Earnings Call Transcript - SCSC Q4 2024

Operator, Operator

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 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, Senior Vice President, Treasurer, 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 webcasts 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, 2024. 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, Chair and CEO

Thanks, Mary, and thanks everyone for joining us today. As we start our new fiscal year, 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 EMC Dell. 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 Resourcive which closed on August 8. Starting with Resourcive, 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 15, 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 fiscal year 2025.

Steve Jones, Chief Financial Officer

Thanks, Mike. As we close our fiscal year, 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 fourth quarter. 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 & 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 ‘24. 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 & Cloud segment declined 11% year-on-year less than the sales decline, reflecting a favorable mix including a higher concentration of recurring revenues from Intelisys. For FY ‘24, net sales declined 14%, while gross profits declined 11%. GAAP and non-GAAP net income declined 12.5% and 20.5%, respectively. FY ‘24 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 & Solutions segment net sales declined 14% year-on-year, while gross profits declined 16%. Modern Communication & 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 12 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 1 times to 2 times adjusted EBITDA. Share repurchases totaled $22 million for Q4 and $43 million for FY ‘24. For FY ‘25, 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 ‘25 annual outlook, the company expects the challenging demand environment to continue in the near term, particularly in the first half of our fiscal year. 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 ‘25 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 ‘25, 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% to 4.6%. As we reported last year, the company is building a cash culture as we believe generating predictable free cash flow is a key measure of success. For FY ‘25, we believe that we will generate at least $70 million in free cash flow. While this is significantly lower than FY ‘24, 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, Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from Adam Tindle of Raymond James. Your line is now open.

Adam 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. 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.

Mike Baur, Chair and CEO

Yeah. Hey, Adam. 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. And 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 EMC Dell 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. And so as Ken and I talked about where Intelisys is, it became more of the conversation about where it can go and what it can become. And 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 Tindle, Analyst

Got it. That's helpful. I heard that he's a Clemson Tiger, too, so I'm sure that he was welcome. I wanted to follow up on that. This is part of a broader strategy to build up the ISS group, and we've made a couple of acquisitions. Could you provide any insight on the expected contribution from those acquisitions as you develop your fiscal '25 guidance? Additionally, I’m curious about how your process for creating the fiscal '25 guidance might differ from what you experienced when entering fiscal '24. I know that process was relatively new to you at that time, and I'm sure you’ve learned a lot since then. Could you elaborate on how the guidance process for fiscal '25 is different? Any details on acquisition contributions would also be appreciated. Thank you.

Steve Jones, Chief Financial Officer

Thank you, Adam, for the question, and good morning. Regarding our acquisitions, we have been considering this for some time. Our acquisition strategy focuses on higher margin opportunities that require low working capital, always keeping in mind the right return for the company. We assess whether these acquisitions add to our EBITDA and overall contribution, and they do, although they are small. These small acquisitions are part of a programmatic approach to our strategy and are included in our guidance, but they are not expected to significantly impact our consolidated results for fiscal 2025. Moving on to your second question, we've learned that predicting top line growth is challenging, especially given the market changes last year. We were emerging from supply chain constraints, and while we have a differentiated technology portfolio, each part of it underwent different cycles. This experience has made forecasting difficult again, which influenced our guidance decisions for 2025. We wanted to maintain guidance, as we believe it is important, and we realized the necessity of focusing the entire company on generating free cash flow and managing working capital effectively. This understanding has given us confidence to provide guidance for free cash flow again this year. So, the key takeaways are that it remains hard to predict top line performance as we progress through the year, leading us to provide wider ranges, and we are focused on balancing top line expansion with the return on free cash flow.

Adam Tindle, Analyst

Makes sense. Thank you very much.

Operator, Operator

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.

