ScanSource, Inc. Form 10-Q Summary
Reporting period: Quarter and nine months ended March 31, 2023. This is ScanSource’s fiscal third quarter of fiscal 2023, compared with the corresponding 2022 periods. The filing was signed May 9, 2023. ScanSource is a hybrid technology distributor serving approximately 30,000 sales partners across the United States, Canada, Brazil, the UK and Europe through Specialty Technology Solutions and Modern Communications & Cloud.
Financial Performance
| Metric | Q3 FY2023 | Q3 FY2022 | Change |
|---|
| Net sales | $885.5 million | $846.0 million | +4.7% |
| Gross profit | $111.8 million | $106.5 million | +4.9% |
| Gross margin | 12.6% | 12.6% | Flat |
| Operating income | $34.3 million | $32.9 million | +4.1% |
| Operating margin | 3.9% | 3.9% | Flat |
| Net income | $21.2 million | $23.5 million | -9.8% |
| Diluted EPS | $0.83 | $0.91 | -$0.08 |
| Metric | Nine Months FY2023 | Nine Months FY2022 | Change |
|---|
| Net sales | $2.841 billion | $2.568 billion | +10.6% |
| Gross profit | $340.6 million | $315.7 million | +7.9% |
| Gross margin | 12.0% | 12.3% | -30 basis points |
| Operating income | $108.6 million | $94.7 million | +14.6% |
| Operating margin | 3.8% | 3.7% | +10 basis points |
| Net income | $71.0 million | $68.9 million | +3.1% |
| Diluted EPS | $2.79 | $2.67 | +$0.12 |
Segment Results
- Specialty Technology Solutions: Q3 sales increased 12.4% to $565.7 million, while operating income decreased 3.9% to $19.8 million. Gross margin declined to 10.2% from 10.7%, reflecting less favorable mix and lower vendor program recognition. Higher bad-debt expense also reduced operating profit.
- Modern Communications & Cloud: Q3 sales declined 6.7% to $319.9 million, primarily due to lower communications hardware volumes, partially offset by higher networking sales. Operating income increased 17.7% to $14.5 million, and operating margin improved to 4.5% from 3.6% because of favorable sales mix. Intelisys sales increased 4.3% year over year in the quarter.
- For the first nine months, Specialty Technology Solutions sales increased 17.8% and Modern Communications & Cloud sales increased 0.5% on a reported basis.
Cash Flow, Liquidity and Capital Structure
- Cash used in operating activities was $20.5 million for the nine months ended March 31, 2023, compared with $45.7 million used in the prior-year period. Working capital absorbed cash as inventory increased 22% from the start of the fiscal year and accounts payable declined 8%.
- Cash used in investing activities was $6.5 million, primarily for capital expenditures and IT investments, compared with $0.2 million in the prior-year period.
- Cash provided by financing activities was $25.6 million, primarily from net borrowings under the revolving credit facility.
- Cash and cash equivalents were $37.4 million at March 31, 2023, compared with $38.0 million at June 30, 2022. Approximately $31.4 million was held outside the United States.
- Total debt was $311.1 million at March 31, 2023, compared with $271.2 million at June 30, 2022. This included $159.2 million drawn under the revolving credit facility and $142.5 million of term-loan debt, net of current portions.
- The amended credit agreement provides a $350 million revolving facility and a $150 million term loan, maturing September 28, 2027, with an accordion feature for up to an additional $250 million subject to lender commitments. Revolving availability was $190.8 million at March 31, 2023.
- ScanSource was in compliance with its leverage-ratio and interest-coverage covenants at March 31, 2023. Management believes available cash, operating resources and borrowing capacity will satisfy requirements for at least the next twelve months.
- Fiscal 2023 capital expenditures are expected to range from $7 million to $9 million, primarily for IT investments and facility improvements.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven primarily by strong North American demand in Specialty Technology Solutions, while Modern Communications & Cloud experienced lower communications hardware volumes.
- Quarterly net income and diluted EPS declined despite higher sales and operating income because interest expense increased substantially, reflecting higher interest rates and higher average revolving borrowings. Q3 interest expense rose to $5.7 million from $1.5 million.
- Nine-month operating income increased faster than sales, but gross margin decreased because of freight costs, sales mix and lower vendor program recognition in Specialty Technology Solutions.
- Inventory increased to $752.8 million from $614.8 million at June 30, 2022, while accounts receivable decreased to $684.5 million from $729.4 million.
- The company repurchased 356,469 shares for approximately $10.9 million during the quarter under its $100 million repurchase authorization. No cash dividends have been paid, and dividends are restricted by the credit facility.
- The company entered into an additional $25 million interest-rate swap on March 31, 2023, extending its hedging of floating-rate debt.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2023 capital expenditures of $7 million to $9 million and forecasts an effective tax rate of approximately 27.4% to 28.4% for fiscal 2023.
- Management stated that macroeconomic uncertainty, inflation, rising interest rates and supply-chain conditions could adversely affect results. It believes supply-chain requirements have been managed effectively to date.
- Key identified risks include economic weakness, customer and supplier credit risk, foreign-exchange and interest-rate volatility, cybersecurity incidents, IT-system failures, employee retention, loss or modification of major supplier and customer relationships, and execution of the organic growth strategy.
- The filing adds financial-services-industry risk: cash balances may exceed FDIC insurance limits, and bank failures or reduced access to credit could adversely affect liquidity and counterparties’ ability to pay.
- Legal proceedings are described as routine, and management does not expect known adverse outcomes to materially affect financial condition, results or cash flows.
- Network1-related Brazilian tax contingencies were supported by indemnification receivables and escrowed funds totaling approximately $3.2 million available at March 31, 2023.
- There were no material discrete tax items in Q3. The nine-month period included a $0.7 million net tax benefit, primarily related to a Brazilian notional interest deduction. The filing text does not provide a separate full-year revenue or earnings forecast.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether inventory levels normalize and operating cash flow improves, given the $20.5 million nine-month operating cash outflow and 4.1x quarterly inventory turns.
- The effect of higher SOFR-linked borrowing costs on earnings, cash flow and covenant headroom.
- Whether the decline in Modern Communications & Cloud hardware sales persists and whether Intelisys connectivity and cloud growth offsets it.
- Specialty Technology Solutions’ gross-margin recovery, including vendor rebates, freight costs and product mix.
- Actual leverage and interest-coverage ratios relative to the 3.50-to-1.00 maximum leverage covenant and 3.00-to-1.00 minimum interest-coverage covenant.
- Progress toward the stated $7 million to $9 million fiscal-year capital expenditure range and the company’s liquidity expectations.
- Potential customer credit losses, foreign-exchange effects, financial-institution exposure and unresolved Brazilian tax contingencies.
