Business Context and Reporting Period
Company: Scan Source, Inc.
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended December 31, 2005
Business Overview: A leading wholesale distributor of specialty technology products, including automatic identification and data capture (AIDC), point-of-sale (POS), voice/data communications, and electronic security products. Operations are divided into North American and International (Latin America and Europe) distribution segments.
Key Financial Metrics
| Metric (in thousands) | Quarter Ended Dec 31, 2005 | Six Months Ended Dec 31, 2005 |
|---|---|---|
| Net Sales | $408,468 | $798,864 |
| Gross Profit | $41,835 | $82,164 |
| Gross Margin % | 10.2% | 10.3% |
| Operating Income | $15,563 | $30,883 |
| Net Income | $9,250 | $18,584 |
| Diluted EPS | $0.71 | $1.42 |
| Cash and Equivalents | $10,927 | $10,927 (Balance Sheet) |
| Working Capital | $244,257 | $244,257 (Balance Sheet) |
| Revolving Credit Borrowed | $28,753 | $28,753 (Balance Sheet) |
| Operating Cash Flow (6mo) | N/A | $11,750 |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 10.4% for the quarter and 9.0% for the six-month period compared to the prior year. International distribution sales grew significantly (17.0% for the quarter, 24.4% for six months), driven by market share gains in Europe, though negatively impacted by foreign exchange fluctuations of approximately $3.8 million for the quarter.
- Profitability: Operating income increased 5.5% for the quarter and 5.0% for the six-month period. However, operating margins decreased slightly due to the adoption of FASB Statement No. 123(R) regarding share-based compensation.
- Accounting Change: Effective July 1, 2005, the company adopted FASB Statement No. 123(R). This resulted in a $935,000 expense for the quarter and $1,827,000 for the six months, reducing reported net income and EPS compared to pro forma figures under the previous standard (APB Opinion No. 25).
- Working Capital: Working capital increased to $244.3 million from $221.5 million at June 30, 2005, primarily due to increases in trade receivables ($34.6 million) and inventory ($12.7 million) to support global growth.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management believes the company has sufficient liquidity to meet forecasted cash requirements for at least the next fiscal year. The company continues to invest in its security business and international expansion (Europe and Latin America).
- Unusual Items:
- Share-Based Compensation: The adoption of FASB 123(R) significantly impacted operating expenses and net income for the current period.
- Profit Sharing: The company recorded $2.4 million in profit-sharing expense and a $400,000 charitable contribution during the six-month period to meet internal return on invested capital goals.
- Risks and Contingencies:
- Tax Dispute: The company is disputing a $1.4 million sales and use tax assessment. As of December 31, 2005, a liability of $874,000 remains after partial payment.
- Foreign Exchange: Significant exposure to currency fluctuations (Euro, British Pound, Canadian Dollar) impacts sales and earnings.
- Concentration: No single customer represented more than 7% of consolidated net sales.
Investor Verification Checklist
- Impact of FASB 123(R): Verify the sustainability of earnings by comparing reported net income against pro forma figures excluding the new share-based compensation expense.
- Foreign Exchange Sensitivity: Assess the volatility of the Euro and British Pound against the USD and its potential impact on future International segment margins.
- Working Capital Efficiency: Monitor Days Sales Outstanding (DSO), which increased to 55 days, and inventory turnover to ensure growth is not straining liquidity.
- Tax Contingency: Track the resolution of the $1.4 million sales tax dispute and potential for additional accruals.
- Debt Covenants: Confirm continued compliance with the revolving credit facility covenants, specifically the funded debt to EBITDA ratio and fixed charge coverage ratio.