Business Context and Reporting Period
ScanSource, Inc. filed its Form 10-K for the fiscal year ended June 30, 2022. The supplied metadata refers to “2021 Q4,” but the filing is an annual report covering fiscal 2022, with fiscal 2021 as the primary comparable period.
ScanSource is a hybrid technology distributor serving approximately 30,000 sales partners across the United States, Canada, Brazil and the United Kingdom. It provides hardware, software, SaaS, connectivity and cloud solutions from more than 500 suppliers. Continuing operations comprise Specialty Technology Solutions and Modern Communications & Cloud. Prior-year divestitures of certain European, Latin American and export product-distribution businesses are reported as discontinued operations.
Key Financial Metrics
| Metric | FY 2022 | FY 2021 | Change |
|---|---|---|---|
| Net sales | $3.530 billion | $3.151 billion | +12.0% |
| Gross profit | $426.5 million | $350.7 million | +21.6% |
| Gross margin | 12.1% | 11.1% | +100 bps |
| Operating income | $122.2 million | $61.5 million | +98.7% |
| Operating margin | 3.5% | 2.0% | +150 bps |
| Income from continuing operations | $88.7 million | $45.4 million | +95.4% |
| Diluted EPS from continuing operations | $3.44 | $1.78 | +$1.66 |
| Net income | $88.8 million | $10.8 million | Significant increase |
| Operating cash flow from continuing operations | $(124.4) million | $116.8 million | $(241.1) million |
| Adjusted EBITDA | $166.7 million | $117.9 million | +41.4% |
| Adjusted ROIC | 17.0% | 12.6% | +440 bps |
Specialty Technology Solutions sales increased 14.7% to $2.082 billion, with gross margin rising to 9.9% from 8.7%. Modern Communications & Cloud sales increased 8.4% to $1.448 billion, with gross margin rising to 15.3% from 14.4%. Intelisys connectivity and cloud net sales increased 14.4%; its net billings totaled approximately $2.25 billion and generated approximately $74.3 million of reported net sales.
SG&A increased 11.3% to $275.4 million, primarily due to higher employee costs, but declined to 7.8% of sales from 7.9%. No restructuring charges or contingent-consideration remeasurement expense were recorded in fiscal 2022, compared with $9.3 million and $0.5 million, respectively, in fiscal 2021.
Liquidity, Capital Resources and Debt
- Cash and cash equivalents were $38.0 million at June 30, 2022, down from $62.7 million a year earlier.
- Net investment in working capital increased to $709.5 million from $486.7 million, primarily because accounts receivable rose 28% and inventories rose 31% to support sales growth.
- Days sales outstanding increased to 68 from 60; fourth-quarter inventory turnover declined to 5.6 times from 6.5 times.
- Total debt was $271.2 million, including $135.8 million drawn on the revolving credit facility and $135.3 million of term-loan and other long-term debt.
- The company had $214.2 million of additional revolving borrowing availability and was compliant with its debt covenants at year-end.
- The credit facility requires a leverage ratio of no more than 3.50:1.00 and an interest coverage ratio of at least 3.00:1.00. The facility matures April 30, 2024.
- Capital expenditures were $6.8 million in fiscal 2022. Management expects fiscal 2023 capital expenditures of $6.5 million to $8.5 million, primarily for information technology and facility improvements.
- The company repurchased 550,194 shares for $18.2 million during fiscal 2022 under a $100 million authorization. It has never paid a cash dividend, and dividends are restricted under the credit facility.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated across both operating segments, with consolidated sales up 12.0% and constant-currency sales up 11.8%.
- Gross margin expanded by 100 basis points, driven by higher sales volume, favorable mix and increased vendor-program recognition.
- Operating income nearly doubled, aided by gross-profit growth and the absence of fiscal 2021 restructuring, divestiture and contingent-consideration charges.
- Cash generation deteriorated materially: operating cash flow changed from $116.8 million provided to $124.4 million used, reflecting substantially higher receivables and inventory.
- Debt increased by approximately $128.0 million, primarily due to borrowings under the revolving credit facility used to fund working capital.
- Fiscal 2022 included only $0.1 million of income from discontinued operations, compared with a $34.6 million loss in fiscal 2021. The prior-year loss principally reflected divestiture-related adjustments.
- Goodwill and intangible-asset impairment charges were zero in fiscal 2022 and 2021, compared with $120.5 million in fiscal 2020.
Outlook, Commentary, Risks and Unusual Items
Management expects existing cash resources, operating cash flows and borrowing capacity to satisfy present and anticipated working-capital and cash requirements for at least the next twelve months. No consolidated revenue or earnings guidance was provided. Management expects a fiscal 2023 effective tax rate of approximately 25.0% to 26.0%.
Management reported that supply-chain requirements had been managed effectively to date, while warning that semiconductor shortages, extended lead times, inflation, rising interest rates, economic weakness and COVID-19-related disruption could affect product availability, costs, customer demand, credit losses and liquidity.
- Working-capital intensity is a key concern because sales growth required large increases in accounts receivable and inventory and resulted in negative operating cash flow.
- The company depends heavily on major suppliers; Cisco and Zebra each represented more than 10% of net sales. Supplier agreements are generally non-exclusive and may often be terminated on 30 to 120 days’ notice.
- Competition may pressure prices, gross margins and market share.
- Customer credit exposure could increase with longer payment terms, recession and inflation. The allowance for doubtful accounts was $16.8 million at year-end.
- International operations expose the company to foreign-exchange, tax, regulatory, political, labor and infrastructure risks, particularly in Brazil and the United Kingdom.
- Variable-rate debt creates interest-rate exposure. A hypothetical 100-basis-point rate change would have affected fiscal 2022 pretax income by approximately $1.1 million, according to the filing.
- Goodwill totaled $214.4 million. Annual testing found no impairment, but the valuation depends on projected growth, operating margins, working-capital requirements and discount rates.
- Network1 pre-acquisition contingencies were estimated at $3.8 million to $15.5 million, with all exposures described as indemnifiable under the purchase agreement.
- Grant Thornton issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported no material weakness or material changes in internal controls.
Important Facts for Investors to Verify
- Confirm that the reporting period is fiscal year 2022 ended June 30, 2022, rather than a 2021 fourth-quarter filing.
- Reconcile reported earnings growth with the sharp deterioration in operating cash flow and the increase in receivables, inventory and debt.
- Review the maturity and refinancing implications of the $135.8 million revolving balance and the April 2024 credit-facility maturity.
- Assess the sustainability of the 12.1% gross margin, including vendor rebates, supplier programs and sales mix.
- Monitor Cisco and Zebra concentration, supplier termination provisions and ongoing product shortages.
- Evaluate goodwill sensitivity to higher discount rates, weaker demand or lower operating margins.
- Review the company’s fiscal 2023 tax-rate and capital-expenditure expectations, noting that no revenue or EPS guidance was provided.