Business Context and Reporting Period
ScanSource, Inc. is a global value-added distributor of technology products and solutions to approximately 33,000 resellers and approximately 400 manufacturers across North America, Latin America and Europe. Its reportable segments are Worldwide Barcode & Security and Worldwide Communications & Services.
The filing covers the quarter and nine months ended March 31, 2016, representing fiscal 2016 third-quarter results. The request metadata identifies “2015 Q3,” but the filing’s stated reporting period is March 31, 2016.
Key Financial Metrics
| Metric | Quarter Ended March 31, 2016 | Quarter Ended March 31, 2015 | Nine Months Ended March 31, 2016 | Nine Months Ended March 31, 2015 |
|---|---|---|---|---|
| Net sales | $798.4 million | $763.2 million | $2.663 billion | $2.362 billion |
| Gross profit | $84.5 million | $80.0 million | $272.7 million | $235.8 million |
| Gross margin | 10.6% | 10.5% | 10.2% | 10.0% |
| Operating income | $21.6 million | $21.5 million | $77.9 million | $76.5 million |
| Operating margin | 2.7% | 2.8% | 2.9% | 3.2% |
| Net income | $14.0 million | $12.9 million | $50.7 million | $49.0 million |
| Diluted EPS | $0.54 | $0.45 | $1.88 | $1.70 |
Quarterly net margin was approximately 1.8%, compared with 1.7% in the prior-year quarter. Nine-month net margin was approximately 1.9%, compared with 2.1% in the prior-year period.
- Quarterly sales increased 4.6%; nine-month sales increased 12.7%.
- Quarterly Barcode & Security sales increased 10.3%, while Communications & Services sales decreased 5.2%.
- Nine-month sales increased 13.7% in Barcode & Security and 10.7% in Communications & Services.
- Quarterly non-GAAP diluted EPS was $0.64 versus $0.52 in the prior-year quarter, excluding acquisition-related intangible amortization, contingent consideration changes and acquisition costs.
- Annualized return on invested capital was 12.3%, compared with 12.1% in the prior-year quarter.
Cash Flow, Liquidity and Debt
- Cash provided by operating activities for the nine months was $24.3 million, compared with $27.1 million in the prior-year period.
- Cash used in investing activities was $70.6 million, including $61.5 million of net cash paid for the KBZ acquisition and $9.1 million of capital expenditures.
- Cash used in financing activities was $30.3 million, primarily reflecting $98.4 million of share repurchases and $7.3 million of contingent consideration payments, partly offset by revolving-credit borrowings.
- Cash and cash equivalents declined to $40.8 million at March 31, 2016, from $121.6 million at June 30, 2015. Approximately $34.3 million was held outside the United States.
- Outstanding borrowings included $73.6 million under the revolving credit facility, $5.4 million of long-term debt and $0.8 million of current debt. Approximately $226.4 million remained available under the $300 million revolving facility.
- The Company was in compliance with its debt covenants at March 31, 2016 and states that existing cash, operating cash flow and available credit should cover requirements for at least the next twelve months.
- Working-capital indicators weakened: DSO increased to 59 days from 57 days at March 31, 2015, and third-quarter inventory turns declined to 4.9 from 5.4.
Material Changes Versus the Prior Comparable Period
- Revenue growth benefited substantially from acquisitions, particularly KBZ, acquired September 4, 2015. On a constant-currency basis excluding acquisitions, consolidated sales decreased 0.7% in the quarter and increased 2.3% for the nine months.
- Gross margin improved modestly, primarily due to a more favorable product mix and the inclusion of KBZ results.
- SG&A increased 5.9% for the quarter and 20.3% for the nine months, driven by acquisition-related employee costs, amortization and higher bad-debt expense.
- Communications & Services operating income declined 12.0% for the quarter and 20.2% for the nine months, primarily due to lower sales, acquisition-related contingent consideration adjustments and higher employee costs.
- Barcode & Security operating income increased 12.8% for the quarter and 19.8% for the nine months.
- The weighted-average diluted share count declined to 26.0 million in the quarter from 28.9 million, reflecting the repurchase of 2.82 million shares during the first nine months for $98.4 million. Approximately $2.8 million remained authorized for repurchases at March 31, 2016.
- Foreign-currency translation produced a $10.3 million comprehensive-income benefit in the quarter, compared with a $31.9 million loss in the prior-year quarter. Nine-month accumulated other comprehensive loss was $77.2 million.
Guidance, Outlook, Risks and Unusual Items
- Management estimated a full-year effective tax rate of approximately 34.5% to 35%.
- Fiscal 2016 capital expenditures were expected to range from $12 million to $15 million, primarily for facility expansions and information-technology investments.
- Management continues to evaluate strategic acquisitions and expects to fund future earnout payments using cash and the existing revolving facility. Contingent consideration totaled $27.1 million at March 31, 2016, including $23.0 million related to Network1.
- The Company recorded $4.5 million of contingent-consideration fair-value expense for the nine months, including $3.8 million related to Network1. These obligations are based on projected performance, probability assumptions, discount rates and foreign-exchange movements.
- Foreign-exchange volatility remains a material risk, particularly involving the Brazilian real, euro and British pound. The Company uses forward contracts for exposure management and does not use derivatives for speculative purposes.
- Interest-rate exposure increased with $79.1 million of variable-rate debt and revolving borrowings; a hypothetical 100-basis-point rate change would have affected quarterly pre-tax income by less than $0.4 million.
- Potential risks include competition affecting pricing and market share, working-capital requirements, acquisition integration, contingent tax exposures in Brazil, customer credit and inventory levels, currency movements, and possible goodwill impairment. Management reported no material litigation exposure and no material off-balance-sheet arrangements.
- The final CDC earnout balance of $1.3 million was paid in April 2016. Network1 purchase accounting was revised during fiscal 2016, including a $7.9 million reclassification to goodwill without an impact on previously reported net income or EPS.
Important Facts for Investors to Verify
- Confirm the extent to which reported revenue and earnings growth is attributable to KBZ and other acquisitions versus organic, constant-currency growth.
- Monitor Communications & Services performance, including the effect of Network1 earnouts, foreign exchange and operating-cost increases.
- Assess liquidity after the substantial share repurchase program, acquisition spending and contingent-consideration payments.
- Track DSO, inventory turns and accounts payable because operating cash flow declined despite higher net income.
- Review the valuation and timing of the $27.1 million contingent-consideration liability, especially the Network1 obligation and its sensitivity to projected EBITDA and currency rates.
- Evaluate the effect of future accounting standards, including revenue recognition, leases, deferred taxes and share-based compensation, which the Company was still assessing.