ScanSource, Inc. (NASDAQ:SCSC) Q4 2022 Earnings Conference Call August 23, 2022 5:00 PM ET
Company Participants
Mary Gentry – Senior Vice President, Treasurer and Investor Relations
Mike Baur – Chairman and Chief Executive Officer
John Eldh – President
Steve Jones – Chief Financial Officer
Conference Call Participants
Keith Housum – Northcoast Research
Mike Latimore – Northland Capital Markets
Matt Sheerin – Stifel
Operator
Hello. Welcome to the ScanSource Quarterly Earnings Conference Call. [Operator Instructions] 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
Good afternoon. And thank you for joining us. Joining me on the call today are Mike Baur, our Chairman and CEO; John Eldh, our President; and Steve Jones, our Chief Financial Officer.
We will review our operating results for the quarter and the fiscal year, 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 actual 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, 2022, 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, except 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.
Mike Baur
Thanks, Mary. And thanks, everyone, for joining us today. Fiscal year 2022 was the year of both strong demand and outstanding execution by our people. We exceeded our full year 2022 outlook delivering 12% net sales growth and record adjusted EBITDA of $167 million.
For fiscal year 2022 our non-GAAP EPS increased 45% to $3.97 per share. And our adjusted ROIC increased to 17%.
Our exceptional FY’22 results demonstrate the success of the new ScanSource and the strong growth of our recurring revenue. The new ScanSource strategy is focused on hybrid, made easy to enable our channel partners to meet in customer demand for devices and digital solutions.
In FY’22, our recurring revenue grew faster than our overall business up 16% year-over year. This excellent growth in our recurring revenue provides the strong profitability our team needs to build the hybrid distribution business of the future.
As a reminder, last year, we decided to provide an annual outlook for the first time. We previously provided quarterly financial guidance, and we were always explaining to our investors that our hardware distribution business works with limited visibility without bookings or backlog. However, with the change in our business to a hybrid model, where we have more recurring revenue each year, and our growing services and software along with our hardware sales, we decided to provide an annual outlook for the first time.
Today, we are introducing an FY’23 annual outlook, as well as midterm goals covering the next three to four years. For FY’23 we expect year-over-year net sales growth to be at least 5.5% and we expect adjusted EBITDA to be at least $174 million. Our midterm goals are net sales growth of 5% to 7.5% and an adjusted EBITDA margin of at least 4.5%. These goals reflect our confidence in our business model and the opportunity ahead for the new ScanSource.
I will now turn the call over to John to discuss our business performance.
John Eldh
Thanks, Mike. I’m very excited about our Q4 results highlighted by strong demand, market share gains and great work by our team in collaboration with our partners and suppliers. It’s rewarding to see the execution and momentum of our winning hybrid distribution strategy. For Q4, we delivered 13% net sales growth and 16% gross profit growth. We took market share due to our amazing team, technology specialization and partner pipeline visibility, while navigating a challenging supply chain environment.
Our hybrid distribution strategy of selling devices plus digital is enabling our partners to win in the marketplace. There is a growing trend of VARs, including some of our largest VARs, actively building hybrid solutions for their end customers, while growing their recurring revenues. As of the end of FY’22, we now have over 540 hybrid partners.
Let me share an example from one of our hybrid partners. In the past, this VAR’s salespeople would sell a mobile computing device and it would be a one-time hardware sale. Today when they sell that same mobile computing device, their sales people are proactively discussing cellular connectivity and network security as digital opportunities orchestrated by ScanSource. Innovative solutions like this are driving incremental value and recurring revenue for our hybrid partners and ScanSource.
Now turning to our segment results. In our Specialty Technology Solutions segment, Q4 net sales increased 13% and gross profits increased 16%. Our excellent growth was fueled by robust demand for our hardware technologies, market share gains, better product availability and increases in big deals. However, not surprisingly, the growth in big deals did lead to a lower gross margin mix for the quarter. Our key areas of growth in Q4 and throughout the year were mobile computing, physical security, networking, payments and point-of-sale solutions. We expect continued growth in these areas in FY2023.
For our Modern Communications & Cloud segment, Q4 net sales increased 13% and gross profit increased 15%. These strong results were achieved with a different hardware mix than we expected going into the quarter. Net sales for Cisco led our strong performance, growing over 40% for the quarter. On the other hand, our premise-based communications hardware and services business declined faster than we expected at a negative 28%.
