Business Context and Reporting Period
ScanSource, Inc. is a wholesale distributor of specialty technology products serving resellers in North America, Latin America and Europe. The filing is an unaudited Form 10-Q for the quarter and nine months ended March 31, 2013, representing fiscal 2013 third-quarter results. Prior-period comparisons are the quarter and nine months ended March 31, 2012; balance-sheet comparisons are to June 30, 2012.
The company reports North American and International distribution segments. Products include automatic identification and data capture, point-of-sale, communications, security and wireless infrastructure equipment.
Financial Results and Liquidity
| Metric | Quarter Ended March 31, 2013 | Quarter Ended March 31, 2012 | Nine Months Ended March 31, 2013 | Nine Months Ended March 31, 2012 |
|---|---|---|---|---|
| Net sales | $683.0 million | $707.9 million | $2.164 billion | $2.261 billion |
| Gross profit | $68.8 million | $69.3 million | $217.2 million | $228.2 million |
| Gross margin | 10.1% | 9.8% | 10.0% | 10.1% |
| Operating income | $20.8 million | $21.5 million | $71.4 million | $85.2 million |
| Operating margin | 3.0% | 3.0% | 3.3% | 3.8% |
| Net income | $14.0 million | $14.8 million | $48.0 million | $54.5 million |
| Diluted earnings per share | $0.50 | $0.53 | $1.72 | $1.97 |
For the nine months, operating cash flow was $76.0 million, compared with $25.1 million in the prior-year period. Capital expenditures were $4.5 million, versus $10.2 million. Cash and cash equivalents totaled $93.9 million at March 31, 2013, compared with $29.2 million at June 30, 2012.
Total debt consisted primarily of a $5.4 million industrial development revenue bond. The company had no borrowings outstanding under its $300 million revolving credit facility and no outstanding balance under its European subsidiary’s €6.0 million line of credit. The revolving facility had $300 million available, excluding any standby letters of credit, and all debt covenants were satisfied.
Accounts receivable were $431.3 million and inventories were $407.1 million at March 31, 2013. The allowance for doubtful accounts was $31.0 million. Net working capital was $587.9 million, and days sales outstanding were 57 days.
Material Changes Versus the Prior Comparable Period
- Quarterly sales declined 3.5%; nine-month sales declined 4.3%. North American sales decreased 4.0% for the quarter and 3.8% for the nine months. International sales decreased 1.9% and 5.5%, respectively, although international nine-month sales increased 1% on a constant-currency basis.
- Gross margin improved in North America to 10.1% from 9.5% for the quarter, primarily due to product and customer mix and vendor-program timing. International gross margin declined to 10.0% from 10.7% because of weaker demand and competitive pricing.
- Quarterly North American operating income increased 16.3% to $25.0 million, while International operations recorded a $4.2 million operating loss compared with $14 thousand of operating income in the prior-year quarter.
- Nine-month operating income declined 16.2% to $71.4 million. International operations generated a $1.8 million operating loss compared with $7.7 million of operating income in the prior-year period.
- SG&A increased 2.6% in the quarter and 1.9% for the nine months. Current-period expenses included $1.2 million of European restructuring costs, higher bad-debt reserves and $2.3 million of ERP-related costs in the quarter.
- Interest expense declined substantially because of lower revolving-credit borrowings. Nine-month net foreign-exchange losses fell to $0.3 million from $3.6 million, partly because the prior-year period included a $2.5 million loss on a Brazilian real forward contract.
- The distribution agreement with Juniper Networks ended in September 2012, materially reducing communications-related sales in North America and Europe.
Guidance, Outlook, Risks and Unusual Items
- The company announced a restructuring of its European Communications business to support profitable growth. Expected annualized cost savings are approximately $3.1 million; approximately $1.2 million of costs were accrued in the March 2013 quarter and are expected to be substantially utilized by fiscal year-end.
- The global ERP project is under review after the replacement systems integrator estimated that remaining effort could bring total project cost near the previously disclosed upper end of $72 million. The company had incurred approximately $41.4 million through March 31, 2013, including $28.6 million capitalized. Management expected fourth-quarter ERP spending to be less than half of third-quarter spending.
- Through its subsidiary Partner Services, the company sued former ERP integrator Avanade for alleged fraud, misrepresentation and breach of contract. The filing does not provide a clear expected recovery or resolution date.
- Venezuela presents heightened collectability risk because government currency controls have restricted customers’ access to U.S. dollars. The company held $3.2 million of Venezuelan accounts receivable and maintained $0.7 million of specific reserves at March 31, 2013.
- Goodwill impairment remains a risk. The Brazilian reporting unit exceeded carrying value by only 7% in the June 30, 2012 test, and the business missed projected results by a wider margin than expected in the current quarter. European Communications losses could also affect the valuation of European goodwill and deferred tax assets.
- Contingent consideration related to the CDC Brasil acquisition was $13.3 million, including $4.5 million current. Future undiscounted payments were estimated to range up to $18.5 million and remain subject to earnings and Brazilian-real exchange-rate fluctuations.
- Pre-acquisition Brazilian tax contingencies were matched by indemnification receivables of $8.8 million in aggregate. The company states that known litigation is not expected to have a material adverse effect, but outcomes are uncertain.
- Management stated that cash, operating cash flow and available credit should provide sufficient liquidity for at least the next twelve months. The company also noted that repatriation of certain foreign cash could trigger significant U.S. taxes.
Most Important Facts for Investors to Verify
- Whether the European Communications restructuring produces the targeted approximately $3.1 million of annualized savings and whether international operations return to profitability.
- The revised scope, timetable, total cost and potential impairment exposure of the ERP project, including the status of the Avanade litigation.
- Trends in Juniper-related revenue losses, communications demand, competitive pricing and North American versus international margins.
- Recoverability of Venezuelan receivables and the adequacy of bad-debt reserves across Europe and Latin America.
- Potential goodwill or deferred-tax-asset impairments in Brazil and Europe if projected operating improvements do not occur.
- Future CDC earnout payments, Brazilian-real currency exposure and the related contingent consideration valuation.
- Actual availability and covenant compliance under the revolving credit facility, along with the tax cost of accessing foreign-held cash.