Business Context and Reporting Period
ScanSource, Inc. is an international wholesale distributor of specialty technology products serving approximately 35,000 resellers across North America, Latin America and Europe. Its two reportable segments are Worldwide Barcode & Security, covering POS, barcode, physical security and 3D printing, and Worldwide Communications & Services, covering voice, video, networking and professional services.
The filing is a Form 10-K for the fiscal year ended June 30, 2015, filed August 27, 2015. The requested “2014 Q4” period corresponds to the prior-year fourth quarter; this filing also reports fourth-quarter fiscal 2015 results for the three months ended June 30, 2015.
Financial Performance and Position
| Metric | Fiscal 2015 | Fiscal 2014 | Change |
|---|---|---|---|
| Net sales | $3.219 billion | $2.914 billion | +10.5% |
| Gross profit | $327.1 million | $301.1 million | +8.6% |
| Gross margin | 10.2% | 10.3% | Down 10 basis points |
| Operating income | $101.4 million | $121.8 million | -16.7% |
| Operating margin | 3.2% | 4.2% | Down 100 basis points |
| Net income | $65.4 million | $81.8 million | -20.0% |
| Diluted EPS | $2.27 | $2.86 | -20.6% |
| Operating cash flow | $75.5 million | $47.7 million | +58.2% |
Fiscal 2015 sales growth was led by Worldwide Communications & Services, up 25.5% to $1.306 billion, primarily from the Imago ScanSource and Network1 acquisitions and growth in North American communications businesses. Worldwide Barcode & Security sales increased 2.1% to $1.912 billion; on a constant-currency basis, the segment increased 6.1%.
Segment gross margins declined to 8.8% from 9.0% in Barcode & Security and to 12.2% from 12.8% in Communications & Services, reflecting unfavorable product mix, large lower-margin deals and lower vendor-program recognition. SG&A increased 15.8% to $223.0 million due primarily to employee-related costs and acquired operations. Acquisition costs were $3.3 million, and the change in fair value of contingent consideration was a $2.7 million operating expense.
Fourth-quarter fiscal 2015 net sales were $856.7 million, gross profit was $91.3 million and net income was $16.4 million, or diluted EPS of $0.57. Fourth-quarter fiscal 2014 net sales were $758.1 million, gross profit was $74.0 million and net income was $27.1 million, or diluted EPS of $0.94.
At June 30, 2015, cash and cash equivalents were $121.6 million versus $194.9 million a year earlier. Working capital was $666.0 million, total assets were $1.477 billion and shareholders’ equity was $809.0 million. Total debt, including current debt, was $8.8 million. The company had no borrowings outstanding under its $300 million revolving credit facility and reported $300 million of available capacity.
Fiscal 2015 investing cash outflow was $80.5 million, including $59.8 million for acquisitions and $20.8 million of capital expenditures. Financing cash outflow was $56.9 million, including debt repayments, contingent consideration payments and $18.8 million of share repurchases. Return on invested capital declined to 14.6% from 15.7%.
Material Changes Versus the Prior Comparable Period
- Revenue increased substantially from acquisitions and communications-related growth, but reported operating income and net income declined because fiscal 2014 included a $15.5 million net legal recovery related to ERP litigation.
- Imago ScanSource was acquired in September 2014 and Network1 in January 2015. The acquisitions added goodwill and intangible assets and resulted in $59.8 million of net acquisition cash payments.
- Goodwill increased to $66.5 million from $32.3 million, and net identifiable intangible assets increased to $46.3 million from $16.0 million, primarily due to the acquisitions.
- Cash declined by $73.2 million, reflecting acquisitions, ERP investment, debt and earnout payments, share repurchases and unfavorable foreign-currency effects.
- Accumulated other comprehensive loss increased to $64.5 million from $16.7 million, primarily from a $47.8 million foreign-currency translation loss.
- The company implemented the new SAP ERP system in Europe in February 2015 and began implementation in North America in July 2015.
- No goodwill impairment was recorded in fiscal 2015 or 2014. Latin American goodwill remained comparatively sensitive, with estimated fair value exceeding carrying value by 26.5% at the fiscal 2015 test date.
Guidance, Outlook, Risks and Unusual Items
Management expects a fiscal 2016 effective tax rate of approximately 34% to 35%. The filing does not provide formal revenue or earnings guidance. Management’s stated strategy is to grow profitable sales, emphasize security and communications technologies, expand 3D printing and evaluate strategic acquisitions. Subsequent to year-end, the company announced a non-binding letter of intent to acquire KBZ, a U.S. Cisco video-conferencing distributor; closing remained subject to due diligence and definitive agreements.
Material unusual items include the fiscal 2014 ERP litigation recovery, fiscal 2015 acquisition costs, recurring fair-value adjustments to earnout liabilities and significant foreign-currency translation losses. Fiscal 2015 contingent consideration liabilities totaled $34.0 million, including $9.4 million current. Estimated undiscounted earnout payments could reach $5.3 million for CDC, $6.1 million for Imago and $32.7 million for Network1.
Key risks include narrow and declining gross margins, intense competition, dependence on major vendors Zebra and Avaya, product availability and inventory obsolescence, reseller credit exposure, foreign-exchange volatility, Brazil and Latin America operating and tax risks, ERP implementation disruption, cybersecurity, reliance on centralized distribution and third-party logistics, acquisition integration, goodwill impairment and contingent consideration volatility.
The company stated that existing cash, operating cash flow and credit facilities should provide sufficient liquidity for at least the next twelve months. It was in compliance with credit and debt covenants at June 30, 2015. Management and Grant Thornton reported effective internal control over financial reporting; the audit opinion on the consolidated financial statements was unqualified, although Imago and Network1 were excluded from management’s internal-control assessment because they were acquired during the year.
Investor Verification Checklist
- Verify the extent to which fiscal 2015 revenue and earnings growth depends on Imago and Network1 acquisitions versus organic growth.
- Monitor segment gross margins, vendor rebates and product mix, particularly in Communications & Services.
- Reconcile reported earnings with non-GAAP earnings, including $6.6 million of intangible amortization, $2.7 million of contingent consideration expense and $3.3 million of acquisition costs.
- Review cash conversion and working-capital trends, including accounts receivable of $522.5 million, inventory of $553.1 million and an allowance for doubtful accounts of $32.6 million.
- Assess liquidity requirements for the $34.0 million fair-value earnout liability and potential undiscounted payments of up to approximately $44.1 million.
- Evaluate foreign-exchange exposure, especially the Brazilian real, euro and British pound, and the effect of the $47.8 million translation loss.
- Review the sensitivity of Latin American goodwill and acquired intangible assets to lower growth, margins or higher discount rates.
- Confirm the progress and operating impact of the North American SAP ERP rollout and the status of the proposed KBZ acquisition.