ScanSource, Inc. Form 10-Q Summary
Business Context and Reporting Period
ScanSource, Inc. is a wholesale distributor of specialty technology products, including automatic identification and data capture, point-of-sale, communications, security and wireless infrastructure products. It reports North American and International distribution segments, serving resellers in North America, Latin America and Europe.
The filing covers the quarter and six months ended December 31, 2011, compared with the corresponding 2010 periods. The statements are unaudited. ScanSource completed its acquisition of CDC Brasil on April 15, 2011; CDC contributed to the international segment during the current periods.
Financial Highlights
| Metric | Quarter Ended December 31, 2011 | Quarter Ended December 31, 2010 | Six Months Ended December 31, 2011 | Six Months Ended December 31, 2010 |
|---|---|---|---|---|
| Net sales | $782.7 million | $683.6 million | $1.553 billion | $1.318 billion |
| Gross profit | $79.8 million | $70.6 million | $158.9 million | $134.1 million |
| Gross margin | 10.2% | 10.3% | 10.2% | 10.2% |
| Operating income | $32.1 million | $33.5 million | $63.7 million | $58.4 million |
| Operating margin | 4.1% | 4.9% | 4.1% | 4.4% |
| Net income | $21.4 million | $21.6 million | $39.7 million | $37.3 million |
| Diluted EPS | $0.77 | $0.80 | $1.44 | $1.38 |
- Quarterly sales increased 14.5%; six-month sales increased 17.8%.
- North American sales rose 7.7% for the quarter and 11.7% year to date. International sales rose 36.7% and 38.4%, respectively, primarily because of CDC and stronger European AIDC and POS sales.
- Quarterly net income declined 1.2%, while six-month net income increased 6.5%.
- The effective tax rate was 34.7% for the quarter and 34.6% year to date, compared with 35.7% in the prior-year periods.
- Annualized return on invested capital declined to 19.8% from 25.0%, primarily because of higher borrowings, the CDC acquisition and prefunding of CDC earnout obligations.
Cash Flow, Liquidity and Capital Structure
- Cash used in operating activities was $22.7 million for the six months ended December 31, 2011, compared with $33.1 million used in the prior-year period.
- Capital expenditures were $5.5 million, primarily related to the global enterprise resource planning implementation.
- Cash and cash equivalents were $42.6 million at December 31, 2011, versus $28.7 million at June 30, 2011. Approximately $35.4 million was held outside the United States.
- Working capital increased to $599.8 million from $532.2 million, reflecting higher receivables, inventory and cash supporting sales growth.
- Accounts receivable were $491.6 million and inventories were $516.7 million at December 31, 2011. Management reported inventory at the high end of its target range; inventory turnover declined to 5.6 times from 6.7 times in the prior-year quarter.
- Borrowings under the domestic revolving credit facility were $95.0 million, with $205.0 million available. The facility was amended and expanded on October 11, 2011 to a five-year, $300 million senior secured facility with a potential $150 million accordion feature.
- European short-term borrowings were $0.7 million. Long-term debt was $5.4 million, consisting primarily of an industrial development revenue bond. The former $25 million unsecured note was repaid in October 2011.
- The Company was in compliance with applicable credit facility and bond covenants at December 31, 2011.
Material Changes Versus Prior Comparable Period
- Sales growth was strong, but quarterly operating income and net income declined because of higher SG&A costs, increased international investment and the absence of a $3.1 million legal recovery recognized in the prior-year quarter.
- SG&A increased 30.7% for the quarter and 25.5% year to date, driven by CDC-related costs, higher compensation and continued investment in Europe.
- North American quarterly operating income declined 8.6%, while international quarterly operating income increased 25.4%. Six-month North American operating income increased 10.5%; international operating income was essentially flat.
- Gross margin was broadly stable overall. North American quarterly gross margin declined to 10.1% from 10.3%, while international year-to-date gross margin improved to 10.8% from 10.6%.
- Foreign exchange produced a $3.3 million net loss for the six months, compared with a $0.3 million loss in the prior-year period. This included a $2.5 million non-recurring loss on a Brazilian real forward contract.
- Debt usage increased materially to fund working capital, inventory, international growth and CDC-related payments. Average funded debt increased to $109.3 million from $38.2 million for the comparable quarter calculation.
Guidance, Outlook, Risks and Unusual Items
- Management expects existing cash, operating cash flow and credit facilities to provide sufficient liquidity for at least the next twelve months; no formal revenue or earnings guidance is provided in the filing.
- Management expects inventory levels to decline during the March quarter as purchases are aligned more closely with forecasts, while balancing the risk of lost sales opportunities.
- The global ERP project may begin phased implementation in 2012 and continue through 2013. Cash flow impact is expected to be $5 million to $9 million in 2012 and approximately $5 million in 2013; total project expense is estimated at $34.5 million to $38.5 million.
- CDC purchase accounting remains provisional. Valuations of intangible assets, goodwill, contingent consideration and pre-acquisition tax contingencies may change during the measurement period and could affect comparative statements, goodwill or current-period earnings.
- CDC contingent consideration had a fair value of $20.0 million at December 31, 2011, including $6.7 million classified as current. Future undiscounted earnout payments were estimated to range from $1.9 million to $30.7 million and are exposed to Brazilian real fluctuations. The first $1.9 million payment was made in January 2012.
- Pre-acquisition CDC contingencies had an estimated undiscounted amount as high as $13.5 million. A $5.1 million import-duty penalty was paid from sellers’ escrow and did not affect the income statement.
- Competition, pricing pressure, vendor program changes, inventory obsolescence, longer product lead times, foreign currency volatility, variable interest rates and international execution are significant operating risks.
- Foreign currency forward contracts had aggregate notional amounts of $72.5 million at December 31, 2011. The Company does not use derivatives for speculative purposes, but records undesignated currency contracts through earnings.
- Management concluded that disclosure controls and procedures were effective as of December 31, 2011, with no material change in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether CDC’s final purchase accounting materially changes goodwill, intangible assets, tax contingencies or reported earnings.
- The amount and timing of remaining CDC earnout payments and the impact of Brazilian real exchange rates.
- Whether elevated inventory converts into sales without margin erosion, write-downs or slower cash conversion.
- Revolving-credit utilization, covenant compliance, interest costs and available borrowing capacity as working-capital needs evolve.
- Progress, costs and operational disruption associated with the ERP implementation.
- Whether international growth and CDC synergies offset continued investment costs and lower returns in Europe and other markets.
- The effect of foreign exchange movements, including any additional non-recurring losses or gains.