ScanSource Earnings: Gross Profit Up Amid TSD Margin Pressure

The latest ScanSource earnings show the hybrid distributor growing both its net sales and gross profit by 5% in a quarter where partners, suppliers and rival distributors faced pressure.

Greenville, South Carolina-based company revealed the numbers from its fiscal year third quarter, which ended March 31, 2023. The company netted $111.8 million in gross profit. Net sales for the company registered at $885.5 million, up 5% from a year prior.

ScanSource chairman and CEO Mike Baur said the earnings exceeded expectations.

“Even in an environment where a lot of people were saying, ‘It’s tough out there,’ we really are pleased with the growth we had in the quarter,” Baur told Channel Futures in an interview.

ScanSource’s Mike Baur

The company ultimately raised its guidance for its fiscal year from at least a $176 million adjusted EBITDA growth to at least $182 million. It continues to forecast at least a 6.5% net sales growth for the year.

ScanSource operates two distinct business segments: specialty technology solutions, and modern communications and cloud. The former contains ScanSource’s legacy POS, barcode and payments solutions, while the latter contains Intelisys’ carrier and cloud services as well as legacy networking and communications technologies from the ScanSource side. Specialty technology once again saw a big year-over-year improvement, growing 12.4% in net sales to to $565.7 million. Executives pointed to physical security, networking and barcode.

While the previous quarter saw a big pull-in coming from earlier-than-expected inventory, ScanSource chief financial officer Steve Jones said he didn’t see significant pull-in in the latest quarter.

“We are seeing supply lead times return to normal levels for most of the products we sell,” Baur added.

Meantime, modern communications and cloud decreased 6.7% in net sales to $319.9 million. As previous quarters have also reflected, on-prem communications hardware continues to decline. Cloud-based communications growth kept profit margin growth positive (3%) at $54 million. Within the modern communications and cloud segment, the Intelisys services distributor business saw net sales growth.  As the company stated in its previous quarterly earnings, annualized end user billings exceed $2.4 billion for Intelisys.

Aruba Growth

ScanSource has been reporting strong growth in its Cisco business, and that trend continued in these earnings with “double-digit” Cisco growth. However, ScanSource’s modern communications and cloud unit saw growth with another networking vendor: HPE’s Aruba.

ScanSource recently earned Aruba’s North American Distributor of the Year. Baur said ScanSource and Aruba have known each other very well over the years.

“We were one of their first distributors, if not the first. Aruba really built a presence in our channel,” Baur told Channel Futures.

However, HP’s 2015 acquisition of Aruba spelled a big adjustment for ScanSource. On one hand, it saw goodbye to some of the Aruba channel people it had built relationships. Moreover, it had entered a much larger pool of partners by virtue of the HP/HPE connection.

“We got new competitors. Overnight we had to compete with the broadline distributors,” Baur said.

Now the award from Aruba represents ScanSource’s “specialized expertise in this space and successful engagement with the Aruba team,” Baur said in the earnings call.

“For us, Aruba was a strong player before. And now over the last year and a half, our team and the Aruba team have really gelled together,” Baur said.

On-Prem Communications

As noted above and as executives have disclosed over the last several ScanSource earnings calls, on-prem communication hardware continues to fall. It now represents only 10% of the total sales within the modern communications and cloud segment, and it represents less than 4% of total consolidated net sales in the overall ScanSource portfolio.

ScanSource’s Steve Jones

ScanSource chief financial officer Steve Jones said this particular technology has been falling at a consistent rate.

“Now it’s really the minimum terms of the total amount of revenue that it’s driving for our company,” Jones told analysts.

The decline of on-prem communications is known to the larger channel ecosystem, with Avaya’s second bankruptcy capturing headlines. The hybrid work era has helped pushed more and more businesses into cloud-based systems, notably unified communications as a service (UCaaS).

