Thanks everybody for joining. My name is Adam Tindle, and this is part of my supply chain coverage here at Raymond James. Very happy to have the team from ScanSource here this morning. I'm gonna have a fireside chat with CEO Mike Baur. In terms of our format, would love to keep it open-ended. If anybody in the room does have questions, please feel free to chime in. But Mike, thank you so much for being here.
Thanks, Adam. It's great.
And weathering the cold for us.
Yes. Yes.
And I know we've got folks on the webcast as well, so and a variety of investors in the audience. For those not as familiar with ScanSource, maybe you could start with a brief history and the evolution of the company.
Sure. 31 years now, I was there at the first day with a team of six of us, and we came out of IT distribution. So, ScanSource was a company that was focused on niche distribution, meaning industries and technologies that were not being distributed by the traditional IT distribution channel. So we found these multiple niche markets that were underserved, and allow ScanSource. And then fast-forward 25 years, and we said: "Hey, hardware distribution was great, but what else can we do that's adjacent, that would leverage those 25 years of building a channel?" And our channel, over time, has been discrete groups of resellers, VARs, system integrators, but we've got a group of point-of-sale VARs, we've got a group of barcode mobility VARs, we've had a group of communication VARs.
So these all of these networks of discrete VARs generally did not sell across each other's technologies. And we were trying to find a technology that would cross across all of those technology areas, and that became this acquisition of Intelisys, which was really out of the telecom industry. It was a group of suppliers, and think companies like Lumen today, AT&T, Verizon, companies selling way back in the day, telecom services like long distance, if anybody remembers that. It's become, of course-
Mm.
... network connectivity and cloud now. But it was, should we and could we get these 30,000 VARs to also sell connectivity, to go along with this Intelisys community of about 3,000 of their agents? And so we ran those businesses kind of parallel for the first four years of the acquisition, 2016 to 2020, and now we've spent much more time trying to offer those Intelisys services to VARs. An example would be, if you're a barcoding mobility VAR, and you're selling mobile devices that are gonna be used inside of a retail store or a warehouse, you might sometimes not have great Wi-Fi connectivity. You might want to have cellular connectivity. So we sell an activation service that allows that mobile device to have internet connectivity via cell service. And so just that alone, that service, is a recurring revenue to the VAR.
They get paid every month for maybe three years. And that's the difference, is we're providing recurring revenues to our channel, and in the past, a VAR or an integrator, they might sell their own services, but they never had anything that was recurring. So that's really the transformation of the company, is adding this recurring revenue opportunity back in 2016.
Yep, interesting, and I know we're gonna talk a lot more about that. But, you mentioned, barcoding, you know, networking. When we hear those terms, I think, you know, those are broader terms. Maybe you could get a little bit more specific on, you know, the key products and vendors as well, just to put it into context on, on who you primarily serve.
Yeah. Our OEMs, companies like Zebra Technologies, and they've got the scanning, the printing, and the connectivity, products. NCR for point of sale, and we've all seen the huge jump in self-checkout systems. Whether you're going through an airport now, or a grocery store, or a retail store, self-checkout is very pervasive and will continue to play. And then on the networking side, we've got some of the traditional players, but Cisco, probably the biggest name that we've talked about. We started with Cisco as their newest distributor back in 2007, and we were added just for the networking products, and today it's much more of their full product line, including their collaboration tools. So think collaboration is video conferencing and all the tools, so think Webex, and so we do a lot with Cisco in that space.
Then we've got this other space that we call physical security or sometimes just security, but think video surveillance, think cameras and the systems around them that are tied to the network today, that allow an end user to monitor their campus, whether it's school systems, a corporation, a warehouse, and that business has also been very. It's been a growth business for a long time. So we've been fortunate to have some businesses growing faster than others at different times, but we've got a diversity of our portfolio and of our customer set, which I think helps us kind of weather the storms.
Yeah, and then maybe double-click on the UCaaS piece. I think, you know, investors sometimes associate ScanSource with some of the Avayas, and Mitel, and ShoreTel, and all those days, right? But it's-
Oh, I have to talk about them?
