ScanSource, Inc. — Form 10-Q Summary
Reporting period: Quarter ended September 30, 2016; unaudited interim results. ScanSource distributes technology products and solutions through its Worldwide Barcode, Networking & Security and Worldwide Communications & Services segments across North America, Latin America, and Europe.
Financial Results and Position
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $932.6 million | $870.8 million | +7.1% |
| Gross profit | $91.5 million | $87.6 million | +4.5% |
| Gross margin | 9.8% | 10.1% | Down 30 bps |
| Operating income | $22.9 million | $24.4 million | -6.4% |
| Operating margin | 2.5% | 2.8% | Down 30 bps |
| Net income | $14.8 million | $16.0 million | -7.4% |
| Diluted EPS | $0.58 | $0.57 | +1 cent |
| Operating cash flow | $6.3 million | $(57.7) million | Improved $64.0 million |
- Segment sales were $633.4 million for Barcode, Networking & Security, up 10.4%, and $299.2 million for Communications & Services, up 0.7%.
- On a constant-currency basis and excluding acquisitions, consolidated sales decreased $9.9 million, or 1.2%.
- Adjusted EBITDA was $29.2 million versus $30.4 million; annualized ROIC declined to 13.1% from 14.6%.
- Cash and cash equivalents were $45.1 million at September 30, 2016, compared with $61.4 million at June 30, 2016.
- Accounts receivable were $637.8 million and inventories were $567.3 million at quarter-end. DSO increased to 59 days from 56 days in the prior-year quarter, while inventory turns improved to 6.0 times from 5.3 times.
- Total assets increased to $1.744 billion from $1.491 billion, primarily reflecting the Intelisys acquisition and related goodwill and intangible assets.
Debt, Liquidity, and Capital Allocation
- Revolving credit borrowings increased to $160.7 million from $71.4 million at June 30, 2016. Approximately $138.9 million remained available under the $300 million facility, which matures November 6, 2018.
- Long-term debt was $5.4 million. The Company was in compliance with all debt covenants.
- Net cash used in investing activities was $85.8 million, primarily reflecting the $83.8 million initial net cash payment for Intelisys.
- Net cash provided by financing activities was $63.3 million, including net revolving-credit borrowings, offset by $17.4 million of share repurchases and $8.6 million of contingent-consideration payments.
- The Board authorized a three-year, $120 million share-repurchase program. During the quarter, 477,113 shares were repurchased for approximately $16.9 million at an average price of $35.35.
- Management expects fiscal 2017 capital expenditures of $5 million to $10 million, primarily for information-technology investments, and believes available liquidity will meet requirements for at least the next twelve months.
Material Changes and Unusual Items
- On August 29, 2016, ScanSource acquired substantially all assets of Intelisys, a telecom and cloud-services company. Intelisys contributed $2.9 million of sales, $0.7 million of operating income, and $0.2 million of net income after acquisition.
- The Intelisys transaction created $109.0 million of goodwill, $63.2 million of identifiable intangible assets, and $95.0 million of initial contingent consideration. The recorded Intelisys contingent-consideration liability was $95.8 million at quarter-end, including $22.8 million classified as current; future undiscounted payments may reach $132.7 million based on current estimates.
- Acquisition-related amortization increased to $3.2 million from $2.2 million, and acquisition costs increased to $0.5 million from $0.2 million. These items, together with contingent-consideration adjustments, reduced GAAP comparability.
- SG&A increased 11.3%, primarily due to acquisition-related employee costs, higher bad-debt expense, and intangible-asset amortization. Management cited unfavorable sales mix and lower networking, security, European, and Brazilian volumes as margin pressures.
- Foreign-currency translation reduced comprehensive income by $0.9 million in the current quarter, compared with a $20.0 million reduction in the prior-year quarter. Net foreign-exchange loss was $0.6 million.
- The Company’s CFO, Charles A. Mathis, notified ScanSource of his resignation effective November 11, 2016. Gerald Lyons was appointed interim CFO effective that date.
Guidance, Outlook, and Risks
- Management’s full-year fiscal 2017 estimated effective tax-rate range is approximately 34.5% to 35%.
- Management expects to continue pursuing strategic acquisitions, particularly in higher-margin and high-growth technology areas, including telecom, cloud, and recurring-revenue services.
- Key risks include competitive pricing and credit terms, product availability, integration and performance of acquisitions, working-capital requirements, foreign-exchange volatility, variable interest rates, customer credit exposure, and contingent-consideration valuation.
- A hypothetical 100-basis-point change in borrowing rates would have affected quarterly pretax income by approximately $1.1 million. Variable-rate debt totaled $166.1 million at September 30, 2016.
- Brazilian tax contingencies related to prior acquisitions are supported by indemnification receivables, but claims may reach the full purchase price. The Company also reports approximately $2.1 million of gross unrecognized tax benefits and $1.2 million of accrued tax interest and penalties.
- The Company stated that existing lawsuits are not expected to have a material adverse effect, although no assurance was provided.
Investor Verification Checklist
- Verify whether Intelisys achieves the projected adjusted-EBITDA thresholds underlying up to $132.7 million of potential undiscounted earnout payments.
- Track acquisition integration, recurring-revenue growth, and the effect of Intelisys on Communications & Services margins.
- Monitor gross margin, SG&A leverage, bad-debt expense, DSO, and inventory turns as underlying sales excluding acquisitions declined.
- Assess leverage and liquidity after the Intelisys acquisition, share repurchases, and future contingent-consideration payments.
- Review the CFO transition and any effect on financial reporting, controls, or capital-allocation execution.
- Evaluate foreign-exchange, interest-rate, Brazilian tax, and other acquisition-related contingencies disclosed in the filing.