ScanSource, Inc. — Fiscal 2011 First-Quarter 10-Q Summary
Business Context and Reporting Period
ScanSource 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. This unaudited Form 10-Q covers the quarter ended September 30, 2011, compared with the quarter ended September 30, 2010; balance-sheet comparisons are with June 30, 2011.
The quarter represents the first full quarter including CDC Brasil, acquired on April 15, 2011, which expanded ScanSource’s presence in Brazil and contributed materially to international sales.
Financial Performance and Key Metrics
| Metric | Q1 FY2011 | Q1 FY2010 | Change |
|---|---|---|---|
| Net sales | $770.3 million | $634.5 million | +21.4% |
| Gross profit | $79.1 million | $63.5 million | +24.6% |
| Gross margin | 10.3% | 10.0% | +30 basis points |
| Operating income | $31.6 million | $24.8 million | +27.3% |
| Operating margin | 4.1% | 3.9% | +20 basis points |
| Net income | $18.4 million | $15.7 million | +17.0% |
| Diluted EPS | $0.67 | $0.58 | +15.5% |
| EBITDA | $31.1 million | $26.3 million | +18.4% |
| Annualized ROIC | 18.2% | 19.5% | Down 130 basis points |
North American sales increased 16.0% to $573.5 million, while international sales increased 40.4% to $196.8 million. International growth primarily reflected CDC Brasil and a $10.5 million favorable foreign-exchange effect from the euro. Europe experienced some local-currency pressure related to the Eurozone debt crisis.
North American operating income increased 32.6% to $28.4 million, supported by higher volumes, favorable product mix, vendor incentives and lower costs on opportunistic purchases. International operating income declined 6.0% to $3.2 million because CDC-related expenses, including approximately $1.9 million of intangible-asset amortization and earnout-related charges, offset sales growth.
Cash and cash equivalents were $37.3 million at September 30, 2011, up from $28.7 million at June 30, 2011. Working capital was $563.2 million, compared with $532.2 million at June 30, 2011. Accounts receivable were $478.7 million and inventories were $481.3 million. DSO was 56 days, while inventory turnover declined to 5.8 times from 6.6 times in the prior-year quarter.
Net cash used in operating activities was $33.6 million, compared with $19.2 million used in the prior-year quarter. The operating cash outflow primarily reflected increased receivables and inventory needed to support higher sales and product lead times. Capital expenditures were $2.3 million, principally related to the ERP implementation.
Debt, Liquidity and Capital Resources
- Borrowings under the existing $250 million revolving credit facility totaled $69.5 million at September 30, 2011, compared with none at September 30, 2010; $180.5 million remained available.
- The European €6.0 million secured revolving facility had $4.1 million outstanding, compared with $3.2 million at June 30, 2011.
- Long-term debt totaled $30.4 million, consisting primarily of a $25.0 million unsecured note and a $5.4 million industrial development revenue bond.
- On October 11, 2011, after the reporting date, the Company replaced the existing facility with a five-year, $300 million senior secured multi-currency revolving facility, with a $150 million accordion feature permitting capacity of up to $450 million. Proceeds were used to repay the existing revolving borrowings and the $25 million promissory note.
- The Company was in compliance with applicable debt covenants at September 30, 2011 and stated that available liquidity should satisfy present and anticipated requirements for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Sales, gross profit, operating income and net income all increased, primarily because of higher North American volumes, market-share gains and the inclusion of CDC Brasil.
- Gross and operating margins improved modestly, but net margin declined to 2.4% from 2.5% because of higher foreign-exchange losses and other expenses.
- Foreign-exchange losses increased to $3.6 million from $0.4 million. This included a disclosed non-recurring $2.5 million loss on a forward contract used to fund Brazilian-real earnout obligations.
- Operating cash flow deteriorated as working-capital investment increased, and average funded debt rose to $86.8 million from $34.4 million.
- Accumulated other comprehensive income declined to a loss of $8.2 million from income of $3.6 million, primarily because of a $12.0 million unfavorable foreign-currency translation adjustment.
Guidance, Outlook, Commentary and Risks
No formal revenue or earnings guidance is provided. Management expects to continue pursuing profitable growth, expanding vendors and market share, investing in Latin America and selected European operations, and evaluating strategic acquisitions. Management expects the ERP rollout to begin in some business units as early as 2012 and continue through 2013.
ERP expenditures were expected to total $30.5 million to $38.5 million, including internal personnel and outside consultants. Additional cash-flow impact was estimated at $4.4 million to $11.4 million in fiscal 2012 and approximately $5 million in fiscal 2013.
- CDC purchase accounting remained preliminary. Valuations of identifiable intangibles, goodwill, contingent consideration and local tax contingencies could change during the ASC 805 measurement period.
- CDC contingent consideration had a fair value of $21.3 million at September 30, 2011. Future undiscounted payments could range from $2.1 million to $52.1 million, depending on CDC performance and foreign-exchange rates.
- The Company faces foreign-currency and floating-interest-rate exposure. Currency volatility, particularly involving the Brazilian real, adversely affected the quarter.
- Competition may pressure pricing, credit terms, service levels, product availability and market share. Management acknowledged that certain international operations are accepting lower-than-normal returns to build market share.
- Other risks include the Eurozone economic slowdown, inventory and supply-chain constraints, reliance on third-party logistics and warehousing providers, ERP implementation risk, cybersecurity breaches and potential tax contingencies.
Important Facts for Investors to Verify
- Whether CDC Brasil achieves the earnings targets underlying the contingent consideration and whether the preliminary purchase accounting changes.
- The effect of the October 11, 2011 refinancing on borrowing costs, covenants, available liquidity and future interest expense.
- Whether elevated receivables and inventory convert into operating cash flow without increased credit losses or inventory write-downs.
- The sustainability of North American margin expansion and whether international operating profitability improves after CDC integration.
- The magnitude and recurrence of foreign-exchange losses, particularly exposure to the Brazilian real and other non-functional currencies.
- Actual ERP implementation costs and timing compared with management’s stated estimates.