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. Operations are reported in North American and International distribution segments. This filing covers the quarter and nine months ended March 31, 2011, the company’s fiscal third quarter, with comparisons to the corresponding 2010 periods.
Key financial metrics
| Metric | Quarter ended March 31, 2011 | Quarter ended March 31, 2010 | Nine months ended March 31, 2011 | Nine months ended March 31, 2010 |
|---|---|---|---|---|
| Net sales | $613.5 million | $496.1 million | $1.932 billion | $1.533 billion |
| Gross profit | $65.8 million | $54.4 million | $199.9 million | $162.1 million |
| Gross margin | 10.7% | 11.0% | 10.4% | 10.6% |
| Operating income | $25.5 million | $19.0 million | $83.9 million | $54.8 million |
| Operating margin | 4.2% | 3.8% | 4.3% | 3.6% |
| Net income | $16.5 million | $12.0 million | $53.9 million | $34.8 million |
| Diluted EPS | $0.60 | $0.45 | $1.98 | $1.30 |
- Quarterly sales increased 23.7%; nine-month sales increased 26.0%.
- Quarterly operating income increased 34.3%; nine-month operating income increased 53.1%.
- Quarterly net income increased 37.6%; nine-month net income increased 54.9%.
- Quarterly effective tax rate was 34.0%, compared with 36.5% in the prior-year quarter; the nine-month rate was 35.2%, compared with 36.5%.
- Annualized return on invested capital increased to 18.2% from 16.8% under the company’s revised calculation method.
Liquidity, cash flow, and debt
- Cash and cash equivalents were $31.2 million at March 31, 2011, versus $34.6 million at June 30, 2010.
- Working capital increased to $507.2 million from $437.0 million, primarily because of higher receivables and inventory.
- Cash used in operating activities was $1.5 million for the nine months, compared with $84.8 million used in the prior-year period.
- Capital expenditures were $10.2 million, compared with $3.7 million in the prior-year period; no acquisition cash payments occurred during the nine months.
- Total debt and borrowings at March 31, 2011 included $30.4 million of long-term debt, $2.1 million drawn on the domestic revolving facility, and $2.0 million drawn on the European facility.
- The $250 million domestic revolving facility had $247.9 million available, and the company was in compliance with its covenants.
- Management stated that available cash, operating cash flow, and credit facilities should provide sufficient liquidity for at least the next twelve months.
Material changes versus the prior comparable period
- North American sales increased 22.4% for the quarter and 23.0% for the nine months. International sales increased 27.7% and 37.1%, respectively.
- International sales growth was reduced by unfavorable foreign exchange effects of $1.1 million for the quarter and $23.9 million for the nine months. Excluding foreign exchange, international growth was 28.7% and 44.4%.
- North American quarterly gross margin declined to 10.5% from 10.8%, primarily because of product mix and larger lower-margin deals. International quarterly gross margin was unchanged at 11.4%; year-to-date international margin declined to 10.9% from 11.5% because of competitive pricing and unusually high prior-year vendor program attainment.
- Operating expenses included a $2.4 million charge for funding the Founder’s Supplemental Executive Retirement Plan. The prior-year comparison also benefited from a $3.1 million legal settlement recovery recorded in the second quarter of fiscal 2011.
- Inventory increased to $401.2 million from $346.6 million. Inventory turnover declined to 5.5 times from 5.7 times, while days sales outstanding improved to 56 days from 59 days in the prior-year quarter.
Outlook, commentary, risks, and unusual items
- Management attributed growth to stronger demand, an improving global economy, increased end-user demand, product-line expansion, and market-share gains.
- The company continues to invest in Latin America and Europe while accepting temporarily lower returns in certain operations to gain market share and customers.
- A standardized global ERP implementation is expected to transition through fiscal 2012 and 2013. Approximately $14.1 million had been spent through March 31, 2011; expected remaining cash costs were $4 million to $5 million in fiscal 2011, $8 million to $14 million in fiscal 2012, and approximately $5 million in fiscal 2013. Total project expense is expected to be $31 million to $38 million.
- On April 15, 2011, after the reporting date, the company acquired CDC Brasil for an estimated total consideration of approximately $65.5 million, including an initial payment of approximately $36.6 million, assumed working-capital debt, and contingent annual payments through June 30, 2015. Funding is expected from cash and the revolving facility.
- The April 2011 acquisition led to an amendment and waiver of the domestic credit agreement and introduces additional Brazil-related political, economic, regulatory, tax, labor, currency, compliance, and integration risks.
- Foreign currency exposure remains material. Forward contracts had notional amounts of $102.9 million at March 31, 2011, and generated a net foreign exchange loss of $0.4 million in the quarter. A 100-basis-point interest-rate change would have affected quarterly pretax income by less than $0.1 million.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Pending litigation was not expected to have a material adverse effect based on information available to management.
Important facts for investors to verify
- Confirm the final purchase accounting, contingent consideration, financing, and operating contribution of CDC Brasil, which were not complete when the filing was submitted.
- Monitor integration costs, implementation timing, and cash requirements for the global ERP program.
- Assess whether sales growth can continue without further pressure on gross margins, particularly in North America and International distribution.
- Evaluate working-capital intensity, inventory turnover, operating cash flow, and reliance on revolving borrowings as sales expand.
- Review exposure to foreign exchange movements, variable interest rates, derivative effectiveness, and the company’s ability to maintain credit-facility covenants.
- Consider the effects of the $2.4 million Founder’s SERP charge and the prior-year $3.1 million legal settlement recovery when assessing normalized earnings.