Earnings Call Transcript - SCSC Q2 2022

Operator, Operator

Welcome to the ScanSource Quarterly Earnings Conference Call. All lines are 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 disconnect at this time. I would now like to turn the call over to Mary Gentry, Senior Vice President, Treasurer and Investor Relations. Ma'am, you may begin.

Mary Gentry, Senior Vice President, Treasurer and Investor Relations

Good afternoon and thank you for joining us. Joining me on the call today are Mike Baur, our Chairman and CEO; John Eldh, our Chief Revenue Officer; and Steve Jones, our Chief Financial Officer. We will review our operating results for the quarter and then take your questions. We posted an earnings infographic that accompanies our comments and webcast in the Investor Relations section of our website. Let me remind you that certain statements in our press release in the earnings infographic and on this call are forward-looking statements. These statements are subject to risks and uncertainties that could cause results to differ materially from such statements. These risks and uncertainties include, but are not limited to, those factors identified in the earnings release we put out today and in ScanSource's Form 10-K for the year ended June 30, 2021, as filed with the SEC. Any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. ScanSource disclaims any duty to update any forward-looking statements to reflect actual results or changes in expectations as required by law. During our call, we will discuss both GAAP and non-GAAP results and have provided reconciliations between these amounts in the earnings infographic and in our press release. These reconciliations also can be found on our website and have been filed with our Form 8-K filed today. I'll now turn the call over to Mike.

Michael Baur, Chairman and CEO

Thanks, Mary, and thanks everyone for joining us today. Our outstanding second quarter performance underscores the strength of our hybrid distribution strategy. For the quarter, we delivered 6.6% net sales growth and adjusted EBITDA margin of 4.9% and record non-GAAP EPS for the quarter and for the trailing 12 month period. Strong demand from channel partners across our technologies drove our top line growth and profitability ahead of expectations. We are proud of the operational excellence delivered by our employees worldwide despite the ongoing supply chain challenges. We are confident in our business model and ability to execute. As a result, we are raising our full-year fiscal year 2022 outlook and now expect net sales growth of at least 7% and adjusted EBITDA of at least $148 million. The foundation of our hybrid distribution strategy is helping suppliers and sales partners accelerate growth across innovative technologies to meet end-user requirements by providing hardware plus services, SaaS and other value-added offerings. Our hybrid distribution strategy guides how we operate our business for sustainable growth and profitability. In addition to our outstanding financial results, I am pleased today to announce the promotion of John Eldh to President of ScanSource Inc. John's successful two years leading the growth of our device digital and cloud businesses, along with his SaaS background, have positioned him to drive the next phase of profitable growth for us at ScanSource. John has built a world-class leadership team that we believe will lead us on a sustainable growth trajectory. As President, John will drive and champion our hybrid distribution growth strategy and communicate this message to our key stakeholders, including employees, sales partners, suppliers and investors. Congratulations, John. I'll now turn the call over to you to discuss our business performance.

