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 now disconnect. I would like to turn the call over to Mary Gentry, Senior Vice President, Treasurer and Investor Relations. Ma'am, you may begin.

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. Tony Sorrentino, our President for Specialty Technology, is also joining us. We will review our operating results for the quarter and then take your questions. We've 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 30, 2023. 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.

Thanks, Mary. Thanks, everyone, for joining us today. In the third quarter, our people responded well in a challenging demand environment. However, we were surprised at our lower-than-expected net sales for our hardware business. Third quarter net sales declined 15% due to lower demand from our channel partners across our portfolio of technologies. Our strong margins and robust free cash flow reflect the strength of our business fundamentals. We operate in highly specialized technology markets with value-added profit margins because of our expertise. ScanSource benefits from this deep knowledge of our sales and supplier services teams, specific value-added tools and working capital investment that is countercyclical with sales volumes. With our hybrid distribution strategy, we are committed to helping our channel partners execute on the expanded opportunity to sell devices and recurring revenues. For our fiscal year 2024, we identified strong free cash flow and focus on Intelisys as important to management and our shareholders. Again, this quarter, we achieved this aim with free cash flow of $158 million and Intelisys growth of 4% year-over-year. Q3 end-user billings for Intelisys increased 7% year-over-year and totaled $2.68 billion annualized. This includes billings growth in Contact Center as a Service, or CCaaS, of 33% and UCaaS of 11%. We are expanding our investments in talent, training and tools to increase our value and drive growth as a technology services distributor. As reported by many channel companies and suppliers, we are experiencing softer demand. Our sales partners tell us that they are seeing a more cautious IT spending environment from end customers accompanied by longer sales cycles. For our third quarter, we expected broad-based declines across our hardware technologies. What surprised us, and what caused our revenue shortfall against our plan, was the significant decline in revenue from our networking products across the board, including Cisco networking. Our hardware portfolio is comprised of a diverse set of business-critical technologies. Right now, they are at different stages of their end-customer demand cycles following the last two years of supply chain and pandemic disruption. We believe we are on a path to return to growth and have confidence in our team's ability to navigate the demand cycles with the support of our channel partners. In the near term, we see both macro uncertainty and the continuing normalization of supply and demand creating a challenging forecasting environment. We generated another quarter of strong free cash flow and have a disciplined capital allocation plan of share repurchases and M&A. Our preferred use of free cash flow is to fund growth of high-margin, recurring revenue businesses that are working capital light. I'll now turn the call over to Steve to take you through our financial results for the quarter and our outlook for fiscal year 2024.