Only to-
Okay.
... explain how it's changed.
Okay.
Right?
All right. Yes, yes.
Then you can talk about RingCentral in a minute.
All right. So yes, so we came out of the telecom premise-based hardware business back in 1997, when it was Lucent, before even Avaya, and again, there was this discrete channel of telecom hardware VARs, who did a fantastic job selling technology until the cloud came along. And when these new cloud companies, like RingCentral, came along, and 8x8, and all the other ones around then, the contact center guys like NICE and Five9, and now even Genesys, all of those companies chose an alternate route to market. They didn't choose to go with the premise-based telecom VARs, because the telecom VARs selling hardware, they really weren't set up to do a recurring revenue sales practice. And so we've kind of got telecom VARs, some of them have moved to selling recurring revenue, some have not. They're still selling hardware only.
Then we've got a strong group of agents, and these are the guys that are the best sellers for RingCentral, even, of course, Zoom Video, and these are the companies that are our primary routes to market to sell cloud-based telecom services. However, even all those cloud-based services still need some hardware. They still need, generally, in an office, you need some kind of handset. You might need some switching, but you need some capabilities beyond just cloud. So, you know, we believe that having the hardware and the cloud connectivity together gives us an advantage in the market.
Yep, makes sense. And, you know, I think that helps to describe some of this, but you refer to ScanSource as a transformed company. Can you provide an overview of that transformation and the value upside for your business?
Well, the real transformation, which at the time almost was a bet the company thing too, was investing in a company, in this case, Intelisys, where we had bought companies at a single-digit multiple of EBITDA, and we were paying a double-digit multiple of EBITDA. Like, "Oh, my God, what the heck are you guys doing?
I remember that.
Yes. And, and we had made 30 or so acquisitions over the years, and so to do that in 2016 was a pretty bold move. But for us, it really was a long-term strategic play that said, there—it is an adjacency. There are gonna be VARs who move into that market. And what we did and why we call it transform is we now have that behind us. It's been 7 years.
Wow!
Yes. And so now we understand what it takes to for these two channels, if you will, to coexist, and we've gotten this behind us. In the middle of buying Intelisys, as a reminder to our investors, we put in SAP the same year, which is a killer for most companies.
Mm-hmm.
We did that successfully. We then, in 2019, transformed our hardware sales force and reduced it from six business units down to two. So we did all that in 2019, which can kill a company, 'cause we changed sales assignments, sales, comp plans, and all that, which, which did not go well, but it did happen. So we did a lot of things from 2016 to 2019, and then guess what happens? Of course, COVID, March 2020, and that made us step back, reassess what we're doing, made some adjustments, and then we came out of 2022 now, and we really feel like we're-- we're really on the right track. And of course, we've got some challenges, like every IT distribution hardware company, with some of the bloated amounts of product that were sold into the end user markets.
Setting that aside, we're now at the place we said we were gonna be seven years ago, which is this company selling recurring revenue and hardware as we go forward.
Okay. Yeah, and that sounds like the concept of hybrid distributor.
Yep, doing both.
Yep. I want to ask a little bit more on kind of macro and near-term spending environment. Just curious, I mean, you touched a lot of different areas as, as we talked about. What are you expecting for IT spending for the end of the year? You know, any budget flush that you're seeing in terms of the pipeline into December, and potentially into 2024?
Well, as a reminder, ScanSource's business model is we don't work with backlog. So we get orders today, we ship today, generally. And we don't, we don't require forecast. We ask for them, and sometimes they're good, sometimes they're not, sometimes accurate, sometimes not. So we depend more on our OEMs to give us really their insight into what they believe is happening. And as we said on our last earnings call, for ScanSource, our fiscal year covers over the, the calendar year, so our fiscal year ends June 30. So we've already been out on that limb earlier than most, saying: "Hey, we think the year is gonna look like X.
