ScanSource, Inc. 2017 Q2 Form 10-Q Summary
Business Context and Reporting Period
ScanSource is a global technology-products and solutions distributor serving specialty markets including point-of-sale, payments, barcode, physical security, unified communications, cloud and telecom services. It operates through Worldwide Barcode, Networking & Security and Worldwide Communications & Services. This unaudited Form 10-Q covers the quarter and six months ended December 31, 2017, compared with the corresponding 2016 periods.
Financial Performance and Position
| Metric | Quarter Ended Dec. 31, 2017 | Quarter Ended Dec. 31, 2016 | Six Months Ended Dec. 31, 2017 | Six Months Ended Dec. 31, 2016 |
|---|---|---|---|---|
| Net sales | $1,032.2 million | $904.8 million | $1,956.8 million | $1,837.4 million |
| Gross profit | $113.0 million | $98.5 million | $218.9 million | $190.1 million |
| Gross margin | 10.9% | 10.9% | 11.2% | 10.3% |
| Operating income | $22.3 million | $23.3 million | $29.9 million | $46.2 million |
| Operating margin | 2.2% | 2.6% | 1.5% | 2.5% |
| Net income | $8.0 million | $23.0 million | $12.1 million | $37.9 million |
| Diluted EPS | $0.31 | $0.91 | $0.47 | $1.48 |
For the quarter, Barcode, Networking & Security sales increased 21.2% to $719.8 million, while Communications & Services sales increased 0.5% to $312.4 million. For the six months, segment sales increased 9.8% and 0.1%, respectively. Consolidated organic sales growth in constant currency was 10.4% for the quarter and 3.1% for the six months.
Six-month operating cash flow was negative $84.2 million, compared with $35.7 million of cash provided in the prior-year period. The change primarily reflected increases in accounts receivable and inventory. Investing cash outflow was $147.1 million, including $143.8 million for the POS Portal acquisition. Financing cash inflow was $209.4 million, principally from net revolving-credit borrowings. Cash declined to $35.4 million from $56.1 million at June 30, 2017.
At December 31, 2017, total assets were $2.005 billion, accounts receivable were $717.3 million, and inventories were $581.8 million. Total debt was $360.9 million, including $355.5 million outstanding under the revolving credit facility. Remaining availability was $44.6 million. The Company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Sales increased 14.1% in the quarter and 6.5% in the six-month period, led by the Barcode, Networking & Security segment and the POS Portal acquisition.
- Gross margin was stable in the quarter but improved by 0.9 percentage points for the six months, reflecting improved vendor-program recognition, sales mix and POS Portal contributions.
- Operating income declined 4.0% for the quarter and 35.1% for the six months. The primary pressure was a $6.9 million quarterly and $23.8 million six-month expense from remeasurement of contingent consideration, compared with $1.8 million and $2.0 million, respectively, in the prior-year periods.
- Net income and diluted EPS declined substantially, reflecting higher contingent-consideration expense, higher interest expense and discrete tax charges.
- Interest expense increased to $2.3 million in the quarter and $3.9 million for six months, primarily because of higher revolving-credit borrowings.
- Cash flow shifted from positive to negative as working capital expanded with higher sales and inventory, while acquisition spending and contingent-consideration payments increased.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2018 capital expenditures of approximately $8 million to $11 million, primarily for information-technology investments.
- Excluding discrete items, management expects an approximately 30% fiscal 2018 effective tax rate. The Tax Cuts and Jobs Act produced a provisional net discrete tax expense of $6.7 million in the quarter, including a $9.3 million transition-tax expense partially offset by deferred-tax remeasurement benefits. The accounting remains subject to refinement.
- The Company acquired POS Portal on July 31, 2017 for approximately $143.8 million net cash. The acquisition added approximately $101.2 million of goodwill and $57.0 million of identifiable intangible assets.
- Contingent consideration liabilities totaled $97.0 million at December 31, 2017. Management estimated potential future undiscounted Intelisys earnout payments of up to $115.2 million and Network1 payments of up to $7.1 million, subject to performance and valuation assumptions.
- Key risks include vendor concentration and termination or modification of supplier relationships, pricing and competitive pressure, customer credit risk, acquisition integration and performance, working-capital requirements, interest-rate exposure, foreign-currency volatility, tax-law changes and demand for technology products and services.
- The Company had no material off-balance-sheet arrangements and believed available cash, operating cash flow and borrowing capacity would satisfy requirements for at least the next twelve months.
Most Important Facts to Verify
- Whether operating cash flow improves as receivables and inventory normalize.
- The sustainability of organic growth, particularly in Communications & Services, which declined 2.1% on a six-month constant-currency, acquisition-adjusted basis.
- The final tax effects of the Tax Cuts and Jobs Act and the resulting effective tax rate.
- Actual future earnout payments and further changes in the fair value of Intelisys and Network1 contingent consideration.
- Debt reduction, revolver availability and covenant compliance given $360.9 million of total debt and only $44.6 million of stated revolver availability.
- POS Portal integration, contribution to sales and margins, and the potential for additional amortization or acquisition-related costs.