ScanSource, Inc. 2019 Q1 Form 10-Q Summary
Business Context and Reporting Period
ScanSource distributes technology solutions and services, including point-of-sale, payments, barcode, physical security, networking, unified communications, telecom and cloud services. It serves approximately 38,000 sales partners and more than 550 suppliers across North America, Latin America and Europe.
This filing covers the quarter ended September 30, 2019, the first quarter of fiscal 2020, compared with the quarter ended September 30, 2018. The two reportable segments are Worldwide Barcode, Networking & Security and Worldwide Communications & Services.
Key Financial Metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $1,006.9 million | $972.9 million | 3.5% increase |
| Gross profit | $112.1 million | $112.2 million | 0.1% decrease |
| Gross margin | 11.1% | 11.5% | Down 40 basis points |
| Operating income | $18.6 million | $21.4 million | 13.2% decrease |
| Operating margin | 1.8% | 2.2% | Down 40 basis points |
| Net income | $11.5 million | $14.3 million | 19.5% decrease |
| Diluted EPS | $0.45 | $0.56 | Decrease |
| Operating cash flow | $47.0 million | $5.7 million | Increase of $41.3 million |
The effective tax rate was 26.0%, compared with 25.5% in the prior-year quarter. Adjusted EBITDA was $31.9 million, compared with $36.9 million, and annualized non-GAAP return on invested capital was 9.6%, compared with 12.8%.
Segment Performance and Material Changes
- Worldwide Barcode, Networking & Security: Sales increased 6.5% to $697.8 million, or 8.3% on a constant-currency basis excluding planned divestitures and acquisitions. Gross margin declined to 8.4% from 9.5%, primarily because of a higher mix of lower-margin large deals. Operating income declined 11.4% to $12.0 million.
- Worldwide Communications & Services: Sales declined 2.7% to $309.1 million, or 6.3% on the comparable constant-currency basis. Lower North American premise-based communications sales were partly offset by Brazil growth and the intY acquisition. Gross margin increased to 17.4% from 15.8%, while operating income declined 10.7% to $7.4 million.
- SG&A increased 5.9% to $82.5 million due primarily to employee-related investments, recent acquisitions and higher bad-debt expense.
- Interest expense increased 44.3% to $3.8 million, principally because of higher borrowings under the revolving credit and term loan facilities.
- On July 1, 2019, ScanSource acquired intY and its CASCADE cloud services platform for approximately $49.1 million, net of cash acquired. Purchase-price allocation remained incomplete at quarter-end.
- On August 20, 2019, the company announced plans to divest physical product distribution businesses in Europe, the United Kingdom, Mexico, Colombia, Chile, Peru and Miami-based export operations. The timing and completion of any transaction remain uncertain.
- ScanSource adopted ASC 842 lease accounting on July 1, 2019, recognizing approximately $37.0 million of right-of-use assets and lease liabilities. The income-statement impact was not material.
Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $25.9 million at September 30, 2019, compared with $23.8 million at June 30, 2019.
- Operating cash flow was $47.0 million. Investing cash flow was negative $50.0 million, primarily reflecting the intY acquisition. Financing cash flow was positive $5.5 million, including net revolving-credit borrowings and $6.1 million of share repurchases.
- Total debt was $370.3 million, including $216.5 million drawn under the revolving credit facility, $144.4 million of term debt, the Mississippi revenue bond and current maturities. Total debt was $360.5 million at June 30, 2019.
- Additional revolving-credit availability was $133.5 million at quarter-end. The facility matures April 30, 2024 and has a $350 million revolving component plus a $150 million term loan, with potential accordion capacity of up to $250 million.
- The company was in compliance with its maximum 3.50-to-1.00 leverage covenant and minimum 3.00-to-1.00 interest-coverage covenant at September 30, 2019.
- Working-capital needs remain significant: accounts receivable were $706.4 million and inventories were $715.2 million. Excluding Intelisys, days sales outstanding were 63 days and inventory turnover was 5.1 times.
Guidance, Outlook, Risks and Unusual Items
- Management expects a fiscal 2020 effective tax rate of approximately 25% to 26% excluding discrete items.
- Fiscal 2020 capital expenditures are expected to range from $4 million to $6 million, primarily for rental equipment, information technology and facility improvements.
- Management believes cash, operating cash flow and available credit will be sufficient for present and future working-capital and cash requirements for at least the next twelve months.
- The Intelisys contingent-consideration liability was $80.4 million at September 30, 2019, including $38.5 million classified as current. The company recorded a $2.5 million fair-value expense, and future undiscounted earnout payments are estimated to reach up to $86.0 million.
- Foreign-currency translation reduced comprehensive income by $14.6 million, and the interest-rate hedge produced a $1.1 million after-tax loss in accumulated other comprehensive income.
- Key risks include foreign-exchange and interest-rate volatility, dependence on major suppliers and customers, credit losses, execution risk related to acquisitions and planned divestitures, demand and pricing pressure, and potential impairment of goodwill if divestiture proceeds or operating results are weaker than expected.
- The company reports no material off-balance-sheet arrangements and believes current litigation is unlikely to have a material adverse effect, although adverse outcomes cannot be assured.
Important Facts for Investors to Verify
- Whether the planned international physical-distribution divestitures close, at what valuation and with what effect on revenue, margins and goodwill.
- Whether intY delivers expected growth and whether the final purchase-price allocation creates additional intangible amortization.
- Trends in gross margin, particularly the mix of lower-margin large deals in Barcode, Networking & Security.
- North American premise-based communications demand and the performance of the Communications & Services segment.
- Accounts-receivable collection, inventory turnover and the company’s ability to manage working-capital funding needs.
- Future Intelisys earnout payments and compliance with leverage and interest-coverage covenants.
- Foreign-currency movements, floating-rate debt exposure and the potential impact of the planned divestitures on goodwill impairment testing.