Yes. Thanks, Mike. Q3 demand was weaker than we expected. While sales were lower, our business delivered strong gross profit and adjusted EBITDA margins. Free cash flow exceeded our projections for the quarter. Q3 net sales of $753 million declined 15% year-over-year, while our gross profit margin of 12.6% is higher than we expected, benefiting from a higher mix of recurring revenues. We expected softer demand across technologies in our Specialty Technology Solutions segment. For our networking business, we saw sharper declines than we anticipated. Segment net sales declined 14% year-over-year and our gross profits declined 22% year-over-year as we're seeing lower benefits from supplier price increases as compared to last year. In our Modern Communications & Cloud segment, revenues declined 16% year-over-year. Cisco networking sales declined as big deals stalled and demand adjusted for supply chain normalizing. Intelisys revenues grew 4% year-over-year. And our gross profit margins in the Modern Communications & Cloud segment declined only 9% year-over-year, reflecting a favorable mix, including higher concentrations of recurring revenues from our Intelisys growth. For the quarter, we delivered $158 million in free cash flow. This reflects lower working capital needed when sales declined and our focus on balancing lasting improvements in our working capital efficiency without sacrificing profitable growth opportunities. As we look to close our fiscal year, the company expects a challenging demand environment to continue, and we are updating our guidance to reflect our current views of near-term demand. As a reminder, we have very little backlog to give us an indication of demand as we ship each day from our inventories based on orders received that day. We are managing our SG&A spending to match our revenue expectations for FY '24 and beyond by redirecting resources and investing in our Intelisys recurring revenue business. We continually review our resource investments. In January, we executed a workforce reduction plan to align our resources with our strategic plans. Q3 GAAP results include restructuring expenses related to employee separation and benefit expenses of $3.9 million. These actions are expected to result in annualized expense savings of approximately $10 million. For FY '24, we now believe that our net sales will be at least $3.3 billion, and our adjusted EBITDA will be at least $140 million, which reflects an EBITDA margin of approximately 4.25%. We are increasing our free cash flow outlook to at least $275 million. Our guidance reflects our expectations of the near-term demand environment. We remain confident in our growth opportunities, the resilience of our business model and the strength of our hybrid distribution strategy. Now going a bit deeper into the balance sheet and cash flows. We are pleased with the progress that we're making with working capital improvement plans. Our goal is to improve our working capital efficiency while maintaining appropriate inventory levels to meet channel partner demand. Q3 inventory turns of 4.8x were negatively impacted by the shortfall in revenue. Inventory levels have decreased $224 million and our paid-for inventory days improved to 11.2. Days sales outstanding, DSO, of 71 days is a slight increase quarter-over-quarter, reflecting sales timing at the end of the quarter. Our balance sheet is very strong. We ended Q3 with $159 million in cash and a net debt leverage ratio below zero on a trailing 12-month adjusted EBITDA basis. Our capital allocation plans, balanced acquisitions and share repurchases, while maintaining a strong balance sheet with modest levels of leverage. For Q3, share repurchases totaled $20 million. Today, we announced a new share repurchase authorization of $100 million. This is in addition to the $45 million of current authorization remaining as of the March quarter end. Our new repurchase program authorized by our Board of Directors reflects our confidence in ScanSource's business and the strength of our long-term free cash flow generation. I'll now turn the call back over to Mike.

Recently, after much research and market analysis, we identified several key trends affecting the future growth opportunities in our Intelisys business. Since ScanSource acquired Intelisys in 2016, the competitive landscape for our distribution business has been changing. During this time, consolidation reduced the number of TSD competitors from 16 down to 5 today. As we have discussed, we have experienced margin pressure in our Intelisys business, which lowers our Intelisys revenue growth results. However, even with the consolidation, Intelisys remains the largest technology services distributor in the business. During the last 24 months, we've also seen increasing consolidation in our agency partners. This activity also pressures margins. We haven't seen these agency roll-ups deliver innovation or new offerings to drive increased end customer demand. In addition, our TSD competitors have introduced various offers to acquire books of business and contracts from agencies. And in some cases, they acquired the agency itself. It is this last development that has convinced us to introduce our own offer to acquire contracts and agencies. Our partners have asked us repeatedly if we were interested in providing this value proposition to them. This offer would give our channel partners a way to take a few chips off the table or exit their business completely as the last stage in the agency business life cycle. So we announced that ScanSource would create a new business entity, separate from Intelisys, to be a platform for the channel model of the future. We are evaluating opportunities to acquire an existing agency that has a strong leadership team and fits with the ScanSource culture. Second, we are evaluating opportunities to acquire the digital tools our channel partners need to manage supplier and end user contracts. These contract management tools and other best practices we would develop in the new entity will be shared with the Intelisys channel. We expect to have more to share about our investments in the agency channel expansion soon. We look forward to launching the channel model of the future to help all our partners grow their businesses faster and better. We'll now open it up for questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Greg Burns with Sidoti. Greg, please proceed with your question.

Good morning. In terms of the declines you saw in networking and from Cisco this quarter, I think Cisco has talked about a couple of quarters of backlog of inventory at their customers that still needs to be deployed. Do you have a view on that? How long do you see this hangover lasting on the networking side of the business?