Our key growth areas are technologies that enable remote work for the enterprise, including UCaaS and CCaaS. Our UCaaS business grew 23% led by RingCentral, 8×8 and Zoom, and our CCaaS business grew 48%, led by Five9, Genesis, Talkdesk and NICE CXone. For FY2022, our agency end user billings grew to over $2.25 billion. During fiscal year 2022, we were very pleased with the adjusted EBITDA margin of 35-plus percent for the agency business in spite of gross margin pressures our sales teams experienced, Agency recurring revenue increased 11% for Q4 and 14% for the full year 2022.
In Brazil, the enterprise market is adopting digital solutions very quickly. Our hybrid model with an expanded digital line guard is well positioned to help partners deliver digital solutions for their end customers. Our team achieved double-digit sales growth driven by increases in big deals, market share gains and growth in new technologies.
In addition to our success in hardware, our business in Brazil continues to build outstanding momentum across our digital solutions. This hybrid growth was driven by best-in-class suppliers including for Fortinet, Cisco, Microsoft, and VMWare.
In summary, we were excited about the strength and momentum across our business throughout fiscal year 2022. We believe our trajectory of sustainable profitable growth will set us up for continued success in FY2023.
In addition, our productivity anywhere work model is proving to be very effective in driving retention of our people and a better overall customer experience. I want to send out a massive thank you to all our people for their dedication and commitment throughout the year and to our partners and suppliers for their trust and loyalty to ScanSource.
Now, I’ll turn it over to Steve, who will take you through our financial results.
Steve Jones
Thanks, John. I’ll first review our Q4 results and then provide some highlights on our incredible full year results. As Mike and John mentioned earlier, FY2022 was a year of strong demand for our technologies and outstanding execution by our teams and our partners.
For Q4, we delivered higher net sales with lower gross profit margins than we expected. We achieved double-digit growth in revenue and adjusted EBITDA with net sales in both our segments up 13% and adjusted EBITDA of $38.7 million up 10% year-over-year. Our gross profits grew 16% year-over-year to $111 million with an 11.5% gross profit margin. Higher hardware sales and a lower margin sales mix contributed to overall lower margins in the quarter.
Our non-GAAP SG&A expense for the quarter of $75.9 million, increased to $11.4 million or 17% year-over-year. Our Q4 results include approximately $2 million of unusual SG&A expense, primarily related to higher marketing and performance based compensation expense recognized in the period. Q4 non-GAAP diluted EPS totaled $0.91 compared to $0.96 for the prior year period. As a reminder, the prior year period included a $0.19 benefit from discrete tax items.
Turning to our full year results. We had strong top line growth in both segments with Specialty Technology and Solutions up 15% and Modern Communications & Cloud up 8.4%. Consolidated FY2022 net sales grew to $3.5 billion up 12% year-over-year, which exceeded our full year outlook.
Our gross profit margins increased to 12.1% up from 11.1% in the prior year and include a temporary benefit from supplier price increases of approximately 25 basis points. Our hybrid distribution strategy continues to win in the market. As we can see in our financial results by looking at the gross profit composition from our recurring revenues. Year-over-year, our recurring revenues grew 16% and is a fast growing part of our business.
For FY2022, approximately 24% of our gross profit is from our recurring revenue businesses. Our FY2022 adjusted EBITDA of $167 million is an all time company record, exceeding our full year outlook and represents a 41% year-over-year growth rate and a 4.72% adjusted EBITDA margin. Our FY2022 non-GAAP EPS of $3.97 increased 45% year-over-year.
Now turning to the balance sheet and cash flows. Our working capital investments increased to support our sales growth. We used operating cash of $79 million for the quarter and $124 million for the full year. Year-over-year, working capital, which includes accounts receivable and inventory net of accounts payable increased $226 million, a 56% year-over-year increase.
Q4 DSO of 68 days is in line with our Q3 DSO and up from the prior year period. This increase is primarily driven by sales timing concentration at the end of the quarter. Our adjusted return on invested capital increased to 17% for fiscal year 2022, up from 12.6% for the prior year. Our improved adjusted ROIC reflects both higher profitability and our stronger – our strong balance sheet management.
We’ve been able to leverage the strength of our balance sheet to accelerate growth. In our device business, we increased inventory availability and created programs like ScanSource Flex, which helps our partners win larger deals while maintaining financial flexibility. In our digital business, we have more sales partners than ever taking advantage of our partner investment programs. These investments help our sales partners grow faster and in turn help our recurring revenues grow faster. As an example of the use of this program, we’ve made a $3.5 million loan against future commissions to a hybrid partner to use to expand their sales force and increase their working capital.