John Eldh, Chief Revenue Officer

Thanks Mike. The past two years working with you and the entire ScanSource team have been amazing. I'm truly excited and also humbled by this opportunity and want to thank you for your trust and belief in me. Our future is bright and I look forward to working together as we architect the next chapter of growth for ScanSource. As for the quarter, our employees delivered impressive results with 6.6% year-over-year net sales growth and a 25% year-over-year increase in gross profits. Strong demand across technologies drove top line growth and margin expansion in both of our segments. I'm delighted with how our team is executing and successfully navigating supply chain challenges. Our second quarter results reflect strong growth from enterprise projects and large deals. While we experience heightened supply chain challenges in the quarter, our differentiators—specialization, deep supplier and customer relationships, and operational excellence—enabled us to manage these challenges and successfully navigate today's supply constrained environment. Another differentiator is our ability to use our balance sheet for strategic inventory investments. Our customers trust us to take care of their business and our dedicated suppliers and sales teams work to create a seamless buying experience. I'd like to share a recent example of how ScanSource is enabling partners to succeed with our hybrid distribution strategy across hardware, SaaS, connectivity and cloud services. In this example from the healthcare market, we enabled a large communication VAR with the design and delivery of a collaboration solution that included cloud-enabled hardware for voice and video, along with the UCaaS software subscription. Our team assisted with the technical design, product specifications, pricing, supplier program requirements and delivery of the total solution. This is a great example of how we enable our sales partners to sell hardware plus SaaS. In our specialty technology solution segment, net sales increased 9% year-over-year fueled by strong market demand, increases in large deals and market share gains. Digital acceleration and technology refresh initiatives with end users are driving demand for our channel partners. A more favorable sales mix and increased supplier sales incentives drove higher segment gross profits, which increased 35% year-over-year with a 10.5% gross profit margin. With increased demand and ongoing labor shortages, customers are implementing mobile computing solutions to increase automation and worker productivity. To address the massive increase in eCommerce caused by COVID-19, retailers are working with our sales partners to implement mobile solutions to expand distribution centers, maximize inventory awareness, and improve the customer experience. Our sales partners are also helping retailers adopt point-of-sale solutions to navigate omnichannel customer buying preferences, including self-checkout, curbside pickup, and storefront fulfillment for online purchases. The pod portal team had strong double-digit year-over-year growth for its business, which has a higher margin profile from selling hardware plus services. For our modern communications and cloud segment, net sales increased 3% year-over-year and segment gross profit increased 18% year-over-year with a 15.2% gross profit margin. We're also encouraged by our momentum in SaaS subscription sales, growing double digits globally. In the communications market, we are well-positioned to serve partners with both on-prem and cloud solutions. The Intelisys team achieved 14% year-over-year net sales growth and exceeded $2 billion in end-user annual recurring revenue or billings by supplier to end users. We're encouraged by the continued adoption of recurring revenue being sold by VARs. During the quarter, a highlight for the Intelisys event lineup was our in-person growth summit held here in Greenville, South Carolina. We shared our strategic plans for growth with a select group of over a hundred sales and supplier partners. I'm also excited about our regional, face-to-face roadshow series, which we are calling 'Amped.' These high-energy educational networking events advance sales partners' understanding of technology topics, engage them in interactive breakout role plays, and demonstrate our industry thought leadership through panel discussions. We've already held two of these powerful events with 10 more planned across the country for our partners' continued enablement and success. Our team in Brazil continues to deliver consistent performance across top line revenue and profitability metrics. During the quarter, we experienced strength in large deals, market share gains, and momentum with new suppliers. In addition to our success in hardware, our business in Brazil continues to build outstanding momentum across SaaS and digital solutions. I'm encouraged by our first half performance as we head into the second half of our fiscal year 2022. We are leading the way in hybrid distribution, accelerating the future of technology for our partners and suppliers across hardware, SaaS, connectivity, and cloud services. I'd like to thank all of our employees for their outstanding efforts in the quarter, and a heartfelt shout out to our employees at our distribution centers worldwide, who show up every day and exceed our customer expectations. I'd also like to thank our suppliers and customers for their continued loyalty and trust with ScanSource. Now, Steve will take you through the financial results.

Stephen Jones, Chief Financial Officer

Thanks, John. Our strong second quarter results demonstrate our team's successful execution of our strategic plan. It was an outstanding quarter for delivering top line growth, and our margins continue to benefit from the expanding mix of recurring revenues and value-added services. We achieved 17.6% ROIC for the quarter, the highest result in five years, as we balance our working capital investment to support our sales growth and meet future demand. As Mike noted in his opening remarks, our strong performance and momentum give us the confidence to raise our FY '22 sales growth and EBITDA expectations. In the second quarter, we achieved strong top line growth of 6.6% year-over-year or 7% on an organic basis and expanded our margins in both segments. Our gross profit margins increased to 12.5%, adjusted EBITDA margins increased to 4.92%, and our non-GAAP operating income margin increased to 4.15%. Our Q2 net sales of $864 million reflect strong customer demand across our technologies. During the quarter, we saw a modest benefit from supplier price increases. Our gross profits grew 25% year-over-year to $108 million. Favorable sales mix and higher supplier sales incentives contributed to our higher gross profit dollars. Our Q2 margins increased to 12.5%, up from 10.6% in the prior year's quarter. Our non-GAAP SG&A expense for the quarter of $69.5 million increased $10.4 million or 18% year-over-year. This includes investments in strategic headcount for Intelisys, Brazil, and other growth areas, as well as IT investments to expand our capabilities. Our focus on IT investments is to enhance our ability to scale our business as part of our growth strategy. Second quarter adjusted EBITDA, which excludes share-based compensation, totaled $42.5 million, up 43% year-over-year, reflecting a 4.92% adjusted EBITDA margin. Higher gross profit margins drove the Q2 margin expansion. Our second quarter income tax rate of 24% reflects an increase in forecasted tax-exempt income, primarily from Brazil. For fiscal year 2022, we estimate the effective tax rate excluding discrete items to range between 24.5% to 25.5%. Now turning to the balance sheet and cash flow. Our working capital investment increased as expected to support our sales growth. We used operating cash of $18 million for the quarter and $74 million for the trailing 12-month period. Year-over-year, working capital increased by $156 million, a 43% year-over-year increase. Q2 DSO came in at 64 days, modestly up from our typical range due to longer terms on selected large deals. Our Q2 inventory terms of 5.7 times were in line with our typical range and reflect higher inventory levels to meet future demand and manage ongoing supply chain challenges. On December 31, 2021, we had cash and cash equivalent of $34 million and debt of $197 million. Our balance sheet remains strong. From a net debt leverage perspective, we ended Q2 at approximately 1.1 times trailing 12-month adjusted EBITDA, demonstrating financial flexibility to support our growth opportunities and create long-term value. During the December quarter, we had approximately $200,000 in share purchases under our $100 million share purchase authorization. Second quarter non-GAAP EPS of $1.22 per share increased 57% year-over-year and is an all-time record high. With our Q2 results, our trailing 12-month non-GAAP EPS of $3.38 is also a record high. We'll now open it up for questions.

