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SCSC > SEC Filings for SCSC > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for SCANSOURCE INC

Form 10-Q for SCANSOURCE INC


2-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

ScanSource, Inc. is a leading wholesale distributor of specialty technology products, providing value-added distribution sales to resellers in specialty technology markets. The Company distributes approximately 100,000 products worldwide. The Company has two geographic distribution segments: the North American distribution segment serving the United States and Canada from the Southaven, Mississippi distribution center and an international distribution segment serving Latin America and Europe from distribution centers located in Florida, Mexico, Brazil and Belgium. Each segment is managed around its geographic customer and vendor bases and is supported by its centralized infrastructure, such as warehousing and back office operations as appropriate. The North American distribution segment markets automatic identification and data capture ("AIDC") and point-of-sale ("POS") products through its ScanSource POS and Barcoding sales unit; voice, data, video and converged communications equipment through its Catalyst Telecom sales unit; video conferencing, telephony and communications products through its ScanSource Communications sales unit; and electronic security products and wireless infrastructure products through its ScanSource Security sales unit. The international distribution segment markets AIDC, POS, communications, and security products through its ScanSource Latin America sales unit; AIDC and POS products through its ScanSource Europe sales unit; and communication products through its ScanSource Communications sales unit in Europe.

The Company was incorporated in South Carolina in December 1992 and is headquartered in Greenville, South Carolina. The Company serves North America from a single, centrally-located distribution center located in Southaven, Mississippi, near the FedEx hub. The single warehouse and strong management information system form the cornerstone of the Company's cost-driven operational strategy. This strategy has been expanded to Latin America and Europe.

The Company distributes products for many of its key vendors in all of its geographic markets; however certain vendors only allow distribution to specific geographies. The Company's key vendors in its worldwide POS and barcoding sales units include Bematech, Cisco, Datalogic, Datamax-O'Neil, Elo, Epson, Honeywell, Intermec, Motorola, NCR, Toshiba and Zebra Technologies. The Company's key vendors in its worldwide communications sales units, including Catalyst Telecom, include Aruba, Avaya, Audiocodes, Dialogic, Extreme Networks, Meru Networks, Plantronics, Polycom and ShoreTel. The Company's key vendors in its security sales units include Arecont, Axis, Bosch, Cisco, Datacard, Exacq Technologies, Fargo, HID, March Networks, Panasonic, Ruckus Wireless, Samsung, Sony and Zebra Card.

As of September 30, 2012, we have ended our relationship with Juniper Networks, which was primarily distributed by our Catalyst Telecom sales unit in North America and to a lesser extent by ScanSource Communications Europe. Sales of Juniper products significantly declined in the September quarter.

We are developing an Enterprise Resource Planning system ("ERP") that is intended to be used globally and standardize our processes throughout the world. We are recognizing more ERP expenses in selling, general and administrative expenses ("SG&A") as the project continues. In the current quarter, we incurred $2.3 million of SG&A expense related to activities that are not capitalized.

Our objective is to achieve an appropriate company-wide Return on Invested Capital ("ROIC") through sales of the various technologies that we distribute. In doing so, our management team faces numerous challenges that require attention and resources. Certain business units and geographies are experiencing increased competition for the products we distribute. This competition may come in the form of pricing, credit terms, service levels, product availability and in some cases, changes from a closed distribution sales model, in which resellers must purchase exclusively from one distributor, to an open distribution sales model, in which resellers may choose to purchase from multiple distributors. As this competition could affect both our market share and pricing of our products, we may change our strategy in order to effectively compete in the marketplace.

In the current quarter, our results in the international distribution segment were weaker than expected as competitive pressures continued. While certain international markets are volatile in the current macroeconomic environment, especially parts of Europe, we are continuing to invest in this business to position the Company favorably against our competitors over the long term.


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Evaluating Financial Condition and Operating Performance

We place a significant emphasis on operating income and ROIC in evaluating and monitoring financial condition and operating performance. We use ROIC, a non-GAAP measure, to assess efficiency at allocating capital under our control to generate returns. ROIC is computed by the Company as net income plus interest expense, income taxes, depreciation and amortization ("EBITDA") annualized by calendar days and divided by invested capital. Invested capital is defined as average equity plus daily average funded debt for the period.

