ScanSource Sales, Earnings Fall Short On Channel Reorganization Issues

'With these changes, and the realignment of our sales teams, we created customer disruption and negatively impacted our service levels. Since April, as we encountered issues, we made adjustments. And now, following this quarter's sales results, we will make more changes,' says ScanSource CEO Mike Baur.

ScanSource Tuesday said its second fiscal quarter 2020 revenue and earnings dipped and missed expectations after a reorganization of its North American solution provider sales teams, which resulted in lost channel sales.

ScanSource Chairman and CEO Mike Baur Tuesday said during the Greenville, S.C.-based distributor's second-quarter financial analyst call that the issues stemmed from its implementation of a new channel organization as part of its One ScanSource strategy.

The goal was to increase customer value by cross-selling and growing recurring revenue around its traditional channel partner solutions, connectivity, cloud, Software as a Service, and its Intelisys and intY acquisitions, Baur said.

[Related: CRN Exclusive: ScanSource CEO On How Consolidation Is Impacting Distribution]

ScanSource in mid-2016 acquired Intelisys, a large master agent that gave the distributor the ability to expand into the SMB telecom services market. ScanSource in July also acquired U.K.-based intY to make that company's platform for bringing cloud services and Microsoft licenses to its channel partners and agents.

The strategy behind One ScanSource was to become channel-partner-centric, add value and enable partner growth, Baur said. To do this, ScanSource in April started combining five North American VAR business units into one, reorganizing its teams by partner segments, changing partner assignments, introducing team selling, implementing Salesforce CRM, and adopting a new sales compensation plan, he said.

"With these changes, and the realignment of our sales teams, we created customer disruption and negatively impacted our service levels," he said. "Since April, as we encountered issues, we made adjustments. And now, following this quarter's sales results, we will make more changes."

Despite the issues, the quarter saw record Intelisys sales, which were up 19 percent year over year, Baur said. Sales through cloud suppliers grew even faster at 68 percent, he said.

One of ScanSource's key objectives with Intelisys was to recruit and sell through more channel partners while still growing its agent channel, Baur said. To date, out of 4,000 Intelisys sales partners about 15 percent are ScanSource traditional channel partners, he said.

"Over a year ago, in order to accelerate the growth of the VAR sales channel, we started our Ignite program to identify and recruit VARs to join the Intelisys sales community," he said. "The Ignite team is focused on the ScanSource strategic sales partners and working with the ScanSource account executives to introduce VARs to the financial benefits of recurring revenue. We've learned that VARs require education and a financial investment to participate successfully."

The Ignite team is working with over 600 key channel partners, Baur said. "This gives us confidence to accelerate our efforts to integrate more closely by aligning with the One ScanSource strategy and creating a teaming approach," he said.

Baur said ScanSource is confident that completing its One ScanSource go-to-market transformation to drive recurring revenue growth is the right strategy for its business.

"After we complete this transformation, we expect to be able to deliver fiscal year 2021 results that reflect our strategy, including moving ROIC [return on invested capital] above 10 percent, and delivering double-digit non-GAAP earnings per share growth," he said.

When asked by a financial analyst about the timing of the One ScanSource reorganization during the question-and-answer period of the conference call, Baur reiterated the changes implemented since April.

"And what we've learned was, that was a lot of moving pieces," he said. "And we didn't see the impact of that until this past quarter, from a negative perspective. Now that we know what happened, and in certain cases we had customers that said, 'Hey, I'm not happy with a new salesperson, I want someone different or I'll go away,' we had to make some adjustments, as we said. And in some cases, [partners], especially the [partners] that are not buying from us regularly, they decided to go somewhere else for now."

However, Baur said, ScanSource by the fourth fiscal quarter of this year expects to return to normal seasonal growth. "So we're planning to get through this," he said. "But yes, we've lost [partners]. We believe we can get many of them back. But we know we have to make some changes quickly."

In response to another financial analyst, Baur said it took time to see the ramifications from the One ScanSource strategy, and that ScanSource made adjustments as it saw deficiencies or gaps.

"So we've made some changes all along," he said. "And what we learned was, in some cases, those changes weren't enough. And if [partners] gave us the benefit of the doubt in the June quarter, they then in the September quarter may have said, 'OK, if you guys don't get this fixed, whatever this is in their particular case, then we're going to go somewhere else.'"

More changes are coming to One ScanSource in response to conversations with the company's sales teams and channel partners, Baur said.

"We believe these [issues] are self-inflicted," he said. "An example is, we might make [partners] mad because we took their sales rep, and then promoted their rep, because they're really good, to another team because we thought we thought they could provide the company more value. And that disconnect with their rep is not something that you can easily replace."

Baur told another analyst that ScanSource has been pushing its channel partners to do what is needed to get ready to make a play for the services market with recurring revenue as the reward.

"Our team [sits] down with VAR's principals, the CFO or the president/CFO owner, and say, 'Here's how this works,'" he said. "To add recurring revenue to a traditional hardware VAR means that you're going to have to invest in salespeople and selling process that you won't get a return on for three years. That is the typical return on making an investment in recurring revenue. Once you get to three years, man, you start printing money. But that's the financial investment. We walk them through that investment. We try to help them minimize it and take some risk out. But that's what we mean by financial investment. This is why it's not easy. It's why it takes longer that everybody realizes. But once you get it going, it's a fantastic way to move your business from a hardware business that has a value to a recurring revenue and hardware business that has a much higher valuation, which gives the owners a better exit path. And that's our pitch."

When another analyst asked about impact ScanSource and its supply chain has felt from the Coronavirus now spreading through China, Baur said the distributor sent a message to its team looking for updates.

"Based on what we've heard so far, there are some potential minimal disruptions," he said. "Some of the vendors are saying they don't have their workers returning to the factory following the [Lunar] New Year yet, and that there might be a one- or two-week disruption."

For its second fiscal quarter 2020, which ended Dec. 31, ScanSource reported sales of $989.5 million, down 5 percent from the $1.046 billion the company reported for its second fiscal quarter of 2019.

Net income for the quarter on a GAAP basis was $11.4 million, or 45 cents per share, down significantly from last year's $20.0 million, or 78 cents per share. On a non-GAAP basis, ScanSource reported net income of $19.5 million, or 77 cents per share, down from last year's $24.7 million, or 96 cents per share.