SCANSOURCE, INC. (SCSC) - FORM 10-Q

Overview

ScanSource is a leading hybrid distributor connecting devices to the cloud and accelerating growth for customers and channel partners across hardware, software as a service (SaaS), and connectivity and cloud services. The company operates primarily in the United States, Canada and Brazil, with two reportable segments based on sales channels: Specialty Technology Solutions and Intelisys & Advisory.

Recent Developments

In August 2024, ScanSource completed the acquisitions of Resourcive, a leading technology advisor, and Advantix, a managed connectivity experience provider. In September 2024, the company executed a cost reduction and restructuring program to align its cost structure with demand expectations in the hardware business, expected to result in $10.5 million in annualized savings.

Strategy

ScanSource’s strategy is to drive sustainable, profitable growth by orchestrating hybrid technology solutions through a growing ecosystem of partners, leveraging its people, processes and tools. The company aims to provide exceptional experiences for customers, suppliers and employees through operational excellence. ScanSource’s hybrid distribution strategy utilizes multiple sales models to offer hardware, SaaS, and connectivity and cloud services from leading technology suppliers.

Financial Performance

Net Sales

For the quarter ended December 31, 2024, net sales decreased 15.5% to $747.5 million, with the Specialty Technology Solutions segment declining 16.0% and the Intelisys & Advisory segment increasing 4.0%. Excluding the impact of foreign exchange and divestitures/acquisitions, adjusted net sales decreased 15.1%.

For the six months ended December 31, 2024, net sales decreased 13.5% to $1.52 billion, with the Specialty Technology Solutions segment declining 14.0% and the Intelisys & Advisory segment increasing 4.1%. Excluding the impact of foreign exchange and divestitures/acquisitions, adjusted net sales decreased 12.9%.

The decreases in the Specialty Technology Solutions segment were primarily due to lower large deals and continued soft demand in a more cautious technology spending environment. The slight decreases in the Intelisys & Advisory segment were primarily due to lower Intelisys net sales, partially offset by the addition of the Resourcive acquisition.

Gross Profit

Gross profit increased 1.0% to $101.7 million for the quarter ended December 31, 2024. Gross margin increased to 13.6% from 11.4% in the prior-year quarter, driven by a more favorable sales mix and higher vendor program recognition in the Specialty Technology Solutions segment.

For the six months ended December 31, 2024, gross profit decreased 1.9% to $203.3 million. Gross margin increased to 13.4% from 11.8% in the prior-year period, again due to a more favorable sales mix and higher vendor program recognition in the Specialty Technology Solutions segment.

The Intelisys & Advisory segment contributed 100% to gross profit dollars and margin, as these sales have no associated cost of goods sold.

Operating Expenses

Selling, general and administrative (SG&A) expenses increased 10.5% to $73.9 million for the quarter ended December 31, 2024, primarily due to higher customer-specific bad debt expense and costs related to recent acquisitions.

For the six months ended December 31, 2024, SG&A expenses increased 2.3% to $145.6 million, also driven by the higher bad debt expense and acquisition-related costs.

The company incurred $0.3 million and $5.4 million in restructuring and other charges during the quarter and six months ended December 31, 2024, respectively, related to employee separation and benefit costs.

Amortization expense increased $1.0 million and $1.1 million for the quarter and six months, respectively, due to intangible assets acquired in the Advantix and Resourcive acquisitions.

ScanSource also recorded a $1.1 million expense in the quarter related to the change in fair value of contingent consideration owed to the former shareholders of the acquired businesses.

Operating Income

Operating income decreased 31.2% to $18.4 million for the quarter ended December 31, 2024. Operating margin declined to 2.5% from 3.0% in the prior-year quarter.

For the six months ended December 31, 2024, operating income decreased 29.1% to $36.1 million. Operating margin declined to 2.4% from 2.9% in the prior-year period.

