ScanSource, Inc. Form 10-Q Summary
Business context and reporting period
ScanSource, Inc. is an international wholesale distributor of specialty technology products serving approximately 300 manufacturers and 29,000 resellers across North America, Latin America, and Europe. Its reportable segments are Worldwide Barcode & Security and Worldwide Communications & Services. This unaudited Form 10-Q covers the quarter and six months ended December 31, 2014, the second quarter of fiscal 2015.
Financial performance
| Metric | Quarter ended Dec. 31, 2014 | Quarter ended Dec. 31, 2013 | Six months ended Dec. 31, 2014 | Six months ended Dec. 31, 2013 |
|---|---|---|---|---|
| Net sales | $807.0 million | $740.6 million | $1,598.7 million | $1,472.5 million |
| Gross profit | $78.1 million | $77.3 million | $155.8 million | $153.8 million |
| Gross margin | 9.7% | 10.4% | 9.7% | 10.4% |
| Operating income | $26.0 million | $27.5 million | $55.0 million | $55.7 million |
| Operating margin | 3.2% | 3.7% | 3.4% | 3.8% |
| Net income | $16.8 million | $18.3 million | $36.0 million | $37.7 million |
| Diluted EPS | $0.58 | $0.64 | $1.25 | $1.33 |
- Quarterly sales increased 9.0%; six-month sales increased 8.6%. Barcode & Security sales rose 4.9% for the quarter and 8.0% year to date, while Communications & Services sales rose 16.2% and 9.6%, respectively.
- Quarterly and year-to-date gross profit increased only 1.1% and 1.3%, respectively, as gross margin declined 70 basis points in each comparison.
- Operating income declined 5.4% for the quarter and 1.3% for the six-month period. The quarter included $1.5 million of corporate acquisition costs; year-to-date acquisition costs were $2.8 million.
- Management reported non-GAAP diluted EPS of $0.68 for the quarter versus $0.67 in the prior-year quarter, excluding acquisition-related intangible amortization, contingent consideration fair-value changes, and acquisition costs.
- The effective tax rate was 35.1% for the quarter and 34.7% year to date, compared with 34.2% and 32.9% in the prior-year periods. Management estimated a full-year effective tax rate of approximately 34.5%.
Cash flow, liquidity, debt, and balance sheet
- Cash and cash equivalents were $121.5 million at December 31, 2014, down from $194.9 million at June 30, 2014. Cash held outside the United States was $38.4 million.
- Six-month operating cash flow was negative $9.7 million, compared with positive $1.3 million in the prior-year period, primarily because of higher accounts receivable and inventory supporting sales growth.
- Investing cash flow was negative $49.3 million, including $35.5 million for the Imago acquisition and $13.8 million of capital expenditures. Financing cash flow was negative $9.8 million, including contingent consideration payments and repayments of short-term borrowings.
- Accounts receivable were $490.7 million and inventories were $518.4 million at December 31, 2014. Days sales outstanding were 55 days, compared with 53 days at December 31, 2013; second-quarter inventory turnover was 5.8 times.
- The Company had $5.4 million of long-term variable-rate debt outstanding and no borrowings under its $300 million revolving credit facility. The full $300 million facility was available, and the Company was in compliance with its covenants.
- Contingent consideration liabilities totaled $10.0 million, consisting of $5.0 million related to CDC in Brazil and $5.1 million related to Imago, partly offset by classification and rounding differences in the reported total.
Material changes, outlook, and unusual items
- On September 19, 2014, ScanSource acquired Imago Group plc, renamed Imago ScanSource, for an initial cash payment of $37.4 million, or $35.5 million net of acquired cash. The acquisition added European video and voice communications distribution capabilities and generated estimated goodwill of $18.8 million and identifiable intangible assets of $19.6 million.
- On January 13, 2015, after the reporting date, ScanSource acquired Network1 in Brazil for an initial purchase price of approximately $60 million, plus additional EBITDA-based payments over four years. Purchase accounting had not been finalized as of the filing date.
- Management expects fiscal 2015 capital expenditures of $16 million to $20 million, primarily for the SAP enterprise resource planning system. The European operations excluding Imago began using the new ERP system on February 2, 2015.
- The Board authorized a three-year, $120 million share repurchase program in August 2014; no shares had been repurchased through December 31, 2014.
- Management stated that existing cash, operating cash flow, and available credit are expected to provide sufficient liquidity for at least the next twelve months.
- Key risks include foreign-currency volatility, competitive pricing and credit terms, working-capital requirements, acquisition integration and earnout variability, ERP implementation costs, potential goodwill impairment, and international tax matters. The Company recorded a $23.3 million year-to-date foreign-currency translation loss in accumulated other comprehensive income.
- The Company is involved in ordinary-course litigation and believes any resulting liability would not materially affect its financial condition, results of operations, or cash flows. Brazilian pre-acquisition tax contingencies were recorded with corresponding indemnification receivables; claims may extend to the full purchase price of the CDC acquisition.
- The Company is evaluating the new revenue-recognition standard, applicable beginning with fiscal 2018. The filing does not provide a quantified expected impact.
Important facts for investors to verify
- Whether sales growth can translate into improved gross margins after the current pressure from large lower-margin deals, product mix, vendor-program timing, and foreign exchange.
- The cash-flow effects of elevated receivables and inventories, the Imago and Network1 acquisitions, and future contingent consideration payments.
- Network1’s finalized purchase-price allocation, post-acquisition operating results, integration progress, and incremental debt or liquidity needs.
- Progress, total cost, and operational risks associated with the SAP ERP implementation.
- Exposure to Brazilian, European, and other foreign-currency movements, including the effect on reported revenue, earnings, comprehensive income, and contingent consideration.
- Potential goodwill impairment, particularly for the Latin America reporting unit, whose estimated fair value exceeded carrying value by 10.2% at the April 30, 2014 annual test.