ScanSource, Inc.

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 disconnect at this time. I would now like to turn the call over to Mary Gentry, Senior Vice President, Finance, and Treasurer. Please go ahead.

Good morning, and thank you for joining us. Our call will include prepared remarks from Mike Bauer, 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 8K filed earlier today. I'll now turn the call over to Mike.

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 channels 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 advisor to technology architect. We'll discuss more about how these business models are evolving as the year progresses. This quarter, in our IntelliSys and 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 LaunchPoint 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 LaunchPoint 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 DataZoom, 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 US carriers, AT&T, Verizon, and T-Mobile. ScanSource's deep relationships with the key suppliers of mobile devices, combined with AdvanTex's and DataZoom'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 plans. I'll now turn the call over to Steve to take you through our financial results and outlook for fiscal year 2026. 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 solution 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 Intellisys and 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 maintain 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 zero on our 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 three year goals that you can find in the infographic and our investor presentation in the investor section of our website. We believe with the contributions and 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 DataZoom 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 one to two times adjusted EBITDA. In closing, we want to reconfirm our FY26 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 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.

Thank you, as a reminder to ask a question, you will need to press star one one on your telephone to remove yourself in the queue, you may press star one one again please stand by, while we compile the Q amp a roster. Our first question. comes from the line of key thousand of North coast research, please go ahead Keith.

Great. Hey, good morning, guys. And good to see the performance of the bottom line. But of course, the top line probably is a little bit troubling here as we look over the past year, year and a half. I guess, Mike, any thoughts there on, you know, are you guys losing share, do you think, to competitors in this space? Or are you guys purposely walking away from some business? But let me any color on the decline in the revenue. And I understand the pull forward that you had in the fourth quarter here. But still, if I look over the past year, year and a half, you know, the trends have been working against you guys on the top line.

Hey, Keith. You know, from our standpoint, we have always said that we want profitable growth, right, from the top line. And I think that's a theme here is there's always business out there that a distributor can take to drive the top line. You know, as we think about what we've consistently been, I think, for the last two years talking about the measure for our future is our GP growth. And I think if you look at that, the 6% growth, we really are pleased with. Would we want more top-line growth? Absolutely. I think part of that will come as we add some of the new suppliers that we're talking about through the addition of LaunchPoint and its strategies, as well as this idea of convergence. We believe that will attract more suppliers than we traditionally have. And again, Keith, part of the challenge is, to answer part of your question, we don't believe we lost market share. And as I've said many times before, I think all the manufacturers tell all the distributors they don't lose market share. So I don't put a lot of credibility there. That's just a side comment. But I believe our teams have executed very well with those key suppliers.

Great, thanks. And you're right, GP was great, especially in STS. And I noticed in the earnings recall, I'm sorry, the earnings report, you guys mentioning suppliers rebates or vendor payments. Are those sustainable? Are those one time? Or has there been a shift here that we should look at going for the rest of the year?

Hey, good morning, Keith. It's Steve. I'll take that one. So our supplier programs have definitely evolved since, you know, over the last few years. The teams are doing a great job tying our supplier programs more to activities and not inventory. And so we think a lot of that is sustainable. What we did see this quarter is some of the price actions that we that the suppliers did last year flow through our inventory turns. So that was a bit of a help to our margins in that segment and on a consolidated basis.

And I know you probably don't want to get too much into details, but anyway, you can parse out how much of your GP was more due to that one-time price action.

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.

Great. Thanks. I appreciate that color. And then congratulations on the DataZoom acquisition. It sounds like it fits in really well with Advantix. Any more color you can give on that company in terms of, I think it's at least 17 employees, but perhaps any revenue or margin profiles you can think about going forward?

Yeah. Keith, when we think about DataZoom and we think about Advantix and what they mean strategically for us, They add capabilities, and DataZoom really helps us scale in this space. As far as size, it's really a tuck-in size 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.

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. Great. Thanks, guys.

I'll jump back in the queue.

Okay. Thank you. Our next question comes from the line of Gary Hardwick of Barclays. Please go ahead, Gary.

It's actually Guy Hardwick. Good morning, guys. So if 30 basis points of GP margin came from supplier rebates implies that 100 basis points came from mix. First of all, have I got that correct? And maybe it'd be a good time for you to give us a refresher on your inventory valuation method. Bear in mind what you said about supplier price increases last year having an impact this year.

