ScanSource, Inc. — Fiscal 2011 Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2011; filed August 29, 2011. The supplied metadata references “2010 Q4,” but the filing is an annual report covering fiscal 2011, with fiscal 2010 as the primary comparable period.
Business Context
ScanSource is a wholesale distributor of specialty technology products, including automatic identification and data capture, point-of-sale, communications, video, security and wireless infrastructure products. It operates through North American and international distribution segments and serves more than 30,000 reseller customers with products from approximately 220 vendors.
- North American distribution revenue was $2.023 billion, up 21.4%.
- International distribution revenue was $643.9 million, up 43.4%, including the impact of the April 2011 acquisition of CDC Brasil.
- CDC Brasil contributed $29.6 million of revenue and $0.7 million of net income from April 15 through June 30, 2011.
Financial Performance and Position
| Metric | Fiscal 2011 | Fiscal 2010 | Change |
|---|---|---|---|
| Net sales | $2.667 billion | $2.115 billion | +26.1% |
| Gross profit | $274.3 million | $218.9 million | +25.3% |
| Gross margin | 10.3% | 10.4% | Down 10 basis points |
| Operating income | $113.1 million | $75.8 million | +49.3% |
| Operating margin | 4.2% | 3.6% | Up 60 basis points |
| Net income | $73.5 million | $48.8 million | +50.6% |
| Diluted EPS | $2.70 | $1.82 | +48.4% |
| Cash provided by operating activities | $10.7 million | $(78.2) million | Improved by $88.9 million |
| Cash and equivalents | $28.7 million | $34.6 million | Down $5.9 million |
| Working capital | $532.2 million | $437.0 million | Up $95.2 million |
POS, barcoding and security sales increased 24.2% to $1.615 billion, while communications sales increased 29.1% to $1.051 billion. SG&A increased 12.6% to $161.2 million, but declined to 6.0% of sales from 6.8% due to operating leverage. Return on invested capital increased to 20.6% from 16.7%.
Accounts receivable were $462.1 million and inventories were $467.4 million at June 30, 2011. Days sales outstanding increased to 57 days from 55 days, and inventory turns declined to 6.1 from 6.4.
Debt and Liquidity
- Total debt, including current and long-term amounts, was $60.1 million; the balance sheet also included $23.8 million of CDC contingent consideration.
- The $250 million revolving credit facility had $26.5 million outstanding and $223.5 million available at June 30, 2011. The facility matures September 28, 2012 and includes a $50 million accordion feature.
- Other debt included a $25.0 million unsecured note and a $5.4 million industrial development revenue bond.
- Cash used in investing activities was $51.1 million, including $36.2 million for CDC and $14.9 million of capital expenditures.
- Cash provided by financing activities was $33.7 million, principally reflecting revolving-credit borrowings and stock-option exercises.
- Management stated that existing cash, operating cash flow and available borrowing capacity should fund working capital and other requirements for at least the next twelve months.
Material Changes and Unusual Items
- ScanSource acquired CDC Brasil for an initial cash payment of $36.2 million, plus earn-out payments based on performance through 2015. The preliminary fair value of the earn-out liability was $23.8 million at year-end, with total future undiscounted payments estimated at up to $52.1 million.
- Changes in the CDC earn-out liability are recorded through SG&A and may create earnings volatility; the fiscal 2011 remeasurement produced $0.2 million of income.
- SG&A included a $2.4 million contribution to the Founder’s supplemental executive retirement plan and approximately $1.1 million of CDC acquisition-related costs. These effects were partly offset by a $3.1 million legal settlement recovery.
- The company spent approximately $18.5 million on a global ERP implementation through June 30, 2011. Expected cash outlays were $8 million to $15 million in fiscal 2012 and $4 million to $5 million in fiscal 2013, with total project expense expected at $30.5 million to $38.5 million.
- European warehouse operations were consolidated in Belgium after year-end, while the German lease continued.
- The company does not pay cash dividends, and its credit facility restricts dividend payments.
Outlook, Risks and Contingencies
Management expected to transition certain business units to the new ERP system during fiscal 2012 and continue implementation through fiscal 2013. It also intended to integrate CDC and continue expanding in Latin America and Europe, while acknowledging that some geographies and business units were accepting lower-than-normal returns to build market share. The filing does not provide specific fiscal 2012 revenue or earnings guidance.
- Key risks include intense competition, narrow margins, vendor concentration, product shortages, inventory obsolescence and reduced vendor rebates or price protection.
- International operations expose the company to foreign exchange, political, regulatory, tax, labor and collection risks, particularly in Brazil.
- The CDC acquisition carries potential Brazilian tax and indemnification exposure. Indemnification assets and related contingent liabilities were estimated within a range of $5.1 million to $22.9 million.
- The company relies on centralized warehouses, information systems and third-party freight carriers; outages or ERP implementation problems could disrupt operations.
- Customer credit risk remains material. The allowance for receivables increased to $26.6 million from $21.9 million.
- Foreign currency forward contracts had $76.8 million of notional exposure at year-end. The company reported a $1.0 million net foreign exchange loss for fiscal 2011.
- The company reported no material adverse legal proceedings based on information known at filing. Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting; CDC was excluded from management’s internal-control assessment because it was acquired during the year.
Investor Verification Priorities
- Verify the final purchase-price allocation, goodwill, intangible assets and earn-out liability for CDC Brasil.
- Monitor CDC earn-out remeasurements, Brazilian tax and indemnification matters, and related cash payments through 2015.
- Assess ERP implementation costs, timing, capitalization and potential operational disruption.
- Review working-capital growth, receivable aging, inventory turns and the adequacy of credit and inventory reserves.
- Track revolving-credit utilization, covenant compliance and the September 2012 debt maturity profile.
- Evaluate the sustainability of growth and operating leverage given modest gross-margin pressure and significant vendor, currency and competitive risks.