On the last call, we had to adjust it somewhat because we said that the second half of our fiscal, which is the March-June quarter, are gonna be stronger than the September-December quarter that we're in now. So I would just continue to echo that, that we don't really know. We do believe that the December quarter is gonna be a tough one, and we expect that on our earnings call on February sixth, we'll be talking more about what do you think the rest of the year is gonna look like. But clearly, all the indicators are that things are not as as brisk as they as we thought back in August. But that's why we did adjust our annual guidance down last quarter. We think it reflects more accurately where we're gonna be for the year.
We didn't talk about what the quarter would be, but we just suggested, again, second half for us is gonna be better than right now.
Were there particular areas that you've seen kind of more acute changes in terms of that softening? Where has it been really?
Yeah, I think we did. And, and you mentioned also budget flush. We're, we're not expecting that. We're, we're not hearing that from our channels, that there's gonna be a budget flush this year. We did in some years past, but not this year. And back to some areas, as the supply chain challenges of 2021 and 2022 got resolved, some of our technologies were able to resolve it faster than others. And so where they resolved the supply chain earlier in our year, those are the businesses that are slowing down now. So the ones that solved the supply chain later, they're just now seeing some of the slowdown. So that's why there is some puts and takes on which technologies have already slowed down versus some that will.
So that's kind of been our message: We're gonna see this probably for the year, flat growth year-over-year, when you take our fiscal year through now through June thirty.
Is there a way for you to maybe help us with which ones kind of, you know, saw the slowdown earlier and which ones are seeing it? I mean, you've mentioned Cisco. We heard on their earnings call, they've been public about it, so maybe-
Yeah. Yeah, that's probably fair. We said that our networking and our physical security business were still doing well the last two quarters, whereas our other businesses, we specifically said our mobility barcode business and point of sale, they, again, things self-checkout, had already slowed down.
Yeah.
Yeah.
Okay, that's helpful. Maybe, and you touched on this a little bit, but the evolution of supply during this pandemic period, and how you would specifically characterize the state of supply as we approach 2024, calendar 2024?
Yeah. For us, historically, we always talked about lead times. And lead times went crazy during COVID and right after the supply chain challenges, and we had lead times of six months or nine months, and as a result, we were placing purchase orders way in advance. And we never wanted to do that or used to doing that. We're not good at managing POs that are six months out. So what I love is the lead times have come in dramatically, and they're pretty much back to normal. So we've always had some suppliers that give us lead times and say, "Hey, the best we're gonna do is..." Let's just make one up. Let's say it's 6 weeks. We can live with six weeks, as long as it's always kind of 6 weeks.
We don't want it to be two weeks, because then they're probably producing too much, and they're gonna put pressure on us to buy more, and we don't want it to be 10 weeks. So we just need consistent lead times from our suppliers as a general rule, and if they give us a certain lead time versus others, it also dictates maybe what our inventory levels would be, and also what our margins would be. If we're required to keep more inventory, they gotta the suppliers have to give us more margin to pay for that, especially in a high interest rate environment. So I would say it's a by vendor, by OEM decision as to what how much stock we have, and it again gets back to the lead times.
But the better they are at lead times and managing those consistently, the more efficient we can be, and I, I think we're almost back to where we were in 2019 now. I think we're going into next calendar year in great shape from a visibility from our suppliers on lead times and what's coming. So I, I think the suppliers are all comfortable that they can give us great lead times right now.
Yeah.
Yeah.
So supply's effectively normalized. Demand's still a little bit, up and down and, and rocky.
Yeah.
Just from an economic standpoint, you know, we were in a very tight supply environment, and so no supply and a ton of demand, and that's starting to kind of reverse itself.
Yep.
I think a lot of investors think about how that will manifest in pricing, right? If supply and demand's starting to flip, how would you characterize the pricing environment as this normalization has happened, and are you seeing any indication of potential deflationary trends?
Well, being in the IT technology distribution business for 31 years at ScanSource, and 3 years before that at an IT distributor, I've never seen prices increase like they did.
Mm-hmm.
Never.
Mm-hmm.
