Business Context and Reporting Period
ScanSource, Inc. filed this unaudited Form 10-Q for the quarter and six months ended December 31, 2019, representing fiscal 2020 second-quarter results. The company distributes technology solutions and services through approximately 38,000 sales partners and operates in the United States, Canada, Latin America and Europe. Its reportable segments are Worldwide Barcode, Networking & Security and Worldwide Communications & Services.
On July 1, 2019, ScanSource acquired intY and its CASCADE cloud-services distribution platform for approximately $48.9 million, net of cash acquired. Purchase-price allocation remained incomplete at the reporting date. The company also continued marketing planned divestitures of physical-product distribution businesses in Europe, the United Kingdom, Mexico, Colombia, Chile, Peru and Miami-based export operations.
Financial Performance and Position
| Metric | Quarter ended Dec. 31, 2019 | Quarter ended Dec. 31, 2018 | Six months ended Dec. 31, 2019 | Six months ended Dec. 31, 2018 |
|---|---|---|---|---|
| Net sales | $989.5 million | $1,046.0 million | $1,996.4 million | $2,018.9 million |
| Gross profit | $113.9 million | $120.5 million | $226.0 million | $232.7 million |
| Gross margin | 11.5% | 11.5% | 11.3% | 11.5% |
| Operating income | $18.5 million | $29.7 million | $37.1 million | $51.1 million |
| Operating margin | 1.9% | 2.8% | 1.9% | 2.5% |
| Net income | $11.4 million | $20.0 million | $22.9 million | $34.3 million |
| Diluted EPS | $0.45 | $0.78 | $0.90 | $1.33 |
Quarterly sales declined 5.4% year over year, while six-month sales declined 1.1%. Quarterly operating income fell 37.7% and six-month operating income fell 27.4%. Management reported that consolidated gross margin was stable in the quarter but declined for the six-month period.
Quarterly segment sales were $686.2 million for Worldwide Barcode, Networking & Security and $303.3 million for Worldwide Communications & Services. Segment operating income was $14.1 million and $5.6 million, respectively. For the six months, segment sales were $1.384 billion and $612.4 million, with operating income of $26.1 million and $12.9 million, respectively.
Management’s non-GAAP measures, excluding specified amortization, contingent-consideration changes, acquisition and divestiture costs, restructuring costs and planned-divestiture effects, showed quarterly diluted EPS of $0.77 versus $0.96 in the prior-year quarter and six-month diluted EPS of $1.49 versus $1.85.
Cash Flow, Liquidity and Debt
- Cash provided by operating activities was $118.1 million for the six months ended December 31, 2019, compared with $51.8 million used in the prior-year period. The improvement primarily reflected higher accounts payable, partially offset by inventory growth.
- Cash used in investing activities was $51.7 million, including $48.9 million for the intY acquisition and $2.8 million of capital expenditures.
- Cash used in financing activities was $47.9 million, primarily reflecting $35.5 million of contingent-consideration payments and $6.1 million of share repurchases or employee-tax withholding transactions.
- Cash and cash equivalents increased to $42.0 million at December 31, 2019 from $23.8 million at June 30, 2019. Approximately $27.7 million was held outside the United States.
- Total debt was $357.7 million, including $202.8 million drawn on the revolving credit facility, compared with $360.5 million at June 30, 2019. Revolver availability was $147.2 million, with $0.3 million of letters of credit outstanding.
- The amended senior secured credit facility matures April 30, 2024 and includes a $350 million revolving facility, a $150 million term loan and a potential accordion increase of up to $250 million. ScanSource was in compliance with its leverage and interest-coverage covenants at December 31, 2019.
- Inventory was $743.0 million, accounts receivable were $645.3 million and accounts payable were $672.9 million at December 31, 2019. Excluding Intelisys, reported DSO was 59 days and second-quarter inventory turnover was 4.8 times.
Material Changes Versus the Prior Comparable Period
- Worldwide Barcode, Networking & Security quarterly sales decreased 2.2%, primarily because of lower sales volume in Europe and North America. Six-month sales increased 2.0%, supported by higher key-technology volume and larger North American deals.
- Worldwide Communications & Services quarterly sales decreased 11.9% and six-month sales decreased 7.5%, mainly because of weaker North American premise-based communications sales. Master-agency revenue increased and contributed to improved segment gross-margin performance.
- Excluding planned divestitures, acquisitions and currency effects, consolidated sales decreased 5.0% in the quarter and 1.0% for the six months. The six-month adjusted Barcode, Networking & Security business grew 3.8%, while adjusted Communications & Services sales declined 10.3%.
- SG&A increased 2.7% in the quarter and 4.2% for the six months as the company invested in recurring-revenue and service-based businesses, particularly employee-related costs.
- Interest expense increased to $3.8 million in the quarter and $7.5 million for the six months, principally because of higher borrowings. Intangible amortization also increased following the intY acquisition.
- The Intelisys contingent-consideration liability was $45.0 million, entirely current, at December 31, 2019. Fair-value expense was $3.2 million in the quarter and $5.6 million for the six months, driven primarily by discount amortization and better-than-expected results.
- The company adopted ASC 842 lease accounting on July 1, 2019, recognizing approximately $37.0 million of right-of-use assets and lease liabilities. Management stated that the adoption was not material to the income statement.
Guidance, Outlook, Commentary and Risks
- Management expects a fiscal 2020 effective tax rate, excluding discrete items, of approximately 25.5% to 26.5%; the six-month effective rate was 26.9%.
- Fiscal 2020 capital expenditures are expected to range from $4 million to $6 million, primarily for rental equipment, information technology and facility improvements.
- Management believes cash, operating cash flow and available credit will provide sufficient liquidity for at least the next twelve months. Future earnout payments are expected to be funded through operating cash flow and the revolving facility.
- The planned divestiture process may not result in a transaction or may occur on a different timetable. Management notes that proceeds below goodwill-impairment assumptions could result in an impairment charge.
- Key disclosed risks include foreign-exchange and interest-rate changes, dependence on major suppliers and customers, credit risk, reduced demand or pricing pressure, unsuccessful acquisitions, execution of the organic-growth strategy, regulatory issues in international markets and covenant or liquidity constraints.
- Future undiscounted Intelisys earnout payments are estimated to range up to $49.4 million, although the filing states there is no contractual limit. The company also disclosed Brazilian tax contingencies associated with the Network1 acquisition, supported by approximately $6.4 million of indemnification receivables.
- The company reported no material off-balance-sheet arrangements and stated that known litigation is not expected to have a material adverse effect, although adverse outcomes cannot be assured.
Important Facts for Investors to Verify
- Whether the decline in Communications & Services sales and operating income stabilizes as recurring-revenue, cloud and master-agency businesses expand.
- The final purchase-price allocation and ongoing contribution of the intY acquisition, including resulting amortization and goodwill.
- The timing, valuation and accounting consequences of the planned international physical-product divestitures.
- Future Intelisys earnout payments, changes in fair value and their impact on cash flow and operating income.
- Revolver utilization, covenant headroom, interest-rate exposure and the effect of potential LIBOR replacement.
- Inventory turnover, receivables collection and vendor-payment timing, which materially influenced the significant improvement in operating cash flow.
- Progress toward the stated tax-rate and capital-expenditure outlook, as well as the potential for goodwill impairment or foreign-currency volatility.