The following table summarizes annualized return on invested capital ratio for the quarters ended September 30, 2012 and September 30, 2011:

Quarter ended September 30, 2012 2011 Return on invested capital ratio, annualized 17.0 % 18.2 %

The discussion that follows this overview explains the change in ROIC from the comparative period. Management uses ROIC as a performance measurement because we believe this metric best balances our operating results with asset and liability management, excludes the results of capitalization decisions, is easily computed and understood, and drives changes in shareholder value. The components of this calculation and reconciliation to our financial statements are shown on the following schedule:

                                              Quarter ended September 30,
                                                   2012                 2011
                                                    (in thousands)
Reconciliation of EBITDA to net income:
Net income                              $       17,642                $ 18,380
Plus: income taxes                               9,097                   9,681
Plus: interest expense                             124                     486
Plus: depreciation & amortization                2,314                   2,582
EBITDA (numerator)                      $       29,177                $ 31,129


                                               Quarter ended September 30,
                                                 2012               2011
                                                     (in thousands)
Invested capital calculations:
Equity - beginning of the quarter          $     652,311       $     587,394
Equity - end of the quarter                      676,136             597,658
Average equity                                   664,224             592,526
Average funded debt (a)                           16,563              86,780
Invested capital (denominator)             $     680,787       $     679,306

Return on invested capital (annualized)(b)          17.0 %              18.2 %

(a) Average funded debt is calculated as the daily average amounts outstanding on our short-term and long-term interest-bearing debt.

(b) The annualized EBITDA amount is divided by days in the quarter times 365 days per year (366 during leap years). There were 92 days in the current and prior year quarters.

Our return on invested capital was 17.0% for the quarter, down from 18.2% in the prior year. The decrease in EBITDA is largely the result of lower sales and gross margin percentage as well as relatively flat operating expenses.


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Results of Operations

Currency

In our Management Discussion and Analysis, we make references to "constant currency," a non-GAAP performance measure, that excludes foreign exchange rate impacts from fluctuations in the weighted average foreign exchange rates between reporting periods. Certain financial results are adjusted by a simple mathematical model that translates current period results from currencies other than the U.S. dollar with the comparable weighted average foreign exchange rates from the prior year period. This information is provided to view financial results without the impact of fluctuations in foreign currency rates, thereby enhancing comparability between reporting periods.

Net Sales

The following table summarizes our net sales results (net of inter-segment
sales) for the quarters ended September 30, 2012 and 2011, respectively:

                                  Quarter ended September 30,
                                       2012                 2011       $ Change     % Change
                                               (in thousands)
North American distribution $       545,813              $ 573,472    $ (27,659 )     (4.8 )%
International distribution          187,792                196,787       (8,995 )     (4.6 )%
Net sales                   $       733,605              $ 770,259    $ (36,654 )     (4.8 )%

North American Distribution

The North American distribution segment consists of net sales to technology resellers in the United States and Canada. For the quarter ended September 30, 2012, net sales decreased from the prior year quarter by $27.7 million or 4.8%.

The North American distribution segment's POS, barcoding and security product revenues remained flat in comparison to the prior year as a result of pricing and other competitive pressures in the POS and barcoding channel, offset by a record quarter for our ScanSource Security sales unit. The decrease in POS and barcoding products was driven by declining revenue from big deal transactions occurring in the quarter. However, we have continued to grow within our security lines with strong gains in business attributable to vendors such as Ruckus Wireless and Axis.

The Company has two North American sales units that sell communications products to our customers - Catalyst Telecom and ScanSource Communications. The combined net sales of these units decreased by 9.9% from the prior year. The decrease is largely attributable to fewer big deals related to Avaya resellers and the end of our distribution agreement with Juniper Networks.

International Distribution

The international distribution segment markets POS, AIDC, communications and security products in Latin America and POS, AIDC and communications products in Europe. For the quarter ended September 30, 2012, net sales for this segment decreased by $9.0 million or 4.6%. The sales decrease over the prior year quarter is primarily driven by foreign currency exchange translation. Foreign currency translation had a $24.4 million unfavorable impact on our net sales for the quarter ended September 30, 2012. On a constant currency basis, the net sales increase was 7.8% or $15.4 million for the quarter. Our international segment's growth was driven by contributions from all of our sales units.


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Gross Profit

The following tables summarize the Company's gross profit for the quarters ended
September 30, 2012 and 2011, respectively:

                                                                                                         % of Net Sales
                                   Quarter ended September 30,                                           September 30,
                                       2012                  2011        $ Change      % Change        2012          2011
                                                (in thousands)
North American distribution $       54,808                $  56,853     $  (2,045 )       (3.6 )%       10.0 %         9.9 %
International distribution          19,232                   22,237        (3,005 )      (13.5 )%       10.2 %        11.3 %
Gross profit                $       74,040                $  79,090     $  (5,050 )       (6.4 )%       10.1 %        10.3 %

North American Distribution

Gross profit for the North American distribution segment decreased 3.6% or $2.0 million for the quarter ended September 30, 2012. As a percentage of net sales for the North American distribution segment, our gross profit increased from 9.9% to 10.0% from the comparative quarter. The increase in margin percentage is mainly due to favorable changes in product mix and higher service business than the prior year.

