Business Context and Reporting Period
Company: Scan Source, Inc.
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended June 30, 2010
Business Overview: Scan Source is a leading wholesale distributor of specialty technology products, including automatic identification and data capture (AIDC), point-of-sale (POS), communications, and security products. The company operates through two geographic segments: North America (served from Southaven, Mississippi) and International (serving Latin America and Europe from facilities in Florida, Mexico, Belgium, and Germany). The company serves over 20,000 reseller customers with products from approximately 200 vendors.
Key Financial Metrics
| Metric | Fiscal 2010 | Fiscal 2009 |
|---|---|---|
| Net Sales | $2,114,979,000 | $1,847,969,000 |
| Gross Profit | $218,927,000 | $208,848,000 |
| Gross Margin | 10.4% | 11.3% |
| Operating Income | $75,776,000 | $74,118,000 |
| Net Income | $48,812,000 | $47,688,000 |
| Diluted EPS | $1.82 | $1.79 |
| Working Capital | $436,953,000 | $399,647,000 |
| Cash and Cash Equivalents | $34,605,000 | $127,664,000 |
| Total Long-Term Debt | $30,429,000 | $30,429,000 |
| Return on Invested Capital (ROIC) | 16.7% | 17.7% |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 14.4% to $2.11 billion, driven by a 11.1% increase in North American sales and a 29.1% increase in International sales. The International growth was bolstered by the acquisition of Algol Europe, GmbH in November 2009 and stronger end-user demand in Europe and Latin America.
- Margin Compression: Gross margin decreased to 10.4% from 11.3%. North American margins declined due to a less favorable product mix and higher margin dilution from larger deals. International margins dropped significantly (from 15.2% to 11.4%) due to the absence of strategic inventory purchases made in the prior year to anticipate vendor price increases.
- Operating Expenses: Operating expenses increased 6.3% to $143.2 million, primarily due to higher bad debt expense and approximately $4.1 million in incremental costs related to the Algol Europe acquisition. However, operating expenses as a percentage of sales decreased to 6.8% from 7.3%.
- Cash Flow: Cash used in operating activities was $78.2 million, a reversal from the $143.3 million provided by operations in the prior year. This was driven by increased receivables and inventory balances to support higher demand.
- Acquisition: The company acquired Algol Europe, GmbH for approximately $10.0 million in cash, expanding its footprint in the European communications market.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management expects continued growth driven by improved economic conditions and the integration of the Algol Europe acquisition. The company focuses on operating income and Return on Invested Capital (ROIC) as key performance metrics.
- Risks:
- Economic Instability: Global economic conditions and credit market disruptions could reduce IT spending and impact the ability of resellers to pay.
- Vendor Concentration: Two vendors, Motorola and Avaya, each constitute more than 10% of net sales. Changes in their terms or availability could materially impact results.
- Inventory Risk: The company faces risks of inventory obsolescence and price reductions, though vendor agreements provide some stock rotation and price protection.
- Foreign Currency: International operations expose the company to exchange rate fluctuations, particularly involving the Euro, British Pound, and Mexican Peso.
- Unusual Items:
- Bad Debt: Operating expenses increased due to bad debt expense recognized primarily from a single customer.
- Legal Settlement: In the prior fiscal year (2009), the company recorded a $3.5 million recovery from a legal settlement against a former service provider, recorded as other income.
Investor Verification Checklist
- Vendor Concentration: Verify the stability of relationships with Motorola and Avaya, which together account for over 20% of sales.
- Inventory Valuation: Review inventory reserves and the adequacy of price protection agreements given the technology sector's rapid obsolescence.
- Bad Debt Exposure: Assess the creditworthiness of the customer base, particularly given the noted increase in bad debt expense from a single customer.
- International Margins: Monitor the sustainability of International segment margins, which were artificially inflated in the prior year by opportunistic inventory purchases.
- Cash Conversion: Evaluate the impact of increased working capital requirements (receivables and inventory) on future cash flow generation.