Greg, this is Tony Sorrentino. There's a lot of uncertainty around when this backlog gets worked through. It's a combination of softer demand and working through that backlog. So I don't know that we have a definitive answer on that.

Okay. And then in terms of this new agency initiative for Intelisys, is there any risk of, I don't know, so maybe the industry works, but is there a risk of channel conflict? Any channel conflict there bringing an agency in-house versus servicing your broader agency partners? And what does that do for the margins for the overall Intelisys business?

Hey Greg, it's Mike. I'll address that question. We are fully aware of the possibility of channel conflict and have been conducting surveys among our channel partners to gauge how our competitors are handling this situation. We've discovered that all our competitors are employing similar strategies with varying models. When we asked our partners if they had any concerns, many indicated that they continue to collaborate with those distributors that have also established somewhat competitive models. We've assessed what others are doing and believe that we are developing a solution that maintains adequate separation. This new company will be distinct from Intelisys and will report to ScanSource instead. We will have a different management team in place. Our objective is to ensure complete separation of data between Intelisys partners and this new agency. We previously discussed this concept with our partners, as we acquired the RPM product back in 2017 or '18, which has become a standard commissioning tool used by many competitors. At that time, I assured our competitors that we would keep their agency's data secure from Intelisys. We have successfully maintained this separation for many years. Moreover, we are going the extra mile to ensure that before the new agency engages with a new customer, they will verify within the ScanSource system whether there is an existing Intelisys partner involved with that customer. If we find that there is, we'll promptly inform the Intelisys partner about the potential opportunity. Our main goal is to establish a competent management team and explore ways an agency can effectively operate in the future while introducing approaches that are currently not seen in the channel. Now I’ll let Steve discuss the second part of your question regarding how this impacts margins for the overall Intelisys business.

Yes. Thanks, Mike. Greg, this is Steve Jones. When we look at the margin opportunity, what's happened in our space is margins have really started to get compressed on the Intelisys side as the agent is taking more of the margin share. So we think for ScanSource, this will help expand our margin opportunity in this agency channel. So that's the way we're looking at it. That's the way we're modeling it.

Okay. Great. Thank you.

Standby for our next question. Our next question comes from Keith Housum with Northcoast Research. Please go ahead with your question.

Great. Thanks guys. And good morning guys. Just obviously, want to continue the line of questioning here on the agency initiative. Mike, can you just give me a little perspective about today, like what is the makeup of the agency market? Are we primarily talking people, like 1 or 2 people and small million-dollar shops? Are we talking an end market that today does tens of millions of dollars of large shops? What kind of market are you guys getting into?

Yes, Keith. Good morning. Just as a reminder for everybody, we today have about 4,000 Intelisys partners doing business with us, and we have it widely distributed. And I would say the typical partner has 10 employees or less. And remember, their primary function as an agency is selling. They do have technical resources, but they have virtually no back office. Most of these agencies run off of QuickBooks, just to be honest, even the larger one. We process all the commissions, and the end users are billed by the suppliers. And so they don't really have to have a back office of any significance. So they're really sales organizations, and that's really what an agency does is they go out and work with end customers on opportunities for new. Where we think we see an opportunity, though, to help the existing partners is with renewals. One of the challenges is most agencies don't have an efficient way to scale over time renewals of contracts, as technologies change, they need to be renewed with new technologies, and as just contracts expire. So we think that's one of the advantages we can build. If we can build this contract management tool set that goes along with people, we believe we can show the rest of the Intelisys partners how to scale and how to use, frankly, some of our resources to work their installed base so that they have less churn. So this is one of the challenges with the typical agency is they don't have a lot of infrastructure to manage renewals.

Okay. I appreciate that. And Steve, explain a little bit more on the margin question about agencies. I guess, I'm just looking for like a margin profile. I mean we know Intelisys has great gross margins. And before the competitive advantage, I mean, I think your EBITDA margins were north of 30% or 35%. Obviously, that's changed quite a bit in the past several years. But how do we think about like an agency's profile? Is it also going to be more gross profit's going to be revenue? And then what type of EBITDA margins, I guess, could your average agency experience?

