ScanSource, Inc. Form 10-Q Summary
Business Context and Reporting Period
ScanSource is a hybrid technology distributor serving approximately 30,000 sales partners across the United States, Canada, Brazil, the United Kingdom and Europe. Its two reportable segments are Specialty Technology Solutions and Modern Communications & Cloud, covering hardware, software, SaaS, connectivity and cloud services.
This unaudited quarterly report covers the three months ended September 30, 2022, the first quarter of fiscal 2023, with comparisons to the quarter ended September 30, 2021. Results are not necessarily indicative of full-year performance.
Key Financial Metrics
| Metric | Q1 FY2023 | Q1 FY2022 | Change |
|---|---|---|---|
| Net sales | $943.8 million | $857.6 million | +10.1% |
| Gross profit | $113.5 million | $101.6 million | +11.7% |
| Gross margin | 12.0% | 11.8% | +20 basis points |
| Operating income | $34.9 million | $30.3 million | +15.0% |
| Operating margin | 3.7% | 3.5% | +20 basis points |
| Net income | $24.0 million | $22.1 million | +8.9% |
| Diluted EPS | $0.94 | $0.86 | +$0.08 |
| Operating cash flow | $(48.5) million | $(57.0) million | Improved by $8.5 million |
Adjusted EBITDA was $45.3 million, compared with $41.4 million in the prior-year quarter. Annualized adjusted return on invested capital declined to 15.6% from 17.5%, primarily reflecting higher invested capital.
At September 30, 2022, cash and cash equivalents were $40.5 million. Accounts receivable were $744.9 million and inventories were $675.8 million. Net working capital investment increased to $793.6 million from $709.5 million at June 30, 2022. Days sales outstanding increased to 71 days from 62 days a year earlier, while inventory turns declined to 5.1 from 6.3.
Segment and Geographic Performance
| Segment | Sales | Year-over-year change | Operating income | Operating margin |
|---|---|---|---|---|
| Specialty Technology Solutions | $576.3 million | +14.9% | $21.9 million | 3.8% |
| Modern Communications & Cloud | $367.5 million | +3.3% | $13.0 million | 3.5% |
Specialty Technology Solutions benefited from strong North American growth and a more favorable sales mix. Its gross margin increased to 10.1% from 9.1%, and operating income increased 54.9%.
Modern Communications & Cloud benefited from increased demand for communications solutions, including 7.0% year-over-year growth in Intelisys sales. However, unfavorable mix and higher employee costs reduced gross margin to 15.0% from 15.7% and operating income by 20.1%.
United States and Canada sales increased 11.7% to $859.5 million. International sales decreased 4.0% as reported, or 3.3% on a constant-currency basis.
Debt, Liquidity and Capital Resources
Total debt was $326.4 million at September 30, 2022, up from $271.2 million at June 30, 2022. This included $172.7 million drawn under the revolving credit facility and $150.4 million of current and long-term term debt and revenue bonds.
On September 28, 2022, the company amended and restated its credit agreement. The facility includes a $350 million multicurrency revolving credit facility and a $150 million senior secured term loan, both maturing September 28, 2027. An accordion feature permits up to an additional $250 million of commitments, subject to lender approval. Borrowings were subject to a 1.50% spread for LIBOR- and SOFR-based loans at September 30, 2022, plus applicable benchmark rates.
Available revolving capacity was $177.3 million at September 30, 2022. The company was in compliance with its maximum 3.50-to-1.00 leverage covenant and minimum 3.00-to-1.00 interest coverage covenant. Management believes existing cash, operating cash flow and borrowing capacity will satisfy working capital and other cash requirements for at least the next twelve months.
Operating activities used $48.5 million of cash, primarily because accounts receivable and inventory increased. Investing activities used $1.8 million for capital expenditures. Financing activities provided $54.0 million, principally through net revolving-credit borrowings. Management expects fiscal 2023 capital expenditures of approximately $6.5 million to $8.5 million, primarily for information technology and facility improvements.
Material Changes Versus the Prior Comparable Period
- Sales increased 10.1%, led by 14.9% growth in Specialty Technology Solutions.
- Gross and operating margins expanded modestly on a consolidated basis, although Modern Communications & Cloud margins declined.
- Interest expense more than doubled to $3.4 million from $1.7 million because of higher borrowings and rising interest rates.
- Net foreign exchange losses increased to $0.9 million from $0.5 million.
- Operating cash use improved but remained substantial due to working-capital investment.
- Debt increased by $55.3 million from June 30, 2022, and the average daily revolving-facility balance increased to $200.5 million from $54.4 million in the prior-year quarter.
- The company amended and extended its credit facility and incurred approximately $1.5 million of related debt issuance costs.
- A $0.5 million discrete tax benefit was recognized in the current quarter; the effective tax rate was 25.5% versus 25.0%.
- No restructuring or divestiture expenses were recorded in the current quarter, compared with $0.1 million in the prior-year quarter.
Guidance, Outlook, Commentary and Risks
Management expects the fiscal 2023 effective tax rate, excluding discrete items, to be approximately 26.4% to 27.4%. It expects capital expenditures of $6.5 million to $8.5 million. No consolidated revenue or earnings guidance was provided in the filing.
Management stated that supply-chain requirements had been managed effectively to date and that demand has benefited in certain technologies from work-from-anywhere adoption and the ongoing digitization and automation of business processes. However, inflation, rising interest rates, supply-chain constraints and broader macroeconomic weakness remain sources of uncertainty.
Principal disclosed risks include customer and supplier credit exposure, loss of major customers or key suppliers, execution of the organic growth strategy, foreign-exchange and interest-rate movements, cybersecurity incidents, IT-system failures, employee retention, regulatory changes affecting international operations and potential effects of COVID-19. Foreign-currency exposure is partially managed with forward contracts, and a $100 million interest-rate swap hedges variable-rate debt exposure.
Brazilian pre-acquisition tax contingencies related to the Network1 acquisition were supported by approximately $4.1 million of escrowed indemnification receivables at September 30, 2022. The company stated that known litigation is not expected to have a material adverse effect, although no assurance is provided.
The company has never paid a cash dividend, and dividends are restricted under the credit facility. An $81.8 million balance remained under the $100 million share-repurchase authorization; the quarter's 20,822 shares withheld were used to satisfy employee tax obligations rather than open-market repurchases.
Important Facts for Investors to Verify
- Whether elevated receivables and inventory convert into operating cash flow and whether DSO and inventory turns normalize.
- The effect of higher interest rates and increased debt utilization on future earnings and covenant headroom.
- Whether Specialty Technology Solutions' strong growth and margin improvement continue.
- Whether Modern Communications & Cloud can reverse its margin and operating-income decline.
- Actual fiscal 2023 tax rate and capital expenditures compared with management's stated ranges.
- Potential effects of inflation, supply-chain conditions, foreign-exchange volatility and macroeconomic weakness.
- Future developments concerning the Network1 Brazilian tax contingencies and related escrowed indemnification receivables.
- Compliance with the credit facility's leverage and interest coverage covenants, particularly if EBITDA declines or borrowing costs rise.
- The filing's non-GAAP measures, including adjusted EBITDA and adjusted EPS, against GAAP results and comparable-company definitions.