ScanSource, Inc. Form 10-Q Summary
Business Context and Reporting Period
ScanSource is a global technology distributor and services provider serving approximately 38,000 customers and more than 500 suppliers across the United States, Canada, Latin America and Europe. Its two reportable segments are Worldwide Barcode, Networking & Security and Worldwide Communications & Services. This unaudited Form 10-Q covers the quarter and six months ended December 31, 2018, the second quarter of fiscal 2019, compared with the corresponding fiscal 2018 periods.
Key Financial Metrics
| Metric | Quarter Ended Dec. 31, 2018 | Quarter Ended Dec. 31, 2017 | Six Months Ended Dec. 31, 2018 | Six Months Ended Dec. 31, 2017 |
|---|---|---|---|---|
| Net sales | $1,046.0 million | $1,032.2 million | $2,018.9 million | $1,956.8 million |
| Gross profit | $120.5 million | $113.0 million | $232.7 million | $218.9 million |
| Gross margin | 11.5% | 10.9% | 11.5% | 11.2% |
| Operating income | $29.7 million | $22.3 million | $51.1 million | $29.9 million |
| Operating margin | 2.8% | 2.2% | 2.5% | 1.5% |
| Net income | $20.0 million | $8.0 million | $34.3 million | $12.1 million |
| Diluted EPS | $0.78 | $0.31 | $1.33 | $0.47 |
- Quarterly sales increased 1.3%; six-month sales increased 3.2% year over year. Excluding acquisitions and foreign exchange, organic constant-currency sales increased 3.2% and 4.7%, respectively.
- Worldwide Barcode, Networking & Security sales declined 2.5% in the quarter but increased 1.2% for the six months. Worldwide Communications & Services sales increased 10.2% and 7.4%, respectively.
- Six-month cash flow from operations was negative $51.8 million, compared with negative $87.2 million in the prior-year period, primarily because of inventory and receivables growth.
- Six-month capital expenditures were $5.8 million. Cash used in acquisitions was $32.2 million, compared with $143.8 million in the prior-year period.
- Cash and cash equivalents were $22.7 million at December 31, 2018, versus $25.5 million at June 30, 2018.
- Total debt was $372.4 million, including $367.3 million drawn under the revolving credit facility, compared with total debt of $249.4 million at June 30, 2018.
- Revolving-credit availability was $32.8 million at December 31, 2018, compared with $156.0 million at June 30, 2018. The company was in compliance with all debt covenants.
Material Changes Versus the Prior Comparable Period
- Profitability improved materially. Quarterly operating income increased 33.0%, and six-month operating income increased 70.8%. Net income increased 150.8% for the quarter and 183.1% for the six months.
- Gross-margin expansion reflected favorable mix and contributions from POS Portal in Barcode, Networking & Security. Communications & Services gross margin declined slightly because of sales mix.
- Operating expenses declined 3.9% for the six months, primarily because the change in fair value of contingent consideration fell to $6.4 million from $23.8 million in the prior-year period. SG&A nevertheless increased 7.4% for the six months, primarily from employee-related costs and acquisitions.
- The effective tax rate declined to 25.0% for the quarter and 25.2% for the six months, from 60.8% and 55.3%, respectively, largely because the prior-year periods included Tax Act-related discrete charges.
- Interest expense increased 48.5% for the six months because of higher average revolving-facility borrowings.
- Working-capital investment increased to $759.0 million from $651.9 million at June 30, 2018. Inventory turns declined to 5.4 times from 6.2 times in the prior-year quarter, reflecting strategic inventory purchases.
Guidance, Outlook, Risks and Unusual Items
- Management expects a fiscal 2019 effective tax rate, excluding discrete items, of approximately 25% to 26%.
- Fiscal 2019 capital expenditures are expected to range from $10 million to $15 million, primarily for information-technology investments.
- Management believes existing cash, operating cash flow and revolving-credit availability will provide sufficient liquidity for at least the next twelve months, although available revolver capacity was substantially reduced at period-end.
- ScanSource completed acquisitions of Canpango, Intelisys Global and RPM during fiscal 2019 for combined net cash consideration of approximately $32.2 million. Purchase-price allocations for certain acquisitions were not yet final at the reporting date.
- Future undiscounted Intelisys contingent consideration payments are estimated to range up to $85.1 million; the discounted liability was $71.9 million at December 31, 2018, including $39.7 million classified as current.
- The company adopted ASC 606 revenue recognition retrospectively on July 1, 2018, with no material effect on consolidated financial statements. It is evaluating the future impact of the new lease standard applicable beginning July 1, 2019.
- Key risks include foreign-exchange and interest-rate volatility, dependence on major suppliers and customers, credit risk, acquisition integration and performance, demand and pricing pressure, and potential changes in regulatory or tax regimes. The company uses foreign-exchange contracts and a $50 million interest-rate swap for risk management.
- Pending lawsuits are not expected by management to have a material adverse effect, although adverse outcomes cannot be assured. Network1 pre-acquisition tax contingencies were supported by indemnification receivables of approximately $17.9 million at December 31, 2018.
Important Facts for Investors to Verify
- Whether inventory growth, lower inventory turns and negative operating cash flow normalize or continue to consume liquidity.
- The timing and amount of remaining Intelisys earnout payments and their effect on debt and cash flow.
- Whether Communications & Services organic growth can offset weaker quarterly performance in Barcode, Networking & Security.
- The sustainability of reported margin improvement after excluding contingent-consideration adjustments, acquisition costs, amortization and other non-GAAP items.
- The company’s limited remaining revolver availability, floating-rate exposure and compliance with debt covenants.
- The integration, purchase-price allocation and financial contribution of Canpango, Intelisys Global and RPM.
- The effect of foreign-currency movements, supplier concentration, customer credit exposure and future accounting-standard adoption.