ScanSource, Inc. Fiscal 2023 Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2023. Although the request references “2022 Q4,” this filing is an annual report for fiscal 2023, with fiscal 2022 as the principal comparable period.
Business Context
ScanSource is a hybrid technology distributor serving approximately 30,000 customers through hardware, software-as-a-service, connectivity and cloud offerings. Its two reportable segments are Specialty Technology Solutions and Modern Communications & Cloud. The company operates primarily in the United States, Canada, Brazil and the United Kingdom and works with approximately 500 suppliers.
Fiscal 2023 net sales were $3.79 billion. Cisco and Zebra each accounted for more than 10% of net sales, creating supplier concentration risk. Prior product-distribution divestitures remain classified as discontinued operations.
Key Financial Metrics
| Metric | Fiscal 2023 | Fiscal 2022 | Change |
|---|---|---|---|
| Net sales | $3.788 billion | $3.530 billion | +7.3% |
| Gross profit | $449.2 million | $426.5 million | +5.3% |
| Gross margin | 11.9% | 12.1% | Down 20 bps |
| Operating income | $135.9 million | $122.2 million | +11.2% |
| Operating margin | 3.6% | 3.5% | Up 10 bps |
| Income from continuing operations | $88.1 million | $88.7 million | Down 0.7% |
| Net income | $89.8 million | $88.8 million | +1.1% |
| Diluted EPS | $3.54 | $3.45 | +2.6% |
| Operating cash flow from continuing operations | $(35.8) million | $(124.4) million | Improved |
- Segment sales: Specialty Technology Solutions increased 11.9% to $2.331 billion; Modern Communications & Cloud increased 0.6% to $1.457 billion.
- Segment profitability: Specialty Technology Solutions operating income rose 13.5% to $75.7 million, while Modern Communications & Cloud operating income rose 11.1% to $61.7 million.
- Intelisys: Connectivity and cloud net sales increased 7.0% to approximately $79.5 million; net billings were approximately $2.47 billion.
- Balance sheet: Cash was $36.2 million, accounts receivable were $753.2 million, inventory was $757.6 million and total assets were $2.068 billion at June 30, 2023.
- Liquidity and debt: Total debt was approximately $329.9 million, including $179.0 million drawn on the revolving facility and $147.2 million under the term loan and revenue bond obligations. The company reported $171.0 million of additional revolving availability and compliance with all debt covenants.
- Working capital: Net investment in working capital increased to $870.3 million from $709.5 million. Days sales outstanding increased to 72 from 68, and fourth-quarter inventory turnover declined to 4.4 times from 5.6 times.
- Share repurchases: The company repurchased 524,108 shares for $15.8 million during fiscal 2023. No cash dividends have been declared or paid.
Material Changes Versus Fiscal 2022
- Sales growth was concentrated in Specialty Technology Solutions and key North American technologies; Modern Communications & Cloud was approximately flat due partly to lower communications hardware volumes.
- Consolidated gross margin declined because of a less favorable Specialty Technology Solutions sales mix, partially offset by improved Modern Communications & Cloud mix.
- Operating income improved despite higher employee costs and approximately $1.5 million of cybersecurity-related costs. SG&A increased 3.7%, but SG&A as a percentage of sales declined to 7.5% from 7.8%.
- Interest expense increased to $19.8 million from $6.5 million because of higher interest rates and higher average revolving borrowings.
- Operating cash use improved substantially but remained negative, primarily because inventory increased 23.2% during the year.
- Net income included $1.7 million of income from discontinued operations related to a tax settlement. Fiscal 2022 included $0.1 million from discontinued operations.
- Adjusted EBITDA increased to $179.9 million from $166.7 million, while adjusted return on invested capital declined to 14.6% from 17.0% because invested capital increased significantly.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2024 capital expenditures of approximately $6.0 million to $8.0 million, primarily for information technology investments and facility improvements.
- The expected fiscal 2024 effective tax rate from continuing operations is approximately 26.6% to 27.6%. A subsequent IRS notice is expected to produce an approximately $1.5 million discrete tax benefit in the first quarter of fiscal 2024.
- On May 14, 2023, ScanSource discovered a ransomware attack that made certain systems inaccessible and interrupted order processing and shipments for approximately nine business days. Substantial restoration was completed by May 26. The company disclosed that information from its systems appeared on the dark web and expects cyber insurance to reimburse some costs, but the ultimate recovery and business interruption impact are not clear.
- Fiscal fourth-quarter sales were adversely affected by the cyberattack. Management stated that some lost sales may have been deferred and that the ultimate impact was not yet fully estimable.
- Key risks include economic weakness and inflation, rising interest rates, supply-chain constraints, inventory obsolescence, customer credit losses, supplier concentration and short-term supplier agreements, intense competition, foreign currency exposure, cybersecurity and information-system disruptions, acquisition integration, employee retention and potential goodwill impairment.
- Goodwill totaled $216.7 million. The annual impairment test found no impairment, but excess fair value over carrying value was limited to 2% for Specialty Technology Solutions and 13% for Modern Communications & Cloud, increasing sensitivity to adverse operating or market changes.
- The credit agreement matures September 28, 2027, includes a $350 million revolving facility and a $150 million term loan facility, and permits up to $250 million of additional commitments subject to lender approval. Financial covenants require a leverage ratio no greater than 3.50:1.00 and interest coverage of at least 3.00:1.00.
- Management and Grant Thornton reported effective internal control over financial reporting, and the auditor issued an unqualified opinion with no critical audit matters.
Investor Verification Priorities
- Verify the ultimate revenue, margin and cash-flow impact of the May 2023 ransomware incident, including insurance recoveries and any continuing data-privacy or legal exposure.
- Monitor inventory levels, inventory turnover, receivables aging and days sales outstanding for signs of working-capital pressure or credit losses.
- Review debt balances, variable-rate exposure, interest-rate swaps, covenant headroom and refinancing requirements through the September 2027 maturity.
- Assess the sustainability of Specialty Technology Solutions growth and the limited growth in Modern Communications & Cloud, including Intelisys recurring-revenue trends.
- Evaluate dependence on Cisco, Zebra and other major suppliers, including renewal, termination, rebate, pricing and product-availability provisions.
- Test goodwill valuation sensitivity, particularly for Modern Communications & Cloud, where the reported fair-value cushion was 13%.
- Reconcile GAAP results with adjusted EBITDA and other non-GAAP measures, especially the effects of amortization, tax recoveries and cybersecurity costs.