Yeah, hi Guy, good morning and thanks for joining us today. So yeah, I would say you're in the right range in terms of what benefited from MIX. And again, when we look at, and Mike talked a little bit about how we're viewing the business, we also have more netted down revenues in that segment than we've historically had. And that's why we've been talking more about the percentage of recurring revenues at a segment level, because we think that's also an important part of our story as we go forward. From a mixed perspective or how we're thinking about our inventory terms, just think of it as a weighted average first in, first out inventory. So our inventory would be valued in a first in, first out weighted average basis.

OK, just to follow up. Obviously on the slide you have, I think it's slide three, the key technologies and growth drivers. That's based on FY25. If you just take those five end markets, which were up and which were down in the quarter?

Well, you know, those charts that we add in there, those really help us guide where we were thinking for the full year. So we do use FY25. 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.

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

Yeah, and Guy, this is Mike. Let me just add a comment to that if I can. We came up with these slides to help out because a year ago we changed segments and we talked less about where the growth was coming from, and we really believe this will give an indicator of what we believe will happen throughout this year. Specifically to your comment about suppliers, just as a reminder, they're their success or not on a quarterly basis isn't always in line, remember, with our channel. All of our suppliers, all of them, still sell direct to end users, and that can impact their results. Sometimes they delineate their results as how much grew in the channel or not, but not always. And so we have to always remind our investors to we're a part of their supplier's story, but we're not always aligned with their story. They can have great revenues and the channel as a group does not. So our measure is typically what we try to lead with, which Steve said was, we don't believe we lost any market share. So within the channel that we compete in, we didn't lose market share. So that's how we separate our results and try to help you guys understand sometimes our results won't mirror the suppliers. And frankly, when we come out sometimes with our results ahead of our suppliers, people try to read that into the suppliers and generally it's wrong. So I wish I could help you more on the specifics of why those two suppliers would be different than ours, but just remember that we're, as a channel, we're only a part of their success. Thank you, Apostle. You bet.

Thank you, Guy. Our next question comes from the line of Adam Tyndall of Raymond James. Please go ahead, Adam.

Okay, thanks, and good morning. Steve, I wanted to start with a question for you on guidance. And leading into this question, I just want to acknowledge, you know, was glad to see gross profit growth put into the three-year targets. I think that, you know, 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, you know, first of all, update the cadence as you're thinking about that. And then secondly, just, you know, what gives the confidence to reaffirm the net sales portion after what you saw in Q1? Why not maybe consider, you know, lowering expectations at this point? Thanks.

Yeah, good morning, Adam. Thanks for the question. You know, when we looked 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.

Okay. I mean, maybe just give us a little bit of color on what you're seeing in October, 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. I'm just wondering what you're seeing early on in calendar Q4, the December quarter.

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 two weeks. What What we've talked about in the past even with our working capital is we would get surprised of 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.

And Adam, I'll just chime in. It's Mike. Good morning. 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.

Okay, that's helpful. And maybe just, Mike, one for you. I was glad to see the three-year target updates, and I know this is a little bit more of what Steve owns, but the conceptual question here, follow me. The 80-plus percent free cash flow consistent on an annual basis was nice to see. I wonder if you guys discussed with the board about maybe outlining a structure on how to allocate that free cash flow. Some companies do sort of X percent to acquisitions, X percent to returning cash to shareholders, et cetera. Is that something that you thought about? And not to put you on the spot, but if we were to try to set investors' expectations on what the – pie chart would look like on that free cash flow in terms of how you're thinking about it. How would you kind of ballpark that for us? Thanks.

Well, I think what we said last quarter and what we said, Steve said in his prepared remarks, is that we still believe we can do share repurchases and acquisitions without any specific structure or percentile on a chart. But it was a very good discussion with our board the last two board meetings, both the fiscal year end, when we gave our guidance for the year, and when we had our meeting a week ago, discussing again, how do we feel about the acquisition pipeline that we have? And Steve indicated we do have a pipeline of acquisitions. At the same time, we believe that, especially at these share price levels, that a good use of our cash right now is for share repurchases. And so we like the fact that we are in the ability, we have the capability to do both. And right now, that's the message we're trying to continue to re-emphasize is that we're still doing both, acquisitions and repurchases.

Okay, great to hear. Thank you, guys.

You bet.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone. Again, that's star 11 on your telephone to ask a question. Our next question comes from the line of Greg Burns of Sudoti. Your line is open, Greg.

Morning. The business development investments you're making in Intellisys, 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.

Hey, 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 six to 18 months in the Intellisys 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.

Okay, great. Great. Thanks for the color there. Appreciate it. You bet.

Thank you. I would now like to turn the conference back to Steve Jones for closing remarks. Sir?

Yes. Thank you, and thank you for joining us today. We expect to hold our next conference call to discuss December 31st quarterly results on Thursday, February 5th at approximately 10.30 a.m.

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