ScanSource, Inc. Form 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. The company reports North American and International distribution segments. This unaudited Form 10-Q covers the quarter ended September 30, 2012, the first quarter of fiscal 2013, compared with the quarter ended September 30, 2011.
Financial performance and liquidity
| Metric | Quarter ended September 30, 2012 | Quarter ended September 30, 2011 |
|---|---|---|
| Net sales | $733.6 million | $770.3 million |
| Gross profit | $74.0 million | $79.1 million |
| Gross margin | 10.1% | 10.3% |
| Operating income | $26.2 million | $31.6 million |
| Operating margin | 3.6% | 4.1% |
| Net income | $17.6 million | $18.4 million |
| Diluted earnings per share | $0.63 | $0.67 |
| Cash flow from operations | $2.4 million | $(33.6) million |
- North American sales declined 4.8% to $545.8 million, while International sales declined 4.6% to $187.8 million as reported.
- International sales increased 7.8% on a constant-currency basis; foreign currency translation reduced reported international sales by $24.4 million.
- North American operating income decreased 14.7% to $25.0 million. International operating income decreased 47.6% to $1.2 million.
- Cash and cash equivalents were $38.7 million at September 30, 2012, including $20.5 million held outside the United States.
- Accounts receivable were $468.7 million and inventories were $471.0 million. Days sales outstanding increased to 58 from 56 at both June 30, 2012 and September 30, 2011.
- Net working capital investment increased to $566.1 million from $533.5 million at June 30, 2012.
- Capital expenditures were $2.0 million. Annualized return on invested capital declined to 17.0% from 18.2%.
- Debt included $12.2 million outstanding under the $300 million revolving credit facility and a $5.4 million industrial development revenue bond. The European subsidiary’s €6.0 million credit line had no balance outstanding.
- The company had $287.8 million of available capacity under the revolving credit facility and reported compliance with its debt covenants.
Material changes versus the prior comparable period
- Revenue decreased 4.8%, primarily because of fewer large transactions, competitive pressures and the termination of the Juniper Networks distribution relationship.
- Gross profit declined 6.4%, and gross margin decreased 20 basis points. International gross margin fell to 10.2% from 11.3%, partly because of higher inventory reserve expense in the European communications business.
- SG&A increased 1.1% to $47.1 million despite favorable currency translation. The company incurred $2.3 million of non-capitalized ERP costs during the quarter.
- Operating income declined 17.1%, and diluted EPS declined from $0.67 to $0.63.
- Other income improved materially: net foreign exchange loss was $0.1 million versus $3.6 million in the prior-year quarter, which included a $2.5 million loss on a Brazilian real forward contract.
- Operating cash flow improved to $2.4 million from a use of $33.6 million, primarily reflecting working-capital movements and lower sales volumes.
- Comprehensive income increased to $20.8 million from $6.5 million, aided by a $3.1 million favorable foreign-currency translation adjustment compared with a $12.0 million unfavorable adjustment in the prior year.
- The company corrected the prior-year segment allocation disclosure: North American prior-year operating income was increased by $0.9 million and International operating income was reduced by $0.9 million. Management considered the correction immaterial.
Guidance, outlook, commentary, risks and unusual items
- Management said International results were weaker than expected because of continuing competitive pressures and volatility in certain markets, particularly parts of Europe, but intends to continue investing in the business.
- The company ended its Juniper Networks relationship as of September 30, 2012; Juniper sales declined significantly in the quarter.
- The ERP project had incurred approximately $35.8 million through September 30, 2012, of which $26.9 million was capitalized. Total project spending was projected at $58 million to $72 million and was expected to extend beyond fiscal 2013. Fiscal 2013 capital expenditures were projected at $9 million to $15 million, with total capital expenditures potentially reaching $41.9 million.
- Management expects existing cash, operating cash flow and available credit to provide sufficient liquidity for at least the next twelve months.
- The CDC Brasil contingent consideration liability was $17.3 million, including $9.8 million classified as current. The company estimated future undiscounted payments could reach $23.6 million; actual payments may vary with Brazilian real exchange rates and CDC earnings.
- A $0.8 million operating loss was recorded for the change in fair value of contingent consideration, primarily from recurring amortization of the unrecognized fair-value discount.
- Cash held by foreign operations is intended to be permanently reinvested abroad; repatriation to the United States could result in significant taxes.
- Key risks include competitive pricing and credit pressures, macroeconomic weakness in Europe and other international markets, foreign-currency volatility, variable interest rates, working-capital requirements, ERP execution and spending risk, customer credit risk, contingent CDC earnout obligations, and potential litigation or tax contingencies.
- The company’s disclosure controls and procedures were reported effective as of September 30, 2012, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Assess the sustainability of revenue and margin performance after the Juniper relationship ended and as large-deal activity fluctuates.
- Track International segment margins, bad-debt expense, inventory reserves and constant-currency growth.
- Monitor ERP spending, capitalization, implementation timing and the potential total cost of $58 million to $72 million.
- Reconcile cash generation with the company’s substantial receivable and inventory balances and rising net working-capital investment.
- Verify available revolving-credit capacity, covenant compliance and the effect of future borrowings on interest expense.
- Update the CDC contingent consideration liability and expected cash payments, including foreign-exchange effects.
- Consider the tax consequences and liquidity limitations associated with cash held outside the United States.
- Review the risk factors incorporated from the fiscal 2012 Form 10-K, as the filing states that additional unknown or currently immaterial risks may materially affect results.