ScanSource, Inc. Form 10-Q Summary
Reporting period: Quarter and nine months ended March 31, 2014. The supplied metadata labels this as “2013 Q3,” but the filing is for the third quarter of fiscal 2014. ScanSource is an international wholesale distributor of specialty technology products serving approximately 250 manufacturers and 28,000 resellers across North America, Latin America, Europe, and Canada.
Financial Performance and Position
| Metric | Q3 FY2014 | Q3 FY2013 | Change |
|---|---|---|---|
| Net sales | $683.0 million | $683.0 million | Flat |
| Gross profit | $73.4 million | $68.8 million | +6.6% |
| Gross margin | 10.7% | 10.1% | +60 basis points |
| Operating income | $25.7 million | $20.8 million | +23.4% |
| Operating margin | 3.8% | 3.0% | +80 basis points |
| Net income | $16.9 million | $14.0 million | +21.3% |
| Diluted EPS | $0.59 | $0.50 | +18.0% |
For the nine months ended March 31, 2014, sales were $2.156 billion versus $2.164 billion in the prior-year period, while gross profit increased to $227.1 million from $217.2 million. Operating income rose to $81.3 million from $71.4 million, and net income increased to $54.7 million from $48.0 million. Diluted EPS was $1.92 versus $1.72.
- Segment sales: Q3 Worldwide Barcode & Security sales increased 4.0% to $455.8 million; Worldwide Communications & Services sales declined 7.2% to $227.2 million.
- Segment operating income: Barcode & Security increased 32.7% to $13.8 million; Communications & Services increased 14.1% to $11.8 million.
- Cash flow: Operating cash flow for the nine months was $32.7 million, down from $76.0 million, primarily because of a $74.5 million inventory investment.
- Liquidity: Cash and cash equivalents were $183.6 million at March 31, 2014, compared with $148.2 million at June 30, 2013.
- Working capital: Net working capital increased to $694.5 million from $614.4 million at June 30, 2013. Inventory was $479.9 million, up from $402.3 million, while accounts receivable declined to $419.9 million from $435.0 million.
- Debt: Long-term debt was $5.4 million. The $300 million revolving credit facility and €6.0 million European line of credit had no outstanding borrowings at March 31, 2014. The revolving facility had $300 million available and was amended to extend maturity to November 6, 2018, with an accordion feature permitting availability up to $450 million subject to lender commitments.
- Cash conversion: DSO was 55 days, unchanged from the comparable periods. Third-quarter inventory turns declined to 5.1 from 5.4 in the prior-year quarter.
- ROIC: Annualized non-GAAP return on invested capital was 14.8%, compared with 13.3% in the prior-year quarter.
Material Changes Versus the Prior Comparable Period
- Sales were essentially unchanged in the quarter, but profitability improved substantially because of higher gross margins, favorable product mix, improved vendor program recognition, higher service fee income, and better European Communications margins.
- SG&A decreased $1.2 million in the quarter and $0.9 million year to date, partly because the prior-year periods included European restructuring, tax compliance, and higher bad debt-related costs.
- The Communications & Services segment experienced lower sales because of declines in Europe Communications and the Catalyst business unit, but its operating income improved due to margin expansion.
- Operating cash flow declined materially because inventory increased amid lower-than-expected sales. Capital expenditures increased to $6.8 million from $4.5 million, primarily for the new ERP system.
- The company’s contingent consideration liability related to the ScanSource Brasil acquisition was $10.7 million, including $5.7 million classified as current, compared with $12.5 million at June 30, 2013. A $1.0 million quarterly and $2.2 million year-to-date fair-value loss was recorded.
- The annual goodwill impairment testing date was voluntarily changed from June 30 to April 30. The company planned to complete the fiscal 2014 test in the fourth quarter and reported no current expectation of impairment based on projected results.
Guidance, Outlook, Risks, and Unusual Items
- Management expects fiscal 2014 capital spending of $11 million to $14 million, primarily related to implementation of a new SAP ERP system.
- Management believes cash, operating cash flow, and available credit capacity will provide sufficient liquidity for working-capital and other cash requirements for at least the next twelve months.
- Strategic priorities include growing profitable sales in security and communications technologies, evaluating acquisitions, and expanding product and geographic coverage.
- Competition remains a risk through pricing, credit terms, service levels, product availability, and shifts from closed to open distribution models.
- Venezuela presents heightened collectability risk because government controls have limited customers’ access to U.S. dollars. The company held $1.9 million of Venezuelan accounts receivable at March 31, 2014, fully reserved.
- International operations expose the company to foreign-currency volatility. Foreign-currency forward contracts had $62.5 million of notional amounts outstanding and a net fair-value payable of less than $0.1 million.
- Brazilian contingent consideration is denominated in Brazilian reais and may fluctuate with operating performance and foreign exchange rates. Future undiscounted payments were estimated to be up to $13.2 million.
- The company is pursuing litigation against former ERP integration partner Avanade; the parties agreed to a court-approved stay to explore a settlement. Management stated that known lawsuits are not expected to have a material adverse effect.
- Zebra Technologies announced its intention to purchase much of Motorola Solutions’ enterprise business. Both companies are key vendors in ScanSource’s barcode business, creating a vendor-concentration and transaction-related item to monitor.
- The effective tax rate was 34.8% for the quarter and 33.5% for the nine-month period. A $0.1 million discrete tax expense was recorded in the quarter, while a $0.7 million discrete tax benefit was recorded in the September 2013 quarter.
Important Facts for Investors to Verify
- Confirm that the filing period is March 31, 2014, rather than 2013, and reconcile quarterly versus nine-month results.
- Monitor inventory growth, inventory turns, and operating cash flow, particularly as ERP-related spending continues.
- Assess whether Communications & Services sales declines and European competitive pressures persist despite improved margins.
- Review the April 30, 2014 goodwill impairment test and the carrying values of at-risk reporting units.
- Track Venezuelan receivables, Brazilian contingent consideration, foreign-exchange exposure, and related fair-value adjustments.
- Review the outcome and potential costs of the Avanade ERP litigation and the progress and total cost of the replacement ERP implementation.
- Verify continued compliance with credit-facility covenants and the availability of the $300 million revolving facility.
- Evaluate the potential effect of the Zebra Technologies and Motorola Solutions transaction on vendor relationships, product availability, and competitive positioning.