ScanSource, Inc. — Fiscal 2017 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended March 31, 2017. The filing is a fiscal 2017 Q3 report, although the request metadata refers to “2016 Q3.” ScanSource distributes technology products and solutions through its Worldwide Barcode, Networking & Security and Worldwide Communications & Services segments across the United States, Canada, Latin America and Europe. Results are unaudited and should be read with the fiscal 2016 Form 10-K.
Financial performance and position
| Metric | Q3 FY2017 | Q3 FY2016 | 9M FY2017 | 9M FY2016 |
|---|---|---|---|---|
| Net sales | $813.5 million | $798.4 million | $2,650.9 million | $2,662.8 million |
| Gross profit | $92.7 million | $84.5 million | $282.7 million | $272.7 million |
| Gross margin | 11.4% | 10.6% | 10.7% | 10.2% |
| Operating income | $20.0 million | $21.6 million | $66.1 million | $77.9 million |
| Operating margin | 2.5% | 2.7% | 2.5% | 2.9% |
| Net income | $12.4 million | $14.0 million | $50.3 million | $50.7 million |
| Diluted EPS | $0.49 | $0.54 | $1.97 | $1.88 |
Cash flow and liquidity: Nine-month operating cash flow was $84.1 million versus $24.3 million in the prior-year period. Investing cash flow was negative $93.8 million, including $83.8 million for the Intelisys acquisition and $3.6 million for acquired intangible assets. Financing cash flow was positive $10.6 million, including net revolving-credit borrowings and $20.9 million of share repurchases. Cash was $62.2 million at March 31, 2017.
Debt: Revolver borrowings were $108.5 million, compared with $71.4 million at June 30, 2016; $191.5 million remained available. Long-term debt was $5.4 million. The company was in compliance with its debt covenants. On April 3, 2017, after quarter-end, the $300 million revolving facility was amended and its maturity extended to April 3, 2022, with a potential $200 million accordion feature.
Balance sheet: Total assets increased to $1.632 billion from $1.491 billion, primarily reflecting the Intelisys acquisition. Goodwill rose to $201.1 million from $92.7 million, identifiable intangible assets rose to $105.6 million from $51.1 million, and contingent consideration liabilities totaled $113.2 million.
Material changes versus the prior comparable period
- Quarterly sales increased 1.9%, but nine-month sales declined 0.4%. Excluding acquisitions and currency effects, consolidated sales declined 0.1% in the quarter and 4.3% for nine months.
- Quarterly gross profit increased 9.7% and gross margin expanded 80 basis points, primarily from the Communications & Services segment and Intelisys. Nine-month gross profit increased 3.7% and margin expanded 50 basis points.
- Operating income declined 7.7% in the quarter and 15.2% for nine months. SG&A increased 14.7% in the quarter and 11.8% for nine months, mainly from employee costs, Intelisys-related amortization and higher bad-debt expense.
- Quarterly diluted EPS decreased from $0.54 to $0.49, while nine-month diluted EPS increased from $1.88 to $1.97. The nine-month comparison benefited from a $12.8 million net legal settlement recognized during the second quarter.
- Intelisys, acquired August 29, 2016, contributed $8.9 million of Q3 sales and $20.2 million for the nine-month period, but reported operating losses of $0.7 million and $0.9 million, respectively, after acquisition-related costs and amortization.
- The Barcode, Networking & Security segment delivered Q3 sales growth of 4.0%, while Communications & Services sales declined 2.2%. For nine months, sales declined 0.6% and 0.2%, respectively.
- Non-GAAP diluted EPS was $0.65 versus $0.64 in the prior-year quarter after excluding acquisition-related amortization, contingent-consideration changes and acquisition costs.
Guidance, outlook, risks and unusual items
- Management expects fiscal 2017 capital expenditures of $7 million to $10 million, primarily for information-technology investments.
- Management estimated a fiscal 2017 effective tax-rate range of approximately 35.3% to 35.8%.
- Management stated that cash, operating cash flow and available credit should provide sufficient liquidity for at least the next twelve months. Future Intelisys earnout payments are expected to be funded through operations and the revolver; Network1 earnouts are expected to be funded through Brazilian cash and operating cash flow.
- Future undiscounted contingent consideration payments were estimated at up to $132.8 million for Intelisys and up to $14.0 million for Network1. These amounts depend on future performance, foreign exchange rates and valuation assumptions.
- Avaya, a major vendor, filed for Chapter 11 bankruptcy protection on January 19, 2017. The filing could affect vendor support, customer confidence, sales and financial results.
- Key ongoing risks include foreign-exchange and interest-rate volatility, vendor concentration, customer credit risk, competitive pricing pressure, acquisition integration and performance risk, and lower demand for distributed products and services.
- The company had $113.9 million of variable-rate debt and no interest-rate swaps; management estimated that a 100-basis-point rate change would affect annual pretax income by approximately $1.1 million.
- The company reported no material off-balance-sheet arrangements and believes known litigation is unlikely to have a material adverse effect, although adverse outcomes cannot be assured.
Investor verification points
- Verify the contribution, profitability and integration progress of Intelisys, including recurring-revenue growth and the remaining earnout obligations.
- Assess whether organic sales trends improve, particularly in North America, Europe and Latin America, after excluding acquisitions and foreign-exchange effects.
- Monitor SG&A, bad-debt expense, gross-margin sustainability and the effect of vendor-program changes.
- Review revolver utilization, interest costs, covenant headroom and the timing and funding of contingent-consideration payments.
- Evaluate the effect of Avaya’s bankruptcy and any changes to key vendor relationships or distribution agreements.
- Reconcile GAAP results with management’s non-GAAP measures, especially acquisition amortization, contingent-consideration remeasurement and the legal-settlement benefit.
- Confirm the subsequent April 3, 2017 credit-facility amendment and its effect on maturity, borrowing capacity and financing costs.