The decreases were primarily driven by lower operating income in the Specialty Technology Solutions segment, due to higher bad debt expense and lower sales volumes, as well as lower operating income in the Intelisys & Advisory segment, due to higher employee costs and the change in fair value of contingent consideration.

Other Income/Expense and Taxes

Total other income was $1.3 million for the quarter ended December 31, 2024, compared to $13.2 million in the prior-year quarter. The decrease was primarily due to the absence of a $14.5 million gain on the sale of a business in the prior-year period.

For the six months ended December 31, 2024, total other income was $6.6 million, compared to $8.3 million in the prior-year period. The decrease was mainly attributable to lower interest expense.

The effective tax rate for the quarter and six months ended December 31, 2024 was 13.5% and 20.3%, respectively, compared to 18.3% and 18.6% in the prior-year periods. The decrease in the quarterly rate was primarily due to discrete items.

Adjusted Metrics

ScanSource presents several non-GAAP financial measures, including adjusted operating income, adjusted pre-tax income, adjusted net income, adjusted EPS, and adjusted EBITDA. These measures exclude the impact of amortization of intangible assets, changes in fair value of contingent consideration, restructuring costs, and other non-recurring items.

On an adjusted basis, operating income decreased 15.4% to $25.9 million for the quarter and 9.6% to $53.4 million for the six months ended December 31, 2024. Adjusted operating margin remained flat at 3.5% for both periods.

Adjusted EBITDA, which provides a measure of profitability from the company’s core business operations, was $35.3 million for the quarter, resulting in an annualized adjusted return on invested capital (ROIC) of 13.3%.

Liquidity and Capital Resources

ScanSource’s primary sources of liquidity are cash flows from operations and borrowings under its $350 million revolving credit facility. The company’s cash and cash equivalents balance was $110.5 million at December 31, 2024, down from $185.5 million at June 30, 2024.

Net cash provided by operating activities was $38.6 million for the six months ended December 31, 2024, compared to $156.8 million in the prior-year period. The decrease was primarily attributable to changes in working capital, including reductions in accounts receivable, inventory and accounts payable.

Cash used in investing activities for the six months ended December 31, 2024 was $58.5 million, largely due to cash paid for acquisitions and capital expenditures. This compares to $13.1 million in cash provided by investing activities in the prior-year period, which included proceeds from the sale of a business.

Cash used in financing activities totaled $52.4 million for the six months ended December 31, 2024, primarily for common stock repurchases, compared to $161.3 million in the prior-year period, which was mainly for repayments of borrowings.

As of December 31, 2024, ScanSource had $350.0 million available for additional borrowings under its revolving credit facility. The company was in compliance with all covenants under the credit facility at the end of the quarter.

Outlook and Analysis

ScanSource’s financial results for the quarter and six months ended December 31, 2024 reflect the challenges the company is facing in the current macroeconomic environment. The declines in net sales and operating income in the Specialty Technology Solutions segment indicate softer demand, particularly for larger deals, as customers have become more cautious with their technology spending.

The company’s strategy to expand its Intelisys & Advisory segment, which provides higher-margin services and solutions, has helped offset some of the pressure in the hardware-focused Specialty Technology Solutions business. However, the Intelisys & Advisory segment also experienced a slight decline in adjusted net sales and operating income, suggesting that the broader economic uncertainty is impacting this part of the business as well.

ScanSource’s recent acquisitions of Resourcive and Advantix are intended to bolster its advisory and connectivity capabilities, which could help drive future growth. However, the integration and associated costs of these acquisitions have weighed on profitability in the near term.

The company’s cost reduction and restructuring program is a prudent step to align its cost structure with current demand levels. If the macroeconomic headwinds persist, ScanSource may need to take further actions to streamline its operations and protect margins.

Overall, ScanSource’s financial performance reflects the challenges facing the technology distribution industry. The company’s diversified business model and focus on higher-margin services provide some insulation, but the broader economic conditions are clearly impacting both its hardware and services segments. Investors will be closely watching ScanSource’s ability to navigate the current environment and position the business for sustainable, profitable growth in the future.