That cannot be the trend for the future. So I expect that we will see some price decreases sometime in the near future. I, I don't, I don't see how we cannot test the market, and when I say we, I mean the OEMs and the distributors together, test the market to see: Will that influence demand? If we don't see demand show up, let's say, in the March quarter or the June quarter. Now, for ScanSource, as a reminder to our investors, our March quarter is seasonally our slowest growth quarter, quarter to quarter, year over year. So we just gotta think about that as we go into this next quarter, too. But speaking about right now, I, I think, I expect that next year we will see some price decreases, and I hate to call it deflation. I just think...
I'm not sure that's the best word. But, for ScanSource and the channel, we should make the same margin on a percentage basis, and so what I think it really does is, I think it hurts the top-line growth, but I don't think it hurts our profitability on a percentage basis. I mean, we then have maybe tighter SG&A management ahead of us to make sure we're managing to the dollars. But I do think that we're not afraid of that for next year, and we believe that, in spite of that, it's our opportunity to take advantage of the ScanSource financial position and take market share next year. That would be our ambition.
Okay, and I'm gonna get into financial metrics here in a second. You alluded to some of them, but any questions so far? It's always a quiet crowd.
Yeah.
I know. It's probably good.
It's the post-lunch crowd.
Exactly. But it, it's been like this the whole time. It's quiet.
I'm waiting on the webcast guys to come in.
Yeah. Yeah. Yes.
You talked about like bunch of sales, security, these different areas.
Yeah.
How do you make sure, like, your sales team speaks to the right areas? Like, how do you manage different areas to make sure sales has one message, or are they kind of specialized? And how do you incentivize sales versus profit dollars, or what's the structure there?
So the question is about: How do we go to market with our sales teams? And historically, we've had. We tried to combine them back in 2019 to where one sales team could sell everything. Well, that did not work, by the way. But, and a good example is, we have a dedicated Cisco team. Back in the day, we used to have a dedicated Avaya team, by the way, because the nuances of how each supplier goes to market when they're a large supplier are so complicated and so different. If you don't know how the supplier either, takes orders, configures orders, provides services, you can't be successful as a distributor or as a partner. So we tend to, on a simple basis, we tend to specialize our sales force.
So it doesn't mean we don't have some of our customers who wanna buy multiple technologies from the same team, so in that case, we've actually created some sales teams. This is kind of a new thing for our company since 2019, is one of, one or two of our customer types will have two or three salespeople on the team, each one having a specialty. And we found that that works, and then, and I'm not a big fan of this, then we pay the sales team on the gross profit of the, the total purchases. I, I like to have salespeople paid on what each one does, but-
Mm.
-that's me.
Old school.
Gross profit is the way we normally have compensated our sales teams. And we tell our suppliers that. "If we make more gross profit, we'll sell more of your product where we can." So we have the opportunity with certain customers, where they ask us for a product by brand. We'll sell that brand. We have a commitment. If they ask us for X brand, we will sell it. If they as long as it works. If they say, "Hey, what do you recommend, sales team at ScanSource?" Our team can sell whatever they want. I want 'em, and they wanna sell the one that makes us the most money, so that is on a gross profit basis. Yep.
Just a quick question about the pick that DeMarco side around the replacement cycle, and you had a big uptick in demand during COVID.
... you have more devices out there today, certainly, than you did in 2019. Maybe talk about, you know, maybe the opportunity around the replacement cycle as these devices come up on end of life, say, four, five, six years, and how that might impact growth for a company like yourself.
Yeah, the question about life cycle and refresh of the installed base is a good one. We were just meeting with some of our key suppliers about this, and there's a point of view that says the old refresh cycle is about seven years, maybe five to seven, I think is maybe what you were asking, too. What we, as hardware sellers, would like it to be is three to five. What I think is, I don't think that's gonna change much. I think it's still gonna be more in that 5-year cycle, but I think what changes it is if the technology needs of the customer change. And an example would be, trying to remember the exact timeframe.
It was probably 2018, when really there was this big shift from Windows operating system on the handhelds to Android, and that was a big shift that took a while. That was a reason for an end user to replace their fleet of devices, was for a different operating system. I don't hear of an operating system change coming, but what I do hear is that there's more applications that are gonna require a more robust processor, and that's what will change. So it's up to the OEMs to bring new applications, and that's why we've seen our key OEMs, like Zebra, invest in some technology, some application technologies, that are gonna require more robust technology at the handheld. Then, of course, we've got the maturation of the network, where we've got Wi-Fi 6 now.