Operator, Operator

Thank you. Our first question comes from Adam Tindle with Raymond James. Your line is open. Please, go ahead.

Unidentified Analyst, Analyst

Hello, Steven. Mike. This is Catherine on for Adam and John, please let me add my congratulations. Mike, can you please start by commenting on the state of the supply constraints today versus the end of the December quarter? Last night, we heard from a large domestic reseller that they're starting to see some signs of light. We are wondering if you're starting to see the same, and is this factored into your forecast for the year?

Michael Baur, Chairman and CEO

I'll let John answer that if that's okay.

Unidentified Analyst, Analyst

No problem.

John Eldh, Chief Revenue Officer

Hey, thanks for the question and thanks for your congratulations. Yes, we expect to see supply chain challenges continue, and overall our lead times have extended two to four times longer than a year ago. We have not seen much change from last quarter. We think the team's doing a fantastic job of managing and navigating through the environment, and yes, the lead times and the supply chain are factored into our second half guidance.

Unidentified Analyst, Analyst

Okay, perfect. Thank you. And then one for Steve, a number of vendor partners have been implementing price increases over the past few quarters, which you mentioned actually benefited ScanSource in the quarter, but what has been the customer response to this so far?

Stephen Jones, Chief Financial Officer

From a customer perspective, we don't have a lot of visibility to end customers and we haven't seen a lot of impact from our channel partners. It was expected and well communicated, so we really haven't seen much of an impact from a customer perspective.

Operator, Operator

Thank you. And our next question comes from the line of Keith Housum with Northcoast Research. Your line is open, please, go ahead.

Keith Housum, Analyst

Good afternoon guys. And John, once again, let me extend my congratulations as well. Well deserved. Hey guys, I'll throw this out and let you decide who wants to answer it, but obviously the supply constraints issue has been out there now for several quarters. Any thoughts on how much did that impact your sales for the quarter?

John Eldh, Chief Revenue Officer

Yeah, Keith, thanks for the question and thanks also for the congratulations. I think the best way to characterize how we're seeing the supply chain is that we did see some impact; we saw some deals pushed out, and we factored that into our second half guidance.

Keith Housum, Analyst

Got you. And is your thinking—I know you partially asked this before—but is your thinking that this is going to continue through the rest of the calendar year? How is your visibility in terms of lead times and are people able to deliver on time or is it constantly fluctuating right now?

Michael Baur, Chairman and CEO

First of all, I would characterize it as kind of fluid and ongoing, and we would definitely say that we see supply chain challenges continuing through the end of the year. I would point back to what I said earlier in my prepared comments, and even last quarter that we are navigating the environment well, and we're extremely proud of our team, and that's one of the key differentiators that helped us deliver such strong results this quarter.

Keith Housum, Analyst

Got you. And then, one of the things we're starting to hear is the vendor's concern that whenever this supply chain glut ends, there might be the risk of a lot of inventory stuck in the channel that might impact sales. Can you address the efforts that the industry and you guys are taking to ensure that doesn't happen at the end of the day?

John Eldh, Chief Revenue Officer

Well, let me take that one. Keith, as we're looking at our inventory levels, we've remarkably been able to keep our inventory levels fairly steady as we've gone through this, which really speaks back to the way we're leveraging our balance sheet. You can see that in our ROIC. We're constantly watching the health of our inventory. We don't get too far out, and so we're managing that.

Operator, Operator

Thank you. And I'm showing no further questions and I would like to turn the conference back over to Mr. Steve Jones for any further remarks.

Stephen Jones, Chief Financial Officer

Well, thank you. And we'd like to thank everyone for joining us. We expect to hold our next conference call to discuss the March 31 quarter results on Tuesday, May 10, 2022.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.