Earnings Call Transcript - SCSC Q1 2026

Mary Gentry, Senior Vice President, Finance and Treasurer

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 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 30, 2025, and in our subsequent reports on Form 10-Q. 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 filed earlier today. I'll now turn the call over to Mike.

Mike Baur, Chair and CEO

Thanks, Mary, and thanks, everyone, for joining us today. Technology distribution is being transformed with the convergence of hardware, software, and services. As IT, connectivity, and cloud computing markets continue to converge, we believe that end users will prefer channel partners who can provide integrated converged solutions. With more choices than ever, end-user purchasing decisions are getting more complex, and that's where solution providers and technology architects add real value. They can help end users make technology decisions that will achieve their expected business outcomes. Because most business outcomes require technology solutions from multiple suppliers, the indirect channel is in the best position to deliver recurring, complex, and high-value solutions. How to win in converging technology markets was the theme at our recent partner events. Partner First in September and Channel Connect earlier this week. Both events highlighted our strategy, helping our partners change and grow as technology markets continue to converge. We are preparing to assist our channel partners in this transformation. We expect to play an expanded role in supporting our partners' transition from traditional VAR to solution provider and from trusted adviser to technology architect. We'll discuss more about how these business models are evolving as the year progresses. This quarter, in our Intelisys & Advisory segment, we are investing to accelerate new order growth. An example of our investment is the growth of our solutions engineering team who have expertise in advanced technologies, including cloud computing, wireless, and IoT. Another way to drive new order growth is to help our partners by providing new and better tools for growth. For example, our product development team launched a new tool called Tech Checks, which combines AI-powered engineering support with conversational sales-friendly discovery questions. During the quarter, in our Integrated Solutions Group, our Launch Point team has delivered new end-to-end industry solutions called Smart Series, starting with Smart Warehouse and Smart Retail. These solutions consist of products and services from ScanSource's suppliers. One of the new Launch Point suppliers we recently signed is a specialist in the next generation of private 5G that adds a managed services offering to our Smart Connectivity Series. Also in ISG, in October, we completed the acquisition of DataXoom, a leading provider of B2B mobile data connectivity solutions. This transaction builds upon our August 2024 acquisition of Advantix and expands our ability to scale our relationships across all three major U.S. carriers: AT&T, Verizon, and T-Mobile. ScanSource's deep relationships with the key suppliers of mobile devices, combined with Advantix and DataXoom's capabilities to integrate carrier data connectivity into these devices is a great example of a converged solution. Looking ahead, we believe the future of technology distribution lies in helping our channel partners deliver innovative converged solutions. This vision drives our strategic plan. I'll now turn the call over to Steve to take you through our financial results and outlook for fiscal year 2026.

Stephen Jones, Chief Financial Officer

Thanks, Mike. We're off to a good start to our new fiscal year. For Q1, we delivered strong profits and free cash flow generation, highlighting the strength of our business model. Gross profits grew 6% and non-GAAP EPS grew 26% year-over-year. We delivered 5.2% adjusted EBITDA margins and our cash conversion of non-GAAP net income was 88%. These results are in line with our annual outlook. Now turning to our segments. I'll start with our Specialty Technology Solutions segment. Net sales declined 5% year-over-year and 9% quarter-over-quarter, including approximately $40 million of large deal pull-ins that benefited our Q4 results. For Q1, many of our larger deals were delayed or broken into smaller orders with a higher mix of run rate orders, favorable technology mix, and benefits from supplier price actions, gross profits increased 7% year-over-year and 3% quarter-over-quarter. For the segment, the percent of gross profits from recurring revenues totaled approximately 13%. Adjusted EBITDA margin for the segment increased 61 basis points to 4.2%. In our Intelisys & Advisory segment, net sales increased 4% year-over-year, in line with our expectations. Annualized net billings increased to approximately $2.78 billion, and we believe we maintained market share. Gross profits increased 2% year-over-year, while adjusted EBITDA for the segment declined slightly due to increased investments in SG&A to drive future billings growth and expand our technical capabilities in advanced technologies. Now going a bit deeper on our balance sheet and cash flow. We ended Q1 with approximately $125 million in cash and a net debt leverage ratio at approximately 0 on a trailing 12-month adjusted EBITDA basis. Adjusted ROIC for the quarter was 14.6% and share repurchases for the quarter totaled $21 million. We have a strong balance sheet and are well-positioned to execute on our strategic priorities and achieve our 3-year goals that you can find in the infographic and our investor presentation in the Investors section of our website. We are very pleased with the contributions from the acquisitions we announced around this time last year, and we're excited about the most recent acquisition of DataXoom and what they bring to our channel capabilities and our strategic plan. We continue to have an active pipeline of acquisition targets for both segments. These targets would expand our capabilities and help us drive additional value across our partner ecosystem while supporting our strategic goals. We will maintain our discipline in evaluating M&A opportunities and believe there is room for both acquisitions and share repurchases while maintaining a target net debt leverage ratio of 1 to 2x adjusted EBITDA. In closing, we want to reconfirm our FY '26 full year outlook. We believe the full year net sales growth will range between $3.1 billion and $3.3 billion. Full year adjusted EBITDA will range between $150 million and $160 million, and we will deliver at least $80 million in free cash flow. We still believe that revenue growth will accelerate in the second half of our fiscal year. We'll now open it up for questions.

