I would now like to turn it back to Steve Jones for closing remarks.

Steve Jones (CFO)

Thank you, and thank you for joining us today. We expect to hold our next conference call to discuss September thirtieth quarterly results on Thursday, November seventh at 10:30 A.M.

Operator (participant)

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.