Business Context and Reporting Period
Company: Scan Source, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: A leading wholesale distributor of specialty technology products (AIDC, POS, communications, security) serving North America and International markets (Latin America and Europe). The company operates two geographic segments: North American Distribution and International Distribution.
Key Financial Metrics
| Metric | Q1 FY2010 (Sep 30, 2009) | Q1 FY2009 (Sep 30, 2008) |
|---|---|---|
| Net Sales | $488.4 million | $539.8 million |
| Gross Profit | $51.4 million (10.5% margin) | $55.5 million (10.3% margin) |
| Operating Income | $17.7 million (3.6% margin) | $20.6 million (3.8% margin) |
| Net Income | $10.9 million | $12.4 million |
| Diluted EPS | $0.41 | $0.47 |
| Cash and Equivalents | $87.8 million | $16.2 million |
| Long-Term Debt | $30.4 million | $30.4 million |
| Working Capital | $414.2 million | $399.6 million (Jun 30, 2009) |
Cash Flow: Net cash used in operating activities was $40.1 million, a significant swing from $31.0 million provided in the prior year quarter, driven by increased receivables and inventory.
Material Changes vs. Prior Period
- Revenue Decline: Consolidated net sales decreased 9.5% year-over-year due to weaker end-user demand and macro-economic challenges. North American sales fell 10.7%, while International sales declined 3.8% (less than 1% on a constant currency basis).
- Profitability: Operating income decreased 14.3% to $17.7 million. While gross margin percentage improved slightly to 10.5%, operating expenses as a percentage of sales increased to 6.9% (from 6.5%) primarily due to a $1.5 million increase in bad debt expense.
- Liquidity Position: Cash balances decreased from $127.7 million at June 30, 2009, to $87.8 million at September 30, 2009. This reduction was driven by operating cash outflows to fund higher inventory and receivables balances, as well as accelerated vendor payments to capture early payment discounts.
- Segment Performance: North American operating income dropped 15.8%, while International operating income declined 5.1%.
Outlook, Risks, and Unusual Items
- Debt Covenant Waivers: The company identified non-compliance with specific intercompany loan covenants within its revolving credit facility, promissory note, and industrial development revenue bond agreements dating back to June 30, 2008. These were technical misunderstandings. Waivers were obtained in November 2009 to cure these violations retroactively.
- Acquisition Activity: On November 3, 2009, the company entered into a definitive agreement to acquire Algol Europe, GmbH, a German-based distributor, to expand its international communications business.
- Market Risks: The company faces exposure to foreign currency exchange rates (Euro, British Pound, Mexican Peso) and interest rate fluctuations. It utilizes forward contracts and an interest rate swap (fair value liability of $1.2 million) to manage these risks.
- Management Commentary: Management noted that while year-over-year sales were down, sequential momentum improved from the previous quarter. The company is aggressively pursuing market share through competitive pricing, which has pressured gross margins in certain product lines.
Investor Verification Checklist
- Covenant Compliance: Verify the status of the debt covenant waivers obtained in November 2009 and ensure no further defaults have occurred.
- Bad Debt Exposure: Review the $1.5 million increase in bad debt expense and the adequacy of the allowance for doubtful accounts given the economic environment.
- Working Capital Trends: Monitor the Days Sales Outstanding (DSO) and inventory turnover ratios to ensure the $40 million cash outflow for working capital is sustainable.
- Acquisition Integration: Assess the financial impact and integration progress of the Algol Europe, GmbH acquisition announced in November 2009.
- Sequential Growth: Confirm if the sequential sales growth mentioned by management continues into the next quarter despite the year-over-year decline.