ScanSource, Inc. Form 10-Q Summary
Business Context and Reporting Period
ScanSource is a global technology distributor and solutions provider serving more than 35,000 customers and over 500 suppliers across the United States, Canada, Latin America and Europe. Its two reportable segments are Worldwide Barcode, Networking & Security and Worldwide Communications & Services. This filing covers the quarter ended September 30, 2017, the first quarter of fiscal 2018, and was filed November 7, 2017.
Key Financial Metrics
| Metric | Quarter Ended Sep. 30, 2017 | Quarter Ended Sep. 30, 2016 |
|---|---|---|
| Net sales | $924.6 million | $932.6 million |
| Gross profit | $105.9 million | $91.5 million |
| Gross margin | 11.5% | 9.8% |
| Operating income | $7.6 million | $22.9 million |
| Operating margin | 0.8% | 2.5% |
| Net income | $4.1 million | $14.8 million |
| Diluted EPS | $0.16 | $0.58 |
| Cash flow from operations | $(37.4) million | $6.3 million |
- SG&A increased 15.7% to $73.2 million; depreciation and amortization increased to $8.3 million in aggregate from $5.2 million.
- The company recorded a $16.9 million operating expense for changes in the fair value of contingent consideration, principally related to Network1 and Intelisys.
- Cash and cash equivalents were $23.6 million at September 30, 2017, compared with $56.1 million at June 30, 2017.
- Total debt was $285.8 million, including $280.3 million drawn on the revolving credit facility, compared with $97.3 million at June 30, 2017. Approximately $119.7 million remained available under the facility.
- Total assets increased to $2.0 billion, primarily reflecting the POS Portal acquisition. Goodwill was $302.9 million and identifiable intangible assets were $154.3 million.
- Annualized non-GAAP return on invested capital was 13.0%, compared with 13.1% in the prior-year quarter. Non-GAAP diluted EPS was $0.76 versus $0.68.
Material Changes Versus the Prior Comparable Period
- Reported sales declined 0.9%; constant-currency sales excluding acquisitions declined 4.0%. North American volume weakness affected both segments, while international sales increased 6.8%.
- Gross profit increased 15.7% and gross margin expanded 170 basis points, benefiting from improved vendor program recognition, POS Portal, and Intelisys.
- Operating income declined 66.8%, primarily because of the $16.9 million contingent-consideration charge, higher employee-related costs, bad debt expense, and acquisition-related depreciation and amortization.
- Worldwide Barcode, Networking & Security operating income increased to $14.0 million from $13.4 million. Communications & Services operating income declined to a $6.3 million loss from income of $10.0 million, primarily because of contingent-consideration remeasurement.
- On July 31, 2017, ScanSource acquired POS Portal for approximately $144.9 million in cash, or $142.8 million net of cash acquired. POS Portal contributed $14.6 million of reported sales during the quarter and included a potential earnout of up to $13.2 million.
- Operating cash flow turned negative, primarily due to increased inventory, receivables and other working-capital requirements. Inventory was $597.3 million versus $531.3 million at June 30, 2017.
- Cash used in investing activities was $144.1 million, including the POS Portal acquisition. Financing activities provided $147.4 million, primarily through net revolving-credit borrowings.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2018 capital expenditures of $8 million to $11 million, primarily for information-technology investments.
- Management expects the fiscal 2018 effective tax rate to range from 35% to 36%; the current-quarter rate was 38.8%, including discrete tax items.
- Management stated that cash, operating cash flow and available credit are expected to provide sufficient liquidity for at least the next twelve months. Future earnout payments are expected to be funded through operating cash flow, existing cash and the revolving facility.
- The revolving credit facility was increased from $300 million to $400 million in August 2017, matures April 3, 2022, and includes a potential $200 million accordion feature. The company was in compliance with all debt covenants at September 30, 2017.
- Key risks include weaker demand and pricing pressure, customer and vendor credit exposure, loss or modification of key vendor relationships, acquisition execution, foreign-exchange and interest-rate volatility, and competition.
- Contingent-consideration liabilities totaled $103.5 million at September 30, 2017. The obligations are based on projected earnings and other estimates and can change materially as forecasts, probabilities and foreign-exchange rates change.
- Cash flow and reported earnings were affected by the POS Portal acquisition, acquisition-related amortization, a $16.9 million contingent-consideration remeasurement expense, and a $0.3 million tax benefit from a Brazil tax settlement, partially offset by a $0.6 million discrete tax expense related to stock compensation accounting.
- The company identified no material adverse effect expected from existing litigation and stated that disclosure controls and procedures were effective as of September 30, 2017.
Important Facts for Investors to Verify
- Whether North American volume weakness reverses and whether organic sales growth improves after excluding acquisitions and currency effects.
- The sustainability of gross-margin expansion and the extent to which vendor programs and acquired businesses contribute to future profitability.
- The timing and amount of POS Portal, Intelisys and Network1 earnout payments, including sensitivity to projected EBITDA and foreign-exchange rates.
- Working-capital trends, particularly receivables aging, inventory turns, operating cash flow and the stated increase in days sales outstanding to 63 days.
- Leverage, borrowing availability, variable-rate exposure and compliance with revolving-credit covenants.
- The final purchase-price allocation and valuation of goodwill and intangible assets for POS Portal, which remained preliminary at the filing date.
- The effect of upcoming revenue-recognition, lease and cash-flow accounting standards, including the company’s still-pending assessment of their impact.