Greg Burns, Analyst

Good morning. We've had some, I guess, I don't know if you characterize it as positive, but maybe improving kind of outlooks 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, like you mentioned, the different technologies 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, Chair and CEO

Hey, Greg. It's Mike. I'll take this one. As Steve mentioned, our approach this year has been consistent with previous years; we ask our teams for their best estimates of our performance. As I've stated for quite some time, as a distributor, we don't control or typically create demand, making it quite difficult for us to predict future trends. We don't maintain a backlog except for a short period during the supply chain crisis when there was a lack of product. We have returned to operating like a typical distributor, relying on our partners to inform us about their needs. We then place orders with our suppliers, who are consistently inquiring whether we are seeing any signs of recovery, as you alluded to. Unlike last year, where we had a specific top-line number, this year we decided to provide a broad range to account for timing uncertainties. Steve also noted the expectation of a dynamic between the first and second halves of the year. While we believe that the first half will be challenging to predict, we anticipate that the second half will be clearer. However, we made similar statements last year, so we are doing our best based on the feedback we receive from our suppliers. We have a variety of suppliers, and some performed better than others last year. For instance, our physical security segment has shown strong resilience, while other parts of our business, even beyond Cisco and Zebra, have not performed as well. We are currently assessing where to make investment decisions for 2025 and 2026, keeping in mind the importance of managing our balance sheet wisely and avoiding the use of it for opportunistic purchases, as we did in the past. We aim to be very cautious in our use of the balance sheet to support working capital.

Greg Burns, Analyst

All right. Thanks. And then in terms of Resourcive, 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, Chair and CEO

When we began discussing the creation of a new business group, we emphasized two main points. First, we believed it was essential to have a management and leadership team that would remain with the company, rather than those who were leaving. Although the Founder and CEO is departing, the team he assembled has been with the company for around seven years, and they are committed to staying. We are enthusiastic about their potential to build a team that will continue to perform well in the future. This is essentially the foundation for our leadership team. Secondly, we recognized the need for a technology tool to assist Resourcive and similar companies that purchase from us, specifically on the Intelisys side, in managing their contracts, renewals, and selling advanced technologies. We still need to identify that additional component and prefer to acquire a technology tool rather than develop one internally. If we had to prioritize, we would choose to focus on the leadership team first, which is where Resourcive excels. We are excited that this team is eager to join ScanSource. Mark Morgan, who is well-known among our investors and in the community, was instrumental in identifying potential acquisition targets and led the acquisition process. His leadership gives us confidence that we have chosen the right team and that we can quickly begin generating the business we expect Resourcive to achieve.

Greg Burns, Analyst

Great. Thank you.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Keith Housum of Northcoast Research. Your line is now open.

Keith 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 to some geographies there? Or you have been actually taking them countrywide now. But how scalable are the businesses and how quickly can you guys scale them up?

Steve Jones, Chief Financial Officer

Good morning, Keith. We view both companies as scalable opportunities. They are smaller firms with unique strengths and management styles that we intend to build upon. The acquisition of Advantix is particularly notable because it enhances our capabilities and adds value, similar to our past experience with POS portal. This should also boost our hardware sales, benefiting our VAR partners and enhancing our technology offerings in the channel. We believe this will set us apart in our established technology areas. Both companies are indeed scalable, starting small, but Resourcive has a strong management team to drive growth, and Advantix is well-established in an exciting space within the hardware technology stack, which has us eager for the potential ahead.

Keith Housum, Analyst

Okay. Appreciate that. And I know you guys say they're higher margin. Do I assume these are 100% gross margin businesses as well as much better on the bottom line as well?

Steve Jones, Chief Financial Officer

Well, they're primarily recurring revenue businesses, Resourcive 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 Resourcive, when the net reporting would be close to 100%. Advantix is going to be very high as well. Just the mix of services in there might bring it down a bit.

Keith Housum, Analyst

In terms of the hardware, there have historically been challenges, particularly as on-prem hardware communication systems have been declining. I'm interested to know if there are any aspects of your product portfolio that are facing challenges that might impede hardware growth sales moving forward. Could you share more about that?

Mike Baur, Chair and CEO

Hey, Keith. It's Mike. And you're talking about our Comms business and whether there's any new challenges, because that's certainly been a story for seven or eight years. Is that really your question? Is there anything new there?

