ScanSource, Inc. Form 10-Q Summary
Business context and reporting period
ScanSource is an international wholesale distributor of specialty technology products serving approximately 250 manufacturers and 28,000 resellers across POS, barcode, security, communications and related services markets. The filing covers the quarter ended September 30, 2013, the first quarter of fiscal 2014, with comparison to the quarter ended September 30, 2012.
During the fourth quarter of fiscal 2013, the Company reorganized its reporting structure from geographic segments to technology-focused segments: Worldwide Barcode & Security and Worldwide Communications & Services. Prior-period segment information was retrospectively reclassified.
Key financial metrics
| Metric | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Net sales | $731.9 million | $733.6 million | (0.2%) |
| Gross profit | $76.5 million | $74.0 million | +3.3% |
| Gross margin | 10.5% | 10.1% | +0.4 percentage points |
| Operating income | $28.2 million | $26.2 million | +7.7% |
| Operating margin | 3.9% | 3.6% | +0.3 percentage points |
| Net income | $19.4 million | $17.6 million | +10.2% |
| Diluted EPS | $0.69 | $0.63 | +6 cents |
| Cash flow from operations | $45.7 million | $2.4 million | +$43.3 million |
Communications & Services sales increased 1.4% to $281.3 million, while Barcode & Security sales declined 1.2% to $450.6 million. North American sales increased 2.3%; international sales declined 7.6%.
Communications & Services operating income rose 19.7% to $16.3 million, supported by improved vendor programs and lower inventory reserve expense. Barcode & Security operating income declined 5.3% to $12.0 million due to lower revenue and higher bad-debt expense.
At September 30, 2013, cash and cash equivalents were $193.8 million, compared with $148.2 million at June 30, 2013. Accounts receivable were $443.3 million and inventories were $433.1 million. Total assets were $1.25 billion.
Total debt consisted primarily of a $5.4 million variable-rate industrial development revenue bond. There were no borrowings under the $300 million revolving credit facility or the €6.0 million European line of credit. The revolving facility had $300 million available, no outstanding letters of credit, and all applicable covenants were satisfied.
Operating cash flow benefited principally from the timing of vendor payments, including a $53.7 million increase in accounts payable. Capital expenditures were $0.2 million during the quarter. Annualized return on invested capital was 16.9%, compared with 17.0% in the prior-year quarter.
Material changes versus the prior comparable period
- Revenue was broadly flat overall, with growth in Communications & Services offset by lower Barcode & Security and international sales.
- Gross margin improved from 10.1% to 10.5%, primarily because of stronger Communications & Services margins.
- SG&A increased 1.0% to $47.5 million, including higher bad-debt expense in European operations and North American POS and Barcode.
- Net income benefited from a $0.7 million discrete tax benefit related to a change in the effective state tax rate. Excluding this item, the current-quarter effective tax rate would have been approximately 34.2%, versus 34.0% in the prior-year quarter.
- Cash flow from operations increased substantially, mainly because of the timing of vendor payments; management cautions that working-capital cash flow varies with sales volume, collections, inventory and payment timing.
- The Company paid $3.6 million of contingent consideration related to the CDC acquisition. The remaining contingent consideration liability was $9.5 million at September 30, 2013, including $5.5 million classified as current.
Guidance, outlook, risks and unusual items
Management expects fiscal 2014 capital expenditures of approximately $3 million to $5 million and believes cash on hand, operating cash flow and available credit will provide sufficient liquidity for at least the next twelve months. The filing does not provide formal revenue or earnings guidance.
- Management continues to emphasize growth in security and communications technologies and is evaluating strategic acquisitions.
- Competitive pressure may affect pricing, credit terms, service levels, product availability, market share and reseller purchasing models.
- Venezuelan resellers have difficulty obtaining U.S. dollars because of government currency controls. The Company held $2.2 million of Venezuelan receivables at September 30, 2013, fully reserved.
- International operations expose the Company to foreign-exchange risk. Foreign-currency forward contracts had aggregate notional amounts of $74.6 million and a net fair value payable of less than $0.1 million.
- Goodwill impairment risk remains relevant for certain international reporting units. Management reported no indication of an additional impairment at September 30, 2013, but adverse operating results or revised forecasts could trigger future impairment.
- The Company faces contingent tax exposures related to the CDC acquisition, supported by corresponding indemnification receivables. Future earnout payments could reach up to $12.9 million on an undiscounted basis, subject to results and foreign-exchange movements.
- ScanSource’s subsidiary Partner Services amended its lawsuit against Avanade concerning an ERP implementation and is seeking damages; Avanade asserted counterclaims. The ultimate outcome is uncertain.
- Management concluded that disclosure controls and procedures were effective as of September 30, 2013, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Communications & Services growth and margin gains can offset continuing weakness and competitive pressure in Barcode & Security and international markets.
- The sustainability of the quarter’s $45.7 million operating cash inflow, particularly given its dependence on vendor-payment timing.
- Venezuelan receivable exposure, international credit risk, and foreign-currency effects on earnings and contingent consideration.
- Potential future goodwill impairments in European and Latin American reporting units.
- The timing and final amount of CDC earnout payments and related Brazilian tax indemnification matters.
- The status and potential financial impact of the Avanade litigation and any other legal proceedings.
- The effect of the $0.7 million discrete tax benefit when assessing normalized earnings and the full-year effective tax rate.