ScanSource, Inc. Form 10-Q Summary
Business context and reporting period
ScanSource is a global technology distributor serving approximately 33,000 resellers and more than 300 manufacturers across North America, Latin America and Europe. Its reportable segments are Worldwide Barcode & Security and Worldwide Communications & Services. This unaudited filing covers the quarter and six months ended December 31, 2015, the second quarter of fiscal 2016.
The company acquired KBZ Communications on September 4, 2015, and continued integrating the previously acquired Network1 and Imago businesses. Certain networking operations were transferred between segments, and prior-period segment results were reclassified for comparability.
Key financial metrics
| Metric | Quarter ended Dec. 31, 2015 | Quarter ended Dec. 31, 2014 | Six months ended Dec. 31, 2015 | Six months ended Dec. 31, 2014 |
|---|---|---|---|---|
| Net sales | $993.5 million | $807.0 million | $1.864 billion | $1.599 billion |
| Gross profit | $100.6 million | $78.1 million | $188.2 million | $155.8 million |
| Gross margin | 10.1% | 9.7% | 10.1% | 9.7% |
| Operating income | $31.9 million | $26.0 million | $56.3 million | $55.0 million |
| Operating margin | 3.2% | 3.2% | 3.0% | 3.4% |
| Net income | $20.7 million | $16.8 million | $36.7 million | $36.0 million |
| Diluted EPS | $0.77 | $0.58 | $1.34 | $1.25 |
- Second-quarter sales increased 23.1%; six-month sales increased 16.6%.
- On a constant-currency basis and excluding acquisitions, consolidated sales increased 5.1% for the quarter and 3.7% for the six months.
- Quarterly Barcode & Security sales increased 26.0% to $689.5 million; Communications & Services sales increased 17.0% to $304.0 million.
- Quarterly gross profit increased 28.8%, with gross margin expanding 40 basis points to 10.1%.
- Quarterly SG&A increased 29.6% to $67.0 million, while the fair-value expense for contingent consideration increased to $1.8 million from $0.5 million.
- Non-GAAP diluted EPS was $0.88 versus $0.68 in the prior-year quarter, excluding acquisition-related amortization, contingent-consideration changes and acquisition costs.
- Annualized return on invested capital increased to 17.5% from 14.8%.
Cash flow, liquidity and debt
- Six-month operating cash flow was negative $40.5 million versus negative $9.7 million in the prior-year period, primarily because of higher inventory and receivables and lower accounts payable.
- Investing cash flow was negative $64.9 million, including $61.5 million of net cash paid for the KBZ acquisition and $3.5 million of capital expenditures.
- Financing cash flow was positive $28.8 million, reflecting net revolving-credit borrowings partly offset by $71.6 million of share repurchases and contingent-consideration payments.
- Cash and cash equivalents declined to $39.4 million at December 31, 2015, from $121.6 million at June 30, 2015.
- Accounts receivable were $588.4 million and inventories were $604.1 million at December 31, 2015. Net working capital investment was $687.4 million.
- The company had $109.0 million outstanding under its $300 million secured revolving credit facility, with $191 million available. The facility matures November 6, 2018, and the company was in compliance with its covenants.
- Total contingent consideration liabilities were $24.0 million, including $8.5 million classified as current for Network1. Total debt, including revolving-credit borrowings, was approximately $115.1 million excluding contingent consideration.
Material changes versus the prior comparable period
- Growth was substantially supported by acquisitions: KBZ contributed approximately $131.5 million of quarterly segment sales, while Network1 and Imago contributed to Communications & Services results.
- Excluding acquisitions and foreign-exchange effects, Barcode & Security sales grew 7.8% in the quarter, while Communications & Services sales declined 0.5%, primarily because of lower North American volume.
- Barcode & Security quarterly operating income increased 43.2% to $19.0 million. Communications & Services operating income declined 9.0% to $12.9 million, reflecting higher employee costs and contingent-consideration expense.
- Six-month operating income increased only 2.4% despite higher sales, and consolidated operating margin declined to 3.0% from 3.4% because of higher operating expenses and acquisition-related charges.
- Weighted-average diluted shares declined to 26.9 million from 28.8 million in the quarter, primarily reflecting the share-repurchase program. The company repurchased 801,040 shares during the quarter and approximately 2.4 million shares for $90.4 million since program inception.
- Accumulated other comprehensive loss increased to $87.5 million from $64.5 million at June 30, 2015, primarily because of foreign-currency translation.
Outlook, commentary, risks and unusual items
- Management expects fiscal 2016 capital expenditures of $10 million to $15 million, primarily for facility expansions and information-technology investments.
- Management believes existing cash, operating cash flow and available credit will provide sufficient liquidity for at least the next twelve months, although operating cash flow was materially negative in the first half.
- The estimated full-year effective tax rate is 34.5% to 35.0%.
- Management continues to evaluate strategic acquisitions and expects to implement its new ERP system in additional geographies. Inventory levels were maintained above normal to support customers and vendors during the North American SAP implementation.
- Key risks include foreign-currency volatility, interest-rate exposure, acquisition integration and earnout obligations, intense competition on pricing and credit terms, working-capital requirements, vendor concentration and potential goodwill impairment.
- The company has approximately $24.0 million of fair-value contingent consideration, whose value depends on projected earnings, achievement probabilities, discount rates and foreign exchange rates. Future undiscounted Network1 earnout payments may reach $26.3 million.
- Brazilian tax contingencies related to CDC and Network1 are recorded with corresponding indemnification receivables; claims may extend to the full purchase price. The filing states that known litigation is not expected to have a material adverse effect.
- Foreign-currency forward contracts had a net payable fair value of approximately $0.6 million at December 31, 2015. The company does not use derivatives for speculative purposes.
- The company is evaluating new revenue-recognition and deferred-tax balance-sheet standards that will generally apply beginning in fiscal 2018; the financial statement impact was not yet determined.
Investor verification items
- Verify whether sales growth excluding acquisitions and currency effects is sustained, particularly in Communications & Services.
- Monitor operating cash conversion, inventory levels, receivables, vendor payment timing and reliance on the revolving credit facility.
- Assess KBZ, Network1 and Imago integration, profitability and the finalization of KBZ purchase accounting.
- Track contingent-consideration remeasurements, future earnout cash payments and related foreign-exchange sensitivity.
- Evaluate the effect of share repurchases on leverage, liquidity and per-share results.
- Review foreign-exchange and interest-rate exposure, including the $114.4 million of variable-rate debt and revolving borrowings.
- Confirm the execution and cost of planned ERP, facility and other capital projects, as well as potential goodwill impairment.