ScanSource, Inc. Form 10-Q Summary
Business Context and Reporting Period
ScanSource, Inc. is an international wholesale distributor of specialty technology products serving approximately 300 manufacturers and 28,000 resellers across North America, Latin America, Europe and other international markets. Its reportable segments are Worldwide Barcode & Security and Worldwide Communications & Services. This unaudited Form 10-Q covers the quarter ended September 30, 2014, the first quarter of fiscal 2015.
Financial Performance and Position
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Net sales | $791.7 million | $731.9 million | 8.2% increase |
| Gross profit | $77.6 million | $76.5 million | 1.5% increase |
| Gross margin | 9.8% | 10.5% | Down 70 basis points |
| Operating income | $29.0 million | $28.2 million | 2.7% increase |
| Operating margin | 3.7% | 3.9% | Down 20 basis points |
| Net income | $19.2 million | $19.4 million | 1.2% decrease |
| Diluted EPS | $0.67 | $0.69 | Decrease |
| Cash flow from operations | $0.7 million | $45.7 million | Significant decrease |
Barcode & Security sales increased 11.2% to $501.0 million, while Communications & Services sales increased 3.4% to $290.8 million. Communications & Services included $4.7 million of sales from the newly acquired Imago business. International sales increased 12.9% to $195.9 million; North American sales increased 6.7% to $595.8 million.
Management reported non-GAAP operating income of $31.8 million, non-GAAP net income of $21.6 million and non-GAAP diluted EPS of $0.75, excluding intangible amortization, contingent consideration fair-value changes and current-period acquisition costs. Annualized ROIC was 16.2%, compared with 17.4% in the prior-year quarter.
At September 30, 2014, cash and cash equivalents were $139.9 million, compared with $194.9 million at June 30, 2014. Accounts receivable were $500.0 million and inventories were $495.1 million. Total assets were $1.361 billion and shareholders’ equity was $810.3 million.
The company had $5.4 million of long-term debt and no borrowings under its $300 million revolving credit facility, leaving $300 million available. The company was in compliance with its debt covenants. Net cash used in investing activities was $42.8 million, including $35.5 million for the Imago acquisition and $7.3 million of capital expenditures.
Material Changes Versus the Prior Comparable Period
- Sales grew substantially, but gross margin declined because of less favorable product mix, including higher volumes of lower-margin large deals in Barcode & Security.
- Communications & Services gross margin declined due to product mix and the absence of prior-year vendor-program timing benefits.
- Operating income increased modestly despite $1.35 million of acquisition costs recorded primarily in corporate expenses.
- Net income and diluted EPS declined despite higher sales and operating income, principally reflecting higher income taxes and acquisition-related effects. The effective tax rate increased to 34.3% from 31.7%.
- Operating cash flow fell to $0.7 million from $45.7 million, primarily because sales growth increased accounts receivable and working-capital needs.
- The company acquired 100% of Imago Group plc on September 19, 2014 for an initial cash payment of $37.4 million, or $35.5 million net of cash acquired. The transaction added approximately $19.3 million of goodwill and $19.6 million of identifiable intangible assets, subject to final valuation.
- Accumulated other comprehensive loss increased to $29.9 million from $16.7 million, primarily because of a $13.2 million unfavorable foreign-currency translation adjustment.
Guidance, Outlook, Risks and Unusual Items
- Management expects a fiscal 2015 effective tax rate of approximately 34% to 34.5%.
- Fiscal 2015 capital expenditures are expected to range from $17 million to $22 million, primarily for implementation of a new SAP enterprise resource planning system. The company incurred $6.2 million of ERP-related capital expenditures in the quarter.
- Management believes cash resources, operating cash flow and available credit will provide sufficient liquidity for at least the next twelve months.
- The company authorized a three-year, $120 million share-repurchase program in August 2014; no repurchases occurred during the quarter.
- A binding letter of intent was signed to acquire Network1, a Brazilian distributor. A definitive agreement was still under negotiation, with closing expected on or before December 31, 2014. The filing does not provide a purchase price.
- Future contingent consideration liabilities totaled $10.2 million at September 30, 2014, including $5.2 million related to CDC and $5.0 million related to Imago. Future undiscounted earnout payments for each acquisition were estimated at up to approximately $5.8 million, subject to performance and foreign-exchange changes.
- Key risks include foreign-currency volatility, competition and pricing pressure, working-capital requirements, execution of the ERP implementation, acquisition integration and valuation of contingent consideration and goodwill. The Latin America reporting unit had only a 10.2% excess of estimated fair value over carrying value at the latest annual impairment test.
- The company is evaluating a new revenue-recognition standard applicable beginning in fiscal 2018; the filing does not provide a quantified impact.
- Management stated that pending lawsuits are not expected to have a material adverse effect, although no assurance was provided.
Important Facts for Investors to Verify
- Whether sales growth can be sustained without further gross-margin compression from large, lower-margin transactions.
- The effect of Imago integration, intangible-asset amortization and contingent consideration on reported and adjusted earnings.
- Cash conversion and working-capital trends, particularly accounts receivable, inventory turns and operating cash flow.
- The final purchase terms and closing status of the proposed Network1 acquisition.
- Actual ERP spending versus the projected $17 million to $22 million fiscal-year range and the timing of implementation benefits.
- Foreign-currency impacts on reported results, comprehensive income and contingent consideration liabilities.
- Future earnout obligations, acquisition-related funding needs and utilization of the company’s available revolving credit capacity.