Keith Housum, Analyst

It's good to see the performance on the bottom line. However, the top line is a bit concerning as we review the past year and a half. Mike, do you have any insights on whether you're losing market share to competitors, or are you intentionally stepping back from some business? Any explanation for the decline in revenue would be appreciated. I understand there was a pull forward in the fourth quarter, but looking back over the last year and a half, the trends seem to be going against you on top line growth.

Mike Baur, Chair and CEO

From our perspective, we have consistently stated our desire for profitable growth, particularly from the top line. There's always business available for distributors to pursue in order to enhance revenue. Over the past two years, we've focused on our gross profit growth as a key metric for our future. We're pleased with the 6% growth in this area. Naturally, we would prefer to see more revenue growth. We believe that introducing new suppliers through our Launch Point initiative and implementing strategies around convergence will help attract more suppliers than we typically have. Additionally, we do not think we have lost market share. As I've mentioned previously, manufacturers generally claim they do not lose market share, so I take that with a grain of salt. Nonetheless, I believe our teams have performed exceptionally well with our key suppliers.

Keith Housum, Analyst

Great. You're correct, GP performed well, particularly in SPS. I noticed in the earnings report that you mentioned supplier rebates or vendor payments. Are those sustainable or are they one-time occurrences? Should we expect a shift here for the rest of the year?

Stephen Jones, Chief Financial Officer

Our supplier programs have definitely evolved over the last few years. The teams are doing a great job connecting our supplier programs more to activities rather than inventory. We believe that a lot of this is sustainable. This quarter, we saw some of the price actions from last year by the suppliers flow through our inventory turns, which positively impacted our margins in that segment and on a consolidated basis.

Keith Housum, Analyst

And I know you probably won't get too much into details, but any way you can parse out how much of your GP is more to that onetime price actions?

Stephen Jones, Chief Financial Officer

Well, I'll give you the number, Keith, because I think it's important. I think if I'm thinking of a consolidated basis, I think it was probably 30 basis points to our gross profit margins on a consolidated basis.

Keith Housum, Analyst

Great, I appreciate that information. Congratulations on the DataXoom acquisition; it seems to align well with Advantix. Can you provide any additional details about that company, such as the number of employees, which I believe is 17, and any insights into its revenue or margin profile for future considerations?

Stephen Jones, Chief Financial Officer

Yes. Keith, when we think about DataXoom and we think about Advantix and what they mean strategically for us, they add capabilities and DataXoom really helps us scale in this space. As far as size, it's really a tuck-in sized acquisition, and we gave the 17 people to kind of help people size what that would look like for us, but it's a tuck-in size acquisition. But they will have higher margins than our typical business in the STS segment. So it will be margin accretive from a percentage.

Mike Baur, Chair and CEO

And maybe I'll add one more comment to that, Keith, that part of the strategy here, as a reminder, is for us to be able to sell more mobile devices by adding the connectivity to the solution set. We believe our mobile device sales will go up as we are more successful communicating this strategy to our channel.

Guy Hardwick, Analyst

It's actually Guy Hardwick. If 30 basis points of gross profit margin came from supply rebates, that implies that 100 basis points came from mix. First of all, is that correct? Maybe it would also be a good time for you to update us on your inventory valuation method, considering what you said about supplier price increases last year affecting this year.

Stephen Jones, Chief Financial Officer

Yes, Guy, thanks for joining us today. You're in the right range regarding what benefited from the mix. When we look at the business, we have more netted down revenues in that segment than we've had in the past. That's why we've been emphasizing the percentage of recurring revenues at a segment level, as it is an important part of our story moving forward. From a mix perspective or in terms of our inventory turns, we value our inventory on a first in, first out, weighted average basis.

Guy Hardwick, Analyst

Okay. Just a follow-up. Obviously, on the slide, you have, I think it's Slide 3, the key technologies and growth drivers that's based on FY '25. If you just take those 5 end markets, which were up and which were down in the quarter?

Stephen Jones, Chief Financial Officer

Well, those charts that we add in there, those really help us guide where we were thinking for the full year. So we do use FY '25. We validate whether that's going to be some trends that continue, and we use that to help us in our guidance. As far as what segments were up or down, that really kind of gets into a supplier discussion in some ways. And so we try to steer clear of that.

Guy Hardwick, Analyst

But just your 2 largest suppliers had revenues up in the quarter year-on-year. So I'm a little bit surprised to see you guys down so much year-on-year.