On June 30, 2022, we had cash and cash equivalents of $38 million and debt of $271 million. Our balance sheet remains very strong. From a net debt leverage perspective, we ended Q4 at approximately 1.4x trailing 12 month adjusted EBITDA, demonstrating financial flexibility to support our growth opportunities to create long-term value. During the June quarter, we had approximately $9.7 million in share purchases under our $100 million share repurchase authorization.
As Mike noted in his opening remarks, we are announcing a full year 2023 outlook, and I want to share a few more details around the assumptions for the year. We expect faster growth in the first half of FY 2023 than in the second half of the year. We are normalizing our gross profit margin expectations to exclude the temporary benefit from supplier price increases, I noted earlier. And as we think about our cash flows, we expect to use cash in the first half of the year and to generate free cash flow in the second half. With this cash pattern and the higher interest rate environment, we expect our interest expense to be higher in FY 2023 than in FY 2022. Finally, for our fiscal year 2023, we estimate the effective tax rate, excluding discrete items to range from 25% to 26%.
We’ll now open it up for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Adam Tindle with Raymond James. Your line is open.
Unidentified Analyst
This is Catherine on for Adam. Thank you so much for taking our questions.
Steve Jones
Hi, Catherine.
Unidentified Analyst
Was there any potential impact from supply chain embedded in gross margin? Like maybe did you work to secure inventory faster? Like, was there anything that affected gross margin on that line?
Steve Jones
Well, we certainly are taking as much inventory as we can when we look at our working capital usage, Catherine. In terms of margin impact from supply chain, not really I wouldn’t say that that’s impacting our margins directly.
Unidentified Analyst
Okay, perfect. And then could you also provide maybe a slight update on Intelisys and where that’s going?
Steve Jones
Yes. For Intelisys, for the full year we saw 14% growth slowed down a little bit as we exited Q4. Still we’re seeing a large top line growth in the billings, in the end user billings, as we noted in the call, it’s $2.25 billion, now that’s up 20% year-to-year. So, we still see a lot of tailwinds in that business as we go forward.
Unidentified Analyst
That’s good news. Thank you so much.
Operator
Thank you. [Operator Instructions] Our next question comes from the line of Keith Housum with Northcoast Research. Your line is open.
Keith Housum
Good morning guys, and congratulations on a strong top line performance there. Examining that 12% growth in the top line a little bit further. Can you perhaps share a little bit of light on, it was strength more from taking share? Was it more expanded product lineup? Because, as I see it, you probably outperform many of your largest vendors in the quarter. So just trying to understand where some of the strength came from?
John Eldh
Hey Keith, this is John. Good afternoon, and thanks for the question. We were, as you heard, we were very excited about our top line growth and for us it really came down to three areas. We absolutely took share, we drove larger deals and really strong execution across our teams.
Keith Housum
I guess, how repeatable is that taking share? Is that a unique performance for this quarter? Or do you make some fundamental changes in the business that we can see that repeating in the future?
John Eldh
Well, as you can see from the results of 2022, we felt like we took share most of the year, and we believe we’ll be able to continue with strong growth as we look into 2023.
Keith Housum
Great, appreciate it. In terms of your FY 2023 guidance, perhaps some of the puts and takes, as you’re thinking about the guidance for the year, are you assuming the economy avoids a recession? I guess just your overall thoughts on the guidance there?
John Eldh
Yes, Keith, the recessions, the big thing that’s sitting out in front of everybody, that’s the unknown. As we look out today, we’re sitting in August, we have pretty good visibility to our first half. And so we’re kind of at a timing benefit right now and how we’re looking at it. Could it – could recession impact our business? Yes, right now, as we model, we’re thinking that the demand will outstrip the recession pressure.
Keith Housum
Got it. And for the quarter, I know that Cisco is up 40%. I think you said you’re on-prem business without 28%, and your on-prem business has been challenged now for a few years. Can you kind of scope it for us? Give us context about how big the on-prem business is overall for the business?
Steve Jones
Yes, Keith, the on-prem business continues to decline and we’re kind of at that tail end where it’s going to remain about where it is. It’s fairly small, it’s less than 15% of our modern com space. In total on that on-prem space and it’s probably just going to set there and remain for a long tail as you’ll still have users, you’ll still have replacements go out. So it’s high margin business for us, so we like it. But it is definitely not – it is a growth headwind for us.
Keith Housum
I appreciate that color. And then I appreciate the near-term guidance going out three to four years. And I think the adjusted EBITDA margin guidance of 4.5%, I guess, as we look at the puts and takes of that 4.5%, I kind of think of about your Intelisys and your agency businesses being a contributor to that going forward. Should we expect that to climb or do you think there’s going to be offsets are going to keep your adjusted EBITDA margins more on that 4.5% range?
