Business Context and Reporting Period
ScanSource, Inc. filed an unaudited Form 10-Q for the quarter ended September 30, 2010, the first quarter of fiscal 2011. The company is a wholesale distributor of specialty technology products serving resellers in North America, Latin America, and Europe. It reports two segments: North American Distribution and International Distribution. The November 30, 2009 acquisition of Algol Europe contributed to international results.
Financial Performance and Position
| Metric | Q1 FY2011 | Q1 FY2010 | Change |
|---|---|---|---|
| Net sales | $634.5 million | $488.4 million | +29.9% |
| Gross profit | $63.5 million | $51.4 million | +23.5% |
| Gross margin | 10.0% | 10.5% | Down 50 basis points |
| Operating income | $24.8 million | $17.7 million | +40.5% |
| Operating margin | 3.9% | 3.6% | Up 30 basis points |
| Net income | $15.7 million | $10.9 million | +43.6% |
| Diluted EPS | $0.58 | $0.41 | +$0.17 |
| Net cash used in operating activities | $(19.2) million | $(40.1) million | Improved by $20.9 million |
North American net sales increased 24.5% to $494.3 million, while international net sales increased 53.7% to $140.2 million, or approximately 67.3% on a constant-currency basis. Annualized return on invested capital increased to 19.5% from 16.0%.
Cash and cash equivalents were $14.4 million at September 30, 2010, compared with $34.6 million at June 30, 2010. Working capital increased to $462.4 million from $437.0 million. Accounts receivable were $413.5 million and inventories were $345.3 million. Days sales outstanding increased to 59 days from 55 days at June 30, 2010, and inventory turnover was 6.6 times versus 7.2 times in the prior-year quarter.
Total debt was $30.4 million, consisting of a $25.0 million unsecured note and a $5.4 million industrial development revenue bond. There were no borrowings under the $250 million domestic revolving credit facility or the €6.0 million European facility. The company reported compliance with applicable debt covenants and $250 million of availability under the domestic facility.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected stronger demand across geographic segments, larger North American deals, fewer vendor supply-chain issues, improved international order-fill rates, and the Algol Europe acquisition.
- Gross profit increased, but segment gross margins declined: North America fell to 9.7% from 10.2%, and international margins fell to 10.9% from 12.0%, primarily due to product mix and pricing pressure.
- Operating expenses increased 14.5% to $38.6 million due primarily to higher headcount and Algol-related costs, partly offset by lower bad-debt expense. Operating expenses declined to 6.1% of sales from 6.9%.
- Net foreign exchange losses increased to $0.4 million from $0.2 million. The company had $66.7 million of foreign-currency derivative notional amounts and a net payable fair value of less than $0.2 million.
- Capital expenditures increased to $1.9 million from $0.1 million, primarily due to the company-wide enterprise resource planning system.
Guidance, Outlook, Risks, and Unusual Items
- Management stated that existing cash, operating cash flow, and available credit are expected to provide sufficient liquidity for at least the next twelve months.
- The ERP project had incurred approximately $6.2 million through September 30, 2010. Management expected fiscal 2011 spending of approximately $15 million to $17 million and fiscal 2012 spending of approximately $7 million to $15 million, financed through operating cash flow and the revolving facility.
- Key risks include foreign-exchange and interest-rate volatility, dependence on information systems, potential ERP cost overruns or implementation delays, business interruptions, cybersecurity or website disruptions, customer and vendor concentration exposure, and general economic conditions.
- The company had a $0.8 million liability for its interest-rate swap and recognized $0.2 million of net interest expense from the swap during the quarter.
- In October 2010, after quarter-end, the company settled a legal claim against a former service provider for a $3.1 million pretax recovery, to be recognized in the second quarter of fiscal 2011.
- The company disclosed approximately $2.3 million of gross unrecognized tax benefits and approximately $0.9 million of accrued interest and penalties. Management did not expect a significant change in unrecognized tax benefits within twelve months.
Important Facts for Investors to Verify
- Whether strong sales growth is sustained after separating organic growth, foreign-currency effects, and the Algol Europe acquisition.
- Whether lower gross margins continue as product mix and vendor pricing pressures evolve.
- Accounts receivable growth, days sales outstanding, inventory turnover, and the resulting effect on operating cash flow.
- Actual ERP implementation spending, timing, operational disruption, and realized efficiency benefits compared with management’s estimates.
- Availability and covenant compliance under the domestic and European credit facilities, particularly if working-capital needs increase.
- Exposure to foreign-exchange movements and the effectiveness of the company’s derivative and interest-rate hedging programs.
- The timing and reported impact of the $3.1 million legal settlement recovery in the second quarter of fiscal 2011.