ScanSource, Inc. Form 10-Q Summary
Reporting period: Quarter ended September 30, 2015, the first quarter of fiscal 2016. ScanSource distributes technology products and solutions through its Worldwide Barcode & Security and Worldwide Communications & Services segments across North America, Latin America, and Europe.
Financial Performance and Position
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net sales | $870.8 million | $791.7 million | Up 10.0% |
| Gross profit | $87.6 million | $77.6 million | Up 12.8% |
| Gross margin | 10.1% | 9.8% | Up 30 basis points |
| Operating income | $24.4 million | $29.0 million | Down 15.7% |
| Operating margin | 2.8% | 3.7% | Down 90 basis points |
| Net income | $16.0 million | $19.2 million | Down 16.7% |
| Diluted EPS | $0.57 | $0.67 | Down $0.10 |
| Operating cash flow | $(57.7) million | $0.7 million | Decrease of $58.4 million |
SG&A increased 27.8% to $61.5 million, driven primarily by acquired operations, employee-related costs, and higher bad-debt expense. The fair-value adjustment for contingent consideration was a $1.6 million expense, compared with $0.5 million in the prior-year quarter. The effective tax rate was 34.5%, compared with 34.3%.
Sales increased 2.9% in Worldwide Barcode & Security and 22.1% in Worldwide Communications & Services. Communications & Services operating income fell 34.9% to $11.6 million, while Barcode & Security operating income rose 4.3% to $13.1 million.
At September 30, 2015, cash and cash equivalents were $41.2 million, down from $121.6 million at June 30, 2015. Accounts receivable were $588.0 million and inventories were $588.2 million. The company had $87.0 million outstanding under its $300 million revolving credit facility, with $213 million available, and reported compliance with all debt covenants. Total liabilities were $778.6 million and shareholders’ equity was $764.7 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was substantially acquisition-driven: the quarter included a full quarter of Network1 and Imago ScanSource sales and a partial quarter of KBZ sales.
- On September 4, 2015, ScanSource acquired substantially all KBZ Communications assets for $64.6 million, or $61.5 million net of acquired cash. Purchase accounting remained subject to change.
- Operating and net margins declined despite higher sales because SG&A, acquisition-related costs, bad-debt expense, amortization, and contingent-consideration expense increased.
- Operating cash flow turned negative as accounts receivable, inventories, prepaid expenses, and other working-capital uses increased. Inventory purchases were elevated during the North American SAP implementation.
- ScanSource repurchased 1.15 million shares for $41.9 million during the quarter. Approximately $59.3 million remained available under the $120 million three-year repurchase authorization at September 30, 2015.
- Foreign-currency translation reduced comprehensive income by $20.0 million, resulting in comprehensive loss of $4.0 million versus comprehensive income of $6.0 million in the prior-year quarter.
- In October 2015, the company moved a portion of its networking business into Barcode & Security and stated that prior-period segment results would be reclassified beginning in the second quarter of fiscal 2016.
Guidance, Outlook, Risks, and Unusual Items
- Management expects fiscal 2016 capital expenditures of approximately $9 million to $11 million, primarily for facility expansions and information-technology investments.
- Management estimated a full-year effective tax-rate range of 34% to 35%.
- Management stated that available cash, operating resources, and existing credit facilities should provide sufficient liquidity for at least the next twelve months.
- Future contingent consideration obligations totaled $29.1 million at fair value, including $15.5 million classified as current. Future payments are dependent on acquired businesses’ performance and are exposed to foreign-exchange movements.
- Undiscounted future earnout payments were estimated at $5.3 million to $6.1 million for Imago ScanSource and up to $26.0 million for Network1; the filing states that CDC had a $4.1 million continuing earnout obligation.
- Key risks include foreign-currency volatility, acquisition integration and purchase-accounting changes, working-capital requirements, customer and vendor competition, credit and bad-debt exposure, variable interest rates, and potential impairment of goodwill or intangible assets.
- The company is evaluating the new revenue-recognition standard, which will apply beginning in fiscal 2018; the filing does not provide a quantified adoption impact.
- The company reported no material off-balance-sheet arrangements and believed existing litigation would not have a material adverse effect based on information available at filing.
Important Facts for Investors to Verify
- Whether acquisition-related revenue growth converts into sustainable organic growth and improved operating margins.
- The integration, profitability, and final purchase-price allocation for KBZ, including goodwill and intangible-asset valuations.
- Working-capital trends, particularly inventory turns, receivables collection, and the impact of the ERP implementation on operating cash flow.
- Future contingent-consideration payments and the sensitivity of those obligations to acquired-business performance and currency movements.
- Revolving-credit usage, covenant compliance, and liquidity after acquisitions, share repurchases, and seasonal working-capital needs.
- The effect of the October 2015 segment reorganization on comparable segment revenue and operating-income trends.
- Exposure to foreign-currency losses, which increased year over year and materially reduced comprehensive income.