Steve Jones
Yes. I think margins will compress a bit in that space as we see more and more competition it’s now enough, not the big secret everybody’s in that space now trying to compete. The way we’d like to frame it is we did say at least 4.5%. So we do want to beat that number.
Keith Housum
Okay. Got it. And then final question for me. For the $2 million that you saw this quarter for the unusual items, I guess the marketing was that a one-time related only, or do we expect that to continue going forward?
Steve Jones
No, both of those are really unique to the quarter when we think about it. The marketing certainly is a one-time event that we saw and then we just are – we had such a great year. We were behind on accruing for some of our performance compensation.
Keith Housum
All right, Steve. I appreciate it. Thank you.
Operator
Thank you. Please stand by for our next question. Our next question comes from the line of Mike Latimore with Northland Capital Markets. Your line is open.
Mike Latimore
Thank you. Yes. Congrats on the quarter there and outlook. So you gave UCaaS and CCaaS growth rates, just wanted to clarify that was – those are quarterly growth rates or were those year growth rates?
John Eldh
Hey, Mike. This is John Eldh. Thanks for your question. Those were quarterly.
Mike Latimore
Okay. Very good. And then also just a clarification. So that end user billings that was for Intelisys and that was for the year though, right?
Steve Jones
That’s correct, Mike. Yes. $2.25 billion are annual end user billing for the Intelisys business.
Mike Latimore
Got it. And did you say Intelisys had – was it 35% EBITDA margin?
Steve Jones
Yes. Just north of 35% EBITDA margin.
Mike Latimore
Okay. Very good. On the UCaaS and CCaaS business any general feeling there for kind of sales cycles? Have you seen any changes in sales cycles, say June, July, August anything like that?
Mike Baur
Mike, we did not see – we did not see much difference in the sales cycle timing over the last quarter. It’s pretty much been the same. And as you said – as we said, we’re excited about the growth rates and looking forward to, to them continuing in 2023.
Mike Latimore
Great. And then just last one on the supply chain, I guess, particularly as it relates to your communications business, do you have any feel for whether the supply chain is going to loosen up kind of during this next 12 months?
Mike Baur
When it comes to the supply chain, we are seeing slightly better supply chain environment, but just slight. We’re not too far off from where we’ve been over the last year; year-and-a-half and we think that lead times are going to be longer probably through mid-2023.
Mike Latimore
Okay, great. Thank you.
Mike Baur
Thanks Mike.
Steve Jones
Thanks Mike.
Operator
Thank you. Please stand by for our next question. Our next question comes from the line of Matt Sheerin with Stifel. Your line is open.
Matt Sheerin
Yes, thanks. Good afternoon. Just wanted to follow-up on the last question regarding supply chain and your outlook. I imagine that your partners or your VAR partners are still seeing very strong backlog because of the constraints. Is that what’s giving you confidence at least for the first half of the year in terms of strong growth at least through those next six months?
Mike Baur
Yes, Matt. Thanks for your question, and absolutely its part of the – its part of the equation. As we talked about, we’ve been taking share; we’ve been doing larger deals with enterprise projects, strong execution by our team. And we have – we’ve had the good fortune of being for the most part number one or number two with most all of our key suppliers, and in instances like that it helps us because they prioritize our inventory requirements.
Matt Sheerin
Okay. And last quarter you mentioned that I think you saw $30 million in incremental revenue due to some pull-ins. And you have, you had some, a strong upside this quarter. Did that same thing happen in any of your businesses?
Mike Baur
Yes, good memory from last quarter and yes again, we had some pull-in wasn’t quite as strong as $30 million, but we did have some pull forward business probably closer to $20.
Matt Sheerin
Okay, great. And in terms of your EBITDA margin or EBITDA outlook for next year, implies relatively slower, modestly slower growth than revenue which implies lower margin. One of the reasons for that is that another mix issue due to the, the higher hardware and the volume business or anything else in terms of OpEx or other reasons?
Steve Jones
Yes. Matt. Hi, this is Steve Jones. Thanks for the question. Yes, really it reflects the fact that for FY 2023, we had this 25 basis points benefit for some of the, supplier price increases. We had multiple throughout the year that we saw. So that’s really the adjustment that we’re making for FY 2023 forecast.
Matt Sheerin
Got it. Okay. Thank you.
Operator
Thank you. [Operator Instructions] I’m showing no further questions in the queue. I will now like to turn the call back over to Steve Jones for closing remarks.
Steve Jones
Well, we’d like to thank you all for joining us. And we expect to hold our next conference call to discuss September 30, quarterly results on Tuesday, November the 8th.
Operator
Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.
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