Keith Housum, Analyst

Yeah. I'm looking for new challenges, if it's Comms or Specialty Group, either one.

Mike Baur, Chair and CEO

Got it. I don't have any new updates regarding the Specialty business. We anticipate that this segment will return to growth as customers will need to refresh their products with the technologies they want to develop and use. We are unsure when this will begin to become evident, whether in the first half or second half of the year. Regarding the Comms side, we have to keep in mind that Cisco's challenges impact this segment more than usual, which may cause it to appear different compared to a year ago. Aside from Cisco, the other businesses in the Comms segment are performing similarly to our other hardware sectors. They are facing challenges, but we expect them to improve as we approach fiscal year '25, although some may still be declining.

Keith Housum, Analyst

Just to touch on the networking business, if I remember correctly, last year had many tough comparisons because Cisco was managing a lot in the supply chain. Those tough comparisons are almost over now after the fiscal first quarter, right?

Mike Baur, Chair and CEO

Yeah. That's right. Yeah.

Keith Housum, Analyst

Okay. Got it.

Mike Baur, Chair and CEO

Yes, as you mentioned, those were the last technologies for us that arose from the supply chain issues.

Keith Housum, Analyst

Certainly. My final question is about the capital allocation strategy. With $185 million available, it's a significant amount of cash. You've repurchased more shares in the last two quarters than you typically do historically. Your acquisition pipeline is also substantial. What is your strategy moving forward regarding the distribution of your capital between mergers and acquisitions and share buybacks?

Steve Jones, Chief Financial Officer

Hey, Keith. This is Steve again. I’ll address that question. It really comes down to our ability to generate free cash flow, which is key to our capital allocation strategy. We believe there's room for both acquisitions and share buybacks. We expected to close some deals back in August, and we still see opportunities ahead. With cash available on our balance sheet, we aren’t worried about the leverage ratio for 2025. Our current approach is to pursue both opportunities in acquisitions and to be disciplined about ensuring they align with our strategy and profile. Additionally, we plan to return capital to our shareholders through a disciplined share repurchase program.

Keith Housum, Analyst

Great. Thank you.

Operator, Operator

Thank you. Please hold for the next question. Our next question comes from Matthew Harrigan of The Benchmark Company. You may now go ahead.

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? I know you're not going to talk about the EV to sales multiples, on the two acquisitions you just did, Resourcive and Advantix, but where do you see that? What's the broad baller for multiples that you're seeing? I know you've got a nice arb between the operating contributions, between what you see in the perceived sellers multiple, but just any general thoughts on where that's going, since it seems like you've got a lot of Pacman opportunities, 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 the equilibrium between secular decline and innovation on the barcode market right now? Thank you.

Mike Baur, Chair and CEO

Hey, this is Mike. I'll address part of the first question and return to the second after Steve responds. Regarding our acquisition strategy, we have a track record of acquiring companies that are eager to join ScanSource, which has allowed us to make favorable acquisitions in terms of multiple and return on investment. These companies recognize that joining ScanSource benefits their employees, founders, and sales teams. Many of our past acquisitions have included earn-outs, making us a generally well-received acquirer, which helps us make informed decisions. Relating to the earlier question about acquisitions, I believe what we will observe in 2025 will reflect the groundwork we laid in 2024, where we focused on identifying potential targets. A year ago, we did not have our targets as well aligned as we do now. I'll let Steve elaborate further on acquisitions and any other relevant points.

Steve Jones, Chief Financial Officer

Yeah. 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, Chair and CEO

Yeah. That's right. And into the Zebra question, or the Barcode question, if you will, 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. And we believe having recurring revenue and being able to sell mobility devices gives us a stronger position in the market as it comes back. So 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, Operator

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, Chief Financial Officer

Thank you. And thank you for joining us today. We expect to hold our next conference call to discuss September 30th quarterly results on Thursday, November 7 at 10:30 AM.

Operator, Operator

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