Yes, thanks. Let me start from the beginning. You mentioned the Intelisys EBITDA margins being around 40% when we acquired it, and that erosion has only recently begun as those margins have started to shift to the agents due to increasing commissions. We want to reclaim some of the margins that have transitioned to the agents. Looking at their margins, we are essentially viewing this from an agent commission perspective, meaning we will see 100% gross margins reported. However, that creates a challenge for our top line growth, as it doesn't grow as quickly or significantly impact our $3.5 billion revenue as much. We need to carefully analyze the economics of this situation. But we anticipate that it will enhance our overall company margins, which is why we find it appealing.

Okay. If I think about like the barcoding space, where you got a generation of VARs that are kind of retiring out. Do you have the same thing in the agency space where they've been around for long enough that you've got owners that are in that 50 to 60-year-old groups that are looking to get out? Or is this a relatively younger, I guess, makeup of owners today?

Yes, Keith, it's Mike again. Exactly right analysis. So the reason that these roll-ups have been happening, there have been investors, let's call them all pretty much private equity investors that have come in and acquired agencies or acquired just their contracts because many of those agency leaders are, frankly, at the end of their cycle. They're ready to exit. And they've asked us for the last few years. And we actually said for the last two years, no, we will not do that. It's not in our DNA to sell to the end user and own an agency. So this is a big change for us. And the agency owners, they're actually very interested. And we were nervous about just even talking about it, but it became obvious to us that part of the reason we're getting pressure on our margins from our competitors is because they're already doing this. They're already benefiting from that, and it's because the agents, once they know that there is a buyer out there like, hey, pick me, pick me. And some of them are saying, we don't want to sell the whole business. But as I said in my prepared remarks, they want to take some chips off the table. And unlike the VAR business, you can't easily buy just a part of a VAR business. You can't just buy because it's not recurring. It's deal by deal. Here, these are contracts that we will have a defined term with, defined amount of profitability, and we'll be able to pretty straightforwardly make an offer to just buy, let's say, $1 million annualized of recurring revenue from a partner, and they don't have to sell the whole business. And so that has gotten a lot of interest in the market. So again, we're responding to what the market is doing.

You announced this several months ago at one of your conferences, and you've had these discussions. So I assume that your M&A strategy involves acquiring a more established agency with some digital tools, perhaps to help establish a solid management team. Is it accurate to say that you are currently having these conversations? If not, is the alternative to pursue organic growth and build it yourself?

For us, we've talked about acquisitions because we want to go faster than we have been, meaning we're catching up. And again, listening to our competitors who have all come out publicly and dodged the question, frankly, of are they doing this, they've already started. We're catching up. So we will absolutely want to do it through acquisition. But then we will grow it with the balance sheet that we have. That means adding headcount, people, tools, and we believe then we can become the player of interest. And what I mean by that is we're not looking to make this agency the largest. It could happen. That's not our goal. Our goal is to create the best agency so that this has the best practices, the best programs so that we can still recruit new and frankly, younger partners in the Intelisys channel who want to maybe do something with their business 10 years from now or five years from now. And so we're trying to create, as I said in my opening remarks, a different model. So we're calling it the channel model of the future, where you can come to your distributor and take some chips off the table or potentially sell the whole business. And again, these are again, relatively, and maybe the point would be, these are all small businesses. These are not the size of Intelisys was. Now having said that, some of them have already been rolled up. Those entities have gotten large. One of our partners today has already rolled up about 30 agencies. And so they've acquired significant EBITDA by rolling them up.

Got it. And I appreciate that you're not going to let time dictate your schedule here. But do you have a goal in your mind about when you want to be able to have an agency under your roof and be running with the strategy?