To that point, ScanSource executives view the UCaaS offerings contained within the Intelisys agency business as a key remedy for …

… traditional resellers of on-prem communications hardware. ScanSource in 2016 purchased Intelisys, a technology services distributor with a portfolio of carrier and cloud service providers. Whereas sales partners in the legacy ScanSource business resold hardware products, legacy Intelisys would sell an ongoing service from the carrier and earn a residual commission passed down from the carrier through Intelisys.

In recent years, ScanSource has rebranded itself as a hybrid distributor, encouraging traditional Intelisys agents to adopt more hardware sales from the legacy ScanSource side, and encouraging legacy ScanSource VARs to sell agent-based cloud and carrier services.

Intelisys’ John DeLozier

John DeLozier, president of Intelisys and ScanSource’s president of modern communications and cloud services, said he’s seeing more and more VARs adopt the other side of the business.

“I think premise-focused VARs know that recurring and cloud is here to stay. I think COVID-19 accelerated it. And I think they know if you’re not asking your customer, somebody else is going and you don’t want to be the dinosaur in the room. So get ahead of it,” he said.

DeLozier also told Channel Futures last week that mobility has emerged as an area where technology advisors (also known as commission-based agents) are making their convergence.

In addition, contact center as a service (CCaaS) end user billings grew 56%, according to the ScanSource earnings.

TSD Margin Pressures

Intelisys is the only publicly traded technology services distributor (TSD), which makes its quarterly earnings a key indicator for the rest of the industry. And the latest ScanSource earnings helped crystallize a trend people in the channel have been talking about for years. While end user billings increased 9% year-over-year for Intelisys, net sales increased 4% year-over-year. Note that net sales equal net commissions Intelisys receives from the suppliers after passing on part of the commission to the sales partner.

In other words, Intelisys’ net margin is not growing at the same rate as what’s happening at the end user level. And that’s due in part to Intelisys a larger part of its commissions to its sales partners before to stay competitive with other TSDs.

This brings us back to the larger trend in the TSD channel: that many TSDs feel pressure to pass through more and more of the overall commission to the subagent on deals. As noted in a previous Channel Futures article, decades ago the TSD might have taken 30% of the vendor’s commission while passing on 70%. But that number has crept up – even into the 90s in many cases.

“As smaller TSDs want to take customers that we sell to today and lure them over, they’re willing to take little or no margin to move the customer over,” Baur told Channel Futures.

Baur stressed, however, that analysts need to look at the resale-based numbers of its hardware business differently than the commission-based numbers of its cloud and carrier services (Intelisys) business. For example, he said while agency sales may come with a lower revenue, its margin stands “at 100%.”

“We’re just trying to be careful that we don’t send the wrong impression that a lower growth rate is suggesting we’re losing market share. We don’t believe we are. And we’re willing at these margins to maintain them, because as all of our investors know, this [Intelisys] is an extremely profitable business on the operating income line and the EBITDA line. And remember, with the limited working capital required for this businesses, it’s a strong long-term strategic flight, even at growth rates of 4%. We believe that might continue, but we’re comfortable that we need to maintain market share while this is going on,” Baur told investors.

For now, Baur said ScanSource is willing to take a lower margin on these deals to remain competitive.

“What that tells us is that we’re not losing market share at the end customer. What’s happening is we’re getting margin pressure. And we’ve talked about this for a few quarters now that we’ve made a specific strategic decision to make sure that we don’t lose customers,” he said.

Baur gave a message to the supplier community in his interview with Channel Futures. He encouraged the vendors to ensure that their TSD partners are making enough money on deals that they can reinvest back into their business.

“The suppliers need to make sure that the TSDs know that they have to invest in this business long-term, or the suppliers lose out. If the margins get reduced by the TSDs beating each other up, there won’t be investments in the channel for that supplier,” Baur said.

Comcast Business channel leader Craig Schlagbaum recently made similar comments to Channel Futures in a Q&A.