International Distribution

In our international distribution segment, gross profit decreased 13.5% or $3.0 million for the quarter ended September 30, 2012. The decrease is largely due to foreign currency translation. On a constant currency basis, gross profit for the international segment decreased 1.7%. As a percentage of net sales for the international distribution segment, our gross profit decreased from 11.3% to 10.2% from the comparative quarter, primarily due to higher inventory reserve expense in our European communications business.

Operating Expenses

The following table summarizes our operating expenses for the quarters ended
September 30, 2012 and 2011, respectively:

                                                                                                      % of Net Sales
                               Quarter ended September 30,                                             September 30,
                                   2012                  2011         $ Change      % Change        2012           2011
                                             (in thousands)
Selling, general and
administrative expense  $       47,061                $  46,569     $      492          1.1  %        6.4 %          6.0 %
Change in fair value of
contingent
consideration                      764                      894           (130 )      (14.5 )%        0.1 %          0.1 %
Operating expense       $       47,825                $  47,463     $      362          0.8  %        6.5 %          6.2 %

Selling, general and administrative expense increased 1.1% or $0.5 million for the quarter ended September 30, 2012. The primary driver in the increase is incremental expenses related to our ERP that have not been capitalized, higher bad debt expense and increased headcount in certain geographies, partially offset by favorable foreign currency translation from the prior year period. SG&A expense included $2.3 million of ERP expenses that are not capitalized. At constant currency, SG&A would have increased an additional $2.0 million to $49.1 million.

We have elected to present changes in fair value of the contingent consideration owed to the former shareholders of CDC separately from other selling, general and administrative expenses. In the current quarter, we recorded a $0.8 million loss on the change in fair value of the contingent consideration. The loss is primarily the result of the recurring amortization of the unrecognized fair value discount.


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Operating Income

The following table summarizes our operating income for the quarters ended
September 30, 2012 and 2011, respectively:

                                                                                                         % of Net Sales
                                   Quarter ended September 30,                                            September 30,
                                       2012                  2011        $ Change      % Change        2012           2011
                                                (in thousands)
North American distribution $       24,983                $  29,274     $  (4,291 )      (14.7 )%        4.6 %          5.1 %
International distribution           1,232                    2,353        (1,121 )      (47.6 )%        0.7 %          1.2 %
                            $       26,215                $  31,627     $  (5,412 )      (17.1 )%        3.6 %          4.1 %

For the North American distribution segment, operating income decreased 14.7% or $4.3 million from the prior year first quarter. The decrease is primarily due to lower sales volumes and higher operating expenses, primarily resulting from ERP spending that has not been capitalized.

For the international distribution segment, operating income decreased 47.6% or $1.1 million from the prior year first quarter. The decrease is primarily due to lower gross margins and higher bad debt expense, partially offset by lower SG&A expenses due to favorable foreign currency translation.

Total Other Expense (Income)

The following table summarizes our total other expense (income) for the quarters
ended September 30, 2012 and 2011, respectively:

                                                                                            % of Net Sales
                          Quarter ended September 30,                                        September 30,
                            2012              2011          $ Change      % Change        2012          2011
                                       (in thousands)
Interest expense       $       124       $         486     $    (362 )      (74.5 )%        0.0  %        0.1  %
Interest income               (633 )              (450 )        (183 )       40.7  %       (0.1 )%       (0.1 )%
Net foreign exchange
(gains) losses                  73               3,573        (3,500 )      (98.0 )%        0.0  %        0.5  %
Other, net                     (88 )               (43 )         (45 )      104.7  %       (0.0 )%       (0.0 )%
Total other (income)
expense, net           $      (524 )     $       3,566     $  (4,090 )     (114.7 )%       (0.1 )%        0.5  %

Interest expense reflects interest incurred on borrowings from the Company's revolving credit facility and other long-term debt borrowings, as well as non-utilization fees. Interest expense for the quarter ended September 30, 2012 was $0.1 million. Interest expense is down 74.5% from the prior year quarter, largely from decreased borrowings on our $300 million revolving credit facility.

Interest income for the quarter ended September 30, 2012 was $0.6 million and includes interest income generated on longer-term interest bearing receivables and interest earned on cash and cash-equivalents. Interest income increased 40.7% from the prior year quarter. The increase is largely the result of interest earned and cash balances maintained in Brazil, since September 2011, to pre-fund a portion of contingent earnout payments to CDC's former shareholders and finance current operations. Over the past year, the cash balances maintained in Brazil have declined with the earnout payments and financings for short-term working capital needs.

Net foreign exchange gains and losses consist of foreign currency transactional and functional currency re-measurements, offset by net foreign currency exchange contract gains and losses. Foreign exchange losses and gains are generated as the result of fluctuations in the value of the British pound versus the euro, the U.S. dollar versus the euro, U.S. dollar versus the Brazilian real, Canadian dollar versus the U.S. dollar and other currencies versus the U.S. dollar. While we utilize foreign exchange contracts and debt in non-functional currencies to hedge foreign currency exposure, our