Yes. I think I said earlier, we expect to have more to share about our investments in channel expansion soon.

All right. I can appreciate that. I'm going to change gears on you here and just talking about more traditional business, the hardware business. Some of your larger barcoding partners have expressed some optimism for an improvement in the second half of the calendar year. I'm not sure I'm hearing that from your conversation here today. And I appreciate the fact that your backlog is one day, two days, it's very short. But are you hearing any constructive conversations that would give you optimism for the second half of the calendar year?

Yes. I will have Tony provide some comments on that because he can discuss our various technologies, and not all of our suppliers have made information public. Perhaps Tony can give you a brief overview of our current status.

Yes, Keith. Hey, it's Tony. So there's certainly still a lot of uncertainty in the near-term. But I would say we're seeing green shoots of opportunity for growth in our physical security, barcode and mobility businesses for sure. That said, there's some optimism there, but there's also a lot of concern as well. So I've spent a lot of time with our top customers over the past month and they're cautiously optimistic, but certainly all the uncertainty in the macro environment is creating concern for them.

Please standby for our next question. Our next question comes from Mike Latimore with NCM. Mike, go ahead with your questions.

All right, great. Thanks. It looks like another good quarter of CCaaS and UCaaS billings growth. I guess, can you just talk a little bit about the sales cycles you're seeing there? Has there been any change in sales cycles for either one or both those categories?

Hey Mike, it's Mike Baur. There's no real change in that, but I want to mention that we're conducting many educational seminars across the country. Unsurprisingly, the main topic is how AI will impact our business, particularly in the contact center sector where there's significant interest. We're experiencing increased traction and engagement. We will observe how this influences our results, but the contact center narrative remains very appealing to our agents who are eager to learn more. We're receiving great attention and attendance at these events. Additionally, we are focused on expanding our team to better understand how the contact center can effectively utilize AI to enhance future revenues. However, it’s important to note that we expect a longer sales cycle due to this technological shift. There may be some hesitation about whether to invest in current offerings or wait for upcoming advancements within the next six to twelve months. Therefore, I wouldn’t be surprised if some transactions slow down. Nevertheless, as we've just reported, we are still experiencing robust growth with our partners. The strength of the Intelisys recurring revenue model allows us to build on that base each quarter, which is why we are very enthusiastic about this sector.

Yes. Yes. How about the pipeline? Any comment on just pipeline growth in UCaaS and CCaaS?

Well, we don't typically give out the pipelines. But again, if I just think about the overall opportunity, and that's one reason that we are excited about this new entity and being closer to the end user, Mike, is we believe we'll benefit from understanding better what the end users are thinking about relative to CCaaS and UCaaS and I think that will help inform us for some of our decisions about the future. And what I hope will happen is we're going to develop some best practices to help our Intelisys channel close business actually faster. And that will be one of our goals with some of the tools.

Great. And just lastly, you talked about some pricing pressure perhaps related to consolidation in the industry. I guess, can you talk about pricing at the end user? Are you seeing pricing pressure for the software vendors themselves and what kind of they're charging in the UCaaS, CCaaS market?

In general, there is significant pressure on seat prices to continue decreasing. Agents are faced with the challenge of adapting, especially considering that a couple of years ago UCaaS was growing at the same pace that CCaaS is experiencing now. The decline in unit prices makes it more difficult to achieve growth from the existing base. It is crucial for the channel to understand how they will increase sales in the future, as they need to sell more seats to generate the same revenue they had two years ago. There is definitely pressure on the number of seats, primarily on UCaaS at the moment, but CCaaS is also experiencing similar pressure at the end user level.

Got it, got it. Okay, thank you.

Thanks.

At this time, seeing no further questions, I'd like to turn it back over to Steve Jones for closing remarks.

Well, thank you for joining us today. We expect to hold our next conference call to discuss June 30 quarterly and full fiscal year results on Tuesday, August 22 - 27 at approximately 10:30 a.m.

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