And so you're gonna have bandwidth requirements, and if you need more bandwidth than your old three-year-old device just is not built for that, that might be another reason to replace it. So I think this is up to the OEMs to figure it out. I think they will. History says they do. History says they find a way to devalue the installed base with new technology.
What do you think about the back of the store versus the front of the store, and having the device in the hands of, say, every employee on the floor?
Yeah.
It makes them more efficient, and it seems like more and more of the retailers are rolling out these devices to almost all their employees. So there's obviously gonna be, I guess, more pressure on the bandwidth as well.
Well, yeah, yeah.
It's-
... No, the idea about more employees at a company using devices is valid. I mean, heck, I love going to Chick-fil-A, and that person's got the handheld, right?
Yes, sir.
I mean, it's right there. You stick your credit card in, and more and more of that, but you don't see that at McDonald's-
Yeah.
... yet.
Yeah.
We'll see. They got the kiosk, right?
Right.
And I think putting it in the hands of the employee is the right customer service idea, whether they can deploy it that way or not. But those are, again, new use cases for the technology. I think the other thing that's going on that's gonna help that is the average price of our handheld devices, that we're talking about, mobility devices, they are gonna come down. I think they did get temporarily inflated. I think once we start seeing the price... Because they're gonna replace them with new technology, the old ones are gonna get reduced in price. I'm not using deflation. I think that will happen, and I think you'll have more use cases. And that's been the history of this channel, is, it's always happened.
Do you wanna maybe just touch on key financial metrics?
Sure. Sure, you know, we decided a year ago, a little over a year and a half ago, to come out with some midterm financial metrics, which we had not done in the past 'cause we were trying not to get ahead of ourselves. And frankly, we were still digesting this implication of how much of our business is Intelisys gonna be and what do we project it to be. And so we love this idea of talking about how much of our gross profit is recurring revenue, so that's one of our key financial metrics and targets. And today, Intelisys is 24%, and we think that our recurring revenue as a group is 24%. We think it could be 30 or better.
And we think as that happens, then we're gonna have a more consistent stream of profits because the recurring revenue recurs. We show up every day, and we don't have to ship a new product. So we love the idea that more recurring revenue is a great goal for our company, and we think we can, we can do that. Today, the Intelisys piece of the recurring revenue is growing faster than our hardware, and so that's why that number will happen. On the hardware side, we think we can grow 5.5%-7% on the top line over the next three to four years. We think ROIC is a key metric for us. Mid-teens is the goal for that as well.
We think our EBITDA margins, 4.5%-5%, are very strong for a distribution business. We think if we could continue to deliver that, I think investors will be pleased with our performance.
In terms of that margin opportunity, is it more just kind of holding at that level? Do you think there's still room for improvement or?
I think it can improve, especially if we accelerate the recurring revenue contribution. So if we were to get to that over the 30% number, if this were to go to 50% recurring, I think that does improve our EBITDA margins, for sure. What I wanna be careful of is make sure that we're building, again, a long-term business, and we won't underinvest in the recurring revenue just to chase that growing EBITDA margin number. I think it should happen normally, but because what I've said on previous earnings calls is, we're gonna invest where our growth is coming from. And in that Intelisys-type business, that's where we're gonna continue to make investments, even in a slower growth environment.
Okay. You've also been, well, in a multi-quarter working capital improvement plan. What are the drivers of that, and are you expecting continued improvement from here, or is it kind of accomplished?
Well, you know, talking about improving, that it was back to the inventories and the days on hand and the supply chain, and that just totally disrupted what used to be our normal working capital metrics. It used to be that when we're growing at single digits, we're producing cash, AR comes in, inventories go down, and we didn't see that back in June of last year. And so we were pleased in the September quarter to show that this is how the model works. When our growth rates slow down on the hardware side, cash comes in. We believe this is unlevering our balance sheet. We got a 1x-2 x leverage target. And last quarter, we got that down to, like, 1.2x-1.3 x.
