ScanSource, Inc. — Form 10-Q Summary
Business context and reporting period
ScanSource is a global technology distributor serving approximately 500 suppliers and 35,000 resellers across the United States, Canada, Latin America and Europe. Its two reportable segments are Worldwide Barcode, Networking & Security and Worldwide Communications & Services. This unaudited Form 10-Q covers the quarter and six months ended December 31, 2016, the second quarter of fiscal 2017.
Key financial metrics
| Metric | Quarter ended December 31, 2016 | Quarter ended December 31, 2015 | Six months ended December 31, 2016 | Six months ended December 31, 2015 |
|---|---|---|---|---|
| Net sales | $904.8 million | $993.5 million | $1,837.4 million | $1,864.4 million |
| Gross profit | $98.5 million | $100.6 million | $190.1 million | $188.2 million |
| Gross margin | 10.9% | 10.1% | 10.3% | 10.1% |
| Operating income | $23.3 million | $31.9 million | $46.2 million | $56.3 million |
| Operating margin | 2.6% | 3.2% | 2.5% | 3.0% |
| Net income | $23.0 million | $20.7 million | $37.9 million | $36.7 million |
| Diluted EPS | $0.91 | $0.77 | $1.48 | $1.34 |
- Operating cash flow for the six months was $35.7 million, compared with cash used of $40.5 million in the prior-year period.
- Investing cash flow was negative $87.1 million, primarily reflecting the $83.8 million initial net cash payment for the Intelisys acquisition.
- Financing cash flow was positive $36.1 million, primarily from net borrowings under the revolving credit facility, partially offset by share repurchases and contingent consideration payments.
- Cash and cash equivalents were $45.1 million at December 31, 2016, compared with $61.4 million at June 30, 2016.
- Accounts receivable were $620.6 million and inventories were $512.9 million at December 31, 2016.
- Borrowings under the revolving credit facility were $136.2 million, compared with $71.4 million at June 30, 2016. Available additional borrowing capacity was $163.8 million. The company was in compliance with its debt covenants.
- Total contingent consideration liabilities were $110.9 million, including $25.5 million current related to Intelisys and $12.7 million related to Network1.
Material changes versus the prior comparable period
- Quarterly sales declined 8.9%; six-month sales declined 1.4%. On a constant-currency basis and excluding acquisitions, sales declined 10.4% for the quarter and 6.2% for the six months.
- Barcode, Networking & Security sales fell 13.7% in the quarter and 2.7% for the six months. Management attributed the decline primarily to lower North American volume, including the absence of a large prior-year KBZ transaction, and vendor program changes.
- Communications & Services sales increased 1.8% in the quarter and 1.2% for the six months, mainly because of Intelisys. Excluding Intelisys and foreign exchange, segment sales declined 1.8% and 1.2%, respectively.
- Gross profit increased 1.0% for the six months despite lower sales, and gross margin improved to 10.3% from 10.1%. Segment margin benefits from Intelisys were partly offset by vendor-program timing and lower margins in the legacy businesses.
- Operating income declined 26.9% for the quarter and 18.0% for the six months. SG&A increased 9.7% and 10.5%, respectively, due primarily to acquisition-related employee costs, intangible-asset amortization and higher bad-debt expense.
- Net income and diluted EPS increased despite lower operating income, primarily because the quarter included $12.8 million of net legal-settlement proceeds. Excluding the settlement and other disclosed adjustments, non-GAAP diluted EPS was $0.75 versus $0.88 in the prior-year quarter.
- Return on invested capital declined to 13.8% from 17.5% for the comparable quarter.
Guidance, outlook, risks and unusual items
- Management expects fiscal 2017 capital expenditures of approximately $5 million to $10 million, primarily for information-technology investments.
- The estimated fiscal 2017 effective tax rate range is approximately 35.0% to 35.5%.
- Management believes cash, operating cash flow and available borrowing capacity will be sufficient to meet working-capital and other requirements for at least the next twelve months.
- The August 2016 Intelisys acquisition added telecom, cloud and recurring-revenue capabilities. Intelisys contributed $8.5 million of quarterly sales and $11.4 million of six-month sales, but reported an operating loss of $0.2 million for the six months after acquisition.
- Future Intelisys earnout payments are estimated at up to $132.5 million on an undiscounted basis. Network1 future earnout payments are estimated at up to $15.6 million. Actual payments may change with performance and foreign exchange rates.
- Avaya, one of the company’s largest vendors, filed for Chapter 11 bankruptcy protection on January 19, 2017. Management expects the relationship to continue, but disruption, unsuccessful reorganization or customer loss could adversely affect sales and financial results.
- Key risks include intense pricing and service competition, foreign-currency volatility, interest-rate exposure, acquisition integration and valuation risk, vendor concentration, credit losses and international tax or legal contingencies.
- The company received $12.8 million of net proceeds from a legal settlement during the quarter. It also repurchased approximately 577,643 shares for $20.3 million under a new $120 million, three-year authorization.
- The company is evaluating upcoming revenue-recognition, lease and cash-flow classification standards; the filing does not provide a clear quantified impact from adoption.
Important facts for investors to verify
- Assess whether the sharp decline in Barcode, Networking & Security sales and operating income is temporary or reflects sustained volume and vendor-program pressure.
- Separate recurring operating performance from the $12.8 million legal settlement and acquisition-related amortization, earnout remeasurement and other adjustments.
- Monitor Intelisys integration, profitability, recurring-revenue growth and the potentially significant future earnout obligations.
- Evaluate leverage and liquidity after the increase in revolving-facility borrowings and planned earnout payments.
- Monitor Avaya’s bankruptcy proceedings and any effects on vendor supply, customer confidence or ScanSource sales.
- Review foreign-currency exposures, including the $58.4 million notional amount of currency contracts and accumulated foreign-currency translation losses of $82.3 million.