Mike Baur, Chair and CEO

Yes, this is Mike. I want to add a comment to that. We created these slides to assist because a year ago, we changed our segments and shifted our focus away from where the growth was originating. We truly believe this will provide an indication of what we expect to happen throughout this year. Regarding your point about suppliers, it's important to remember that their quarterly success doesn’t always align with our channel. All of our suppliers sell directly to end users, which can influence their results. Sometimes, they detail how much they grew in the channel, but it doesn’t always reflect the entire picture. We want to remind our investors that while we play a role in their supplier story, we are not completely aligned with it. They may report strong revenues while the channel overall might not reflect that. Typically, our focus is on whether we lost any market share, which, as Steve mentioned, we believe we have not. Within the channel we compete in, we have maintained our market share. This distinction helps you understand that sometimes our results may not mirror those of the suppliers. Furthermore, when we report results that exceed those of our suppliers, it can be misinterpreted, which is usually incorrect. I wish I could clarify why the performance of those two suppliers differs from ours, but keep in mind that we are only a part of their success in the channel.

Adam Tindle, Analyst

Steve, I wanted to start with a question for you on guidance. And leading into this question, I just want to acknowledge, I was glad to see gross profit growth put into the 3-year targets. I think that metric makes a lot more sense. But for now, for this year, we're basing guidance on net sales. So I've got to ask on that. You decided to reaffirm net sales growth for the year, but we're obviously starting with net sales down in Q1. I think you had previously thought maybe low single-digit growth in first half and accelerating in the back half to get to that full year net sales growth that you talked about. I wonder if you might, first of all, update the cadence as you're thinking about that? And then secondly, just what gives the confidence to reaffirm the net sales portion after what you saw in Q1? Why not maybe consider lowering expectations at this point?

Mike Baur, Chair and CEO

Adam, thanks for the question. When we look internally to our plan, Q1 is fairly close to what we thought. And so that gave us confidence to reconfirm our guidance and our outlook. One of the things that we continue to look at. We talked about netted down revenues, and we are more and more looking at gross profit as a better proxy for the success of our sales teams and our company overall. And then when we think about whether first half or second half, the other thing I would lead to is we keep seeing these large deals push out or break up. They're not getting canceled. And so that gives us confidence that this is a timing issue, not necessarily a weakness in overall demand.

Adam Tindle, Analyst

Okay. I mean maybe just give us a little bit of color on what you're seeing in October or early November and the pipeline for December on those? And any quantification of those large deals? I know those are typically deals that can get done at calendar year-end, so it might make sense for that to happen. But just wondering what you're seeing early on in calendar Q4, the December quarter.

Stephen Jones, Chief Financial Officer

Adam, we typically don't talk about the quarter mid-quarter because a lot of times, what we see is the last month of the quarter is our biggest quarter, and we could make up a lot even in the last 2 weeks. What we've talked about in the past even with our working capital is we would get surprised by how good of sales we have. And so maybe our accounts receivable may have moved up. And so it's dangerous for us to try to predict the quarter midpoint.

Mike Baur, Chair and CEO

And Adam, I'll just chime in, it's Mike. Our enthusiasm for our guidance is reaffirmed as of last week. So what we knew last week about the quarter-to-date is reflected in our reaffirming the annual.

Adam Tindle, Analyst

Okay. That's helpful. Mike, I wanted to ask about the recent 3-year target updates. It's more in Steve's area, but I have a conceptual question. It's great to see consistent free cash flow of over 80 percent annually. Did you discuss with the Board how to allocate that free cash flow? Some companies designate a certain percentage for acquisitions or for returning cash to shareholders. Is that something you've considered? Without putting you on the spot, if we were to set investors' expectations on how that free cash flow might be distributed, how would you estimate that?

Mike Baur, Chair and CEO

We mentioned last quarter, and Steve reiterated in his prepared remarks, that we believe we can manage share repurchases and acquisitions without following a strict percentage structure. Our discussions with the Board during the last two meetings, including our fiscal year-end guidance and our recent meeting about the acquisition pipeline, were productive. Steve pointed out that we do have potential acquisitions lined up. Additionally, given the current share price, we view share repurchases as an effective use of our cash. We appreciate being able to pursue both strategies and want to emphasize that we are actively involved in both acquisitions and repurchases.

Greg Burns, Analyst

The business development investments you're making in Intelisys, are you seeing that translate into pipeline activity? I'm just wondering when we might start to see maybe some of those investments start converting into stronger revenue growth for the segment?

Mike Baur, Chair and CEO

Greg, it's Mike. I'll take that. One of the ways that we're talking about the success or not is the new order growth rate because an order doesn't get billed and, if you will, either installed or delivered for anywhere from 6 to 18 months in the Intelisys model. And it is different based on the type of technology being deployed. Because of that, we have put a much bigger emphasis starting, frankly, last year on new order growth. And in this quarter, we had double-digit new order growth year-over-year and quarter-over-quarter. And we believe that's our benchmark as to are the investments working.

Stephen Jones, Chief Financial Officer

Thank you, and thank you for joining us today. We expect to hold our next conference call to discuss December 31 quarterly results on Thursday, February 5, at approximately 10:30 a.m.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.