So we're in a fantastic position from a balance sheet utilization standpoint, and I do believe, looking out, that's really what investors at least have told us they wanna see. And that's gonna allow us to do a couple of different things from a capital allocation standpoint. One is, look at opportunities for high-margin businesses that we can acquire to complement what we're doing, and secondly, to repurchase shares under our existing repurchase authorization.
Maybe just talk about capital allocation. How do you prioritize whether to lean into share repurchase or M&A? What's the process and metric you look at?
Well, we certainly think that we've been incredibly undervalued. Now, the last week or two have been kind of interesting. We're watching that. But after our last earnings call, there was clearly some reasons to say, "Wow, this is unprecedented to be at this level." So we're gonna always be opportunistic where we can, but I also don't wanna trade a quarter, you know, for a strategic acquisition where we wanna deploy the capital, where we can get a very strong return. And we've got a pretty good history of making good acquisitions. They haven't all been perfect, but we are going to look at some things that maybe are not as traditional as we did in the past. I've used a couple of different terms. One, my team likes, one they don't like. I don't think they like aggressive.
I think they do like this idea of disruptive, and so I'm gonna stay with disruptive for today. So, so we're looking at disruptive acquisition. That doesn't mean bet the company-
Yeah.
... just so we're clear, but changing some of the dynamics in how we go to market. Because one thing we've learned is that the end user, at the end of the day, the end user customer of our customer is who we've got to get more intelligence from and about. The more we know why they're wanting to buy devices and cloud will help us plan our future, and we don't get enough of that intelligence today. And we wanna find a way to glean that from our channel and do things differently than we have in the past. And so it's always been this supplier, OEM, manufacturer sells to us, the distributor. We sell to another company, they sell to another company. There's a lot of friction there from a data standpoint.
We don't share enough data as to what the heck is going on and who's selling what, and we get questions from our investors all the time, "Hey, Mike, what vertical markets are you in?" I have no idea. I mean, I can tell you the names of our resellers. I can't tell you who they're selling to 'cause they don't always tell me. But guess what? We actually have the data, we just don't do anything with it. And so the more we can learn about our end markets, we think is better for our company.
How do you do that while not upsetting the partners themselves?
Pretty simple. We've been doing... For 31 years, we've been a trusted partner. I think they trust us. I think our suppliers trust us, our partners trust us. We've, we've - hey, listen, we've made some mistakes with them, like back in 2019, and some of them took a hiatus and said, "Mike, we'll get back to you when you guys are good again.
Mm.
We went through an incredibly challenging time back in May with the cyberattack, where our systems were down for nine days, and we told our partners, "Hey, if you have to go buy it somewhere else for now, we understand." We recovered from that, too. So we've got a level of trust with our channel that I don't think is common, and I think we have the ability to say, "Hey, trust us on this. We're gonna get a little closer to your end user than maybe you're used to, but you can trust that we're not gonna use that against you.
Perfect. We're about out of time. I guess maybe one last question for a key message that you'd like to leave with investors as they think about ScanSource, both near and longer term.
Well, I think, there's always a question over the years. I've been coming to this conference, I don't know, 20 years or something, about one day somebody either competing with us and disintermediating us or customers going direct or during tough times, you know, what happens? And I would tell you, when tough times happen, companies like ours, we tend to benefit because most of our OEM suppliers, they're going through layoffs right now because they have a cost of sales issue, and we're the place they can have a variable cost sales strategy that can help them grow their business, but they only pay us when we sell something. And so I think what we're gonna see is a new crop of supplier executives coming to distribution with, "Hey, can you guys do this for us?" And so we're excited.
We think we have some great opportunities for this year that are over and above whatever the industry says it's gonna be from a growth perspective. We think we can gain share from share shift, from direct sales by the manufacturers to the indirect channel.
Perfect. Mike, Mary, thank you so much for joining us.
Adam, thanks. Great to be here.
Thanks.
Appreciate it.