ScanSource, Inc. Form 10-K Summary
Business Context and Reporting Period
This filing covers the fiscal year ended June 30, 2017, with comparative fiscal-year information for 2016 and 2015. ScanSource is a global value-added distributor of technology products and solutions, operating in North America, Latin America and Europe. Its two reportable segments are Worldwide Barcode, Networking & Security and Worldwide Communications & Services.
The filing also reports fourth-quarter fiscal 2017 results for the three months ended June 30, 2017. The requested “2016 Q4” appears to refer to the prior comparable fourth quarter, which ended June 30, 2016.
Key Financial Metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Net sales | $3.568 billion | $3.540 billion | +0.8% |
| Gross profit | $383.6 million | $355.4 million | +7.9% |
| Gross margin | 10.8% | 10.0% | +80 bps |
| Operating income | $88.2 million | $96.9 million | -8.9% |
| Operating margin | 2.5% | 2.7% | -20 bps |
| Income before taxes | $101.5 million | $96.0 million | +5.7% |
| Net income | $69.2 million | $63.6 million | +8.9% |
| Diluted EPS | $2.71 | $2.38 | +13.9% |
| Operating cash flow | $94.9 million | $52.2 million | +81.7% |
FY2017 net sales included $2.389 billion from Worldwide Barcode, Networking & Security and $1.179 billion from Worldwide Communications & Services. North American sales increased 2.5% to $2.686 billion, while international sales decreased 4.1% to $882.4 million.
Fourth-quarter fiscal 2017 net sales were $917.3 million, gross profit was $100.9 million and net income was $19.0 million, compared with $877.5 million, $82.8 million and $12.9 million, respectively, in the fourth quarter of fiscal 2016. Fourth-quarter diluted EPS was $0.74 versus $0.50.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $56.1 million at June 30, 2017, compared with $61.4 million a year earlier; $47.9 million was held outside the United States.
- Working capital was $624.7 million, down from $643.8 million.
- Total debt was $97.3 million, including $91.9 million outstanding under the revolving credit facility and $5.4 million of long-term debt.
- The company had $208.1 million of additional borrowing availability at June 30, 2017 and was in compliance with its debt covenants.
- The revolving facility maturity was extended to April 3, 2022. On August 8, 2017, after year-end, committed capacity was increased from $300 million to $400 million, with a potential accordion increase to $600 million.
- Cash used in investing activities was $96.2 million, including $83.8 million for the Intelisys acquisition and $8.8 million of capital expenditures.
- The company repurchased 577,643 shares for approximately $20.3 million during fiscal 2017. No cash dividends have been declared or paid.
Material Changes Versus the Prior Comparable Period
- Reported sales rose modestly, but organic sales in constant currency excluding acquisitions declined 2.4%. Barcode, Networking & Security organic sales declined 2.0%, and Communications & Services organic sales declined 3.2%.
- Gross margin improved primarily because of segment mix and timing of vendor program recognition. Barcode, Networking & Security margin declined slightly to 8.2%, while Communications & Services margin increased to 15.9%.
- Operating expenses increased 14.2% to $295.4 million. SG&A rose 10.4%, depreciation increased 28.9%, intangible amortization increased 58.0%, and the fair-value charge for contingent consideration increased to $5.2 million.
- Operating income declined despite higher gross profit, reflecting acquisition-related amortization, contingent consideration expense, bad debt expense and higher employee-related costs.
- Net income benefited from $12.8 million of net legal settlement proceeds and a favorable Brazilian tax settlement. These items materially increased pre-tax income and reduced the effective tax rate to 31.8% from 33.7%.
- Intelisys, acquired August 29, 2016, contributed $29.4 million of sales but reported a $4.2 million operating loss, including $5.4 million of amortization and $12.1 million of contingent consideration expense.
- Goodwill increased to $200.9 million from $92.7 million, primarily due to Intelisys. No goodwill impairment was recorded.
Guidance, Outlook, Risks and Unusual Items
- Management’s strategy is to grow profitable sales, emphasize higher-margin businesses, expand technology and service offerings, and evaluate strategic acquisitions.
- Management expected fiscal 2018 capital expenditures of approximately $8 million to $11 million, primarily for information technology investments, and an effective tax rate of approximately 35% to 36%.
- On July 31, 2017, after the reporting period, ScanSource acquired POS Portal for approximately $144.9 million in cash, with a potential earnout of up to $13.2 million. Purchase accounting estimates were not yet available when the filing was prepared.
- Remaining contingent consideration for Network1 and Intelisys had a June 30, 2017 fair value of $114.0 million. Estimated undiscounted future payments could reach $136.1 million for Intelisys and $7.5 million for Network1.
- Key risks include dependence on major vendors, particularly Avaya, Cisco and Zebra, intense price competition, customer credit losses, inventory obsolescence, foreign exchange volatility, international and Brazilian regulatory exposure, cybersecurity, ERP implementation, acquisitions and goodwill impairment.
- Avaya, one of the company’s largest vendors, filed for Chapter 11 bankruptcy protection in January 2017. Management expected the relationship to continue but disclosed substantial uncertainty.
- The company’s DSO increased to 61 days from 57 days, reflecting an aging receivables portfolio, primarily in North America. The allowance for doubtful accounts increased to $44.4 million from $39.0 million.
- The company reported no material off-balance-sheet arrangements and stated that known litigation was not expected to have a material adverse effect, although legal outcomes remain uncertain.
Important Facts for Investors to Verify
- Reconcile reported sales growth with the 2.4% decline in organic constant-currency sales.
- Assess whether Intelisys and the subsequent POS Portal acquisition can generate sufficient recurring revenue and operating profit to offset integration, amortization and earnout costs.
- Review the $114.0 million contingent consideration liability and sensitivity to projected EBITDA, discount rates and foreign exchange movements.
- Monitor receivables aging, bad debt expense, DSO and inventory levels for evidence of working-capital or credit deterioration.
- Evaluate vendor concentration and the continuing impact of Avaya’s bankruptcy and any changes in vendor rebates, pricing or distribution rights.
- Consider the effect of the $12.8 million legal settlement and favorable Brazilian tax settlement when assessing sustainable earnings.
- Confirm the post-year-end POS Portal purchase price allocation, financing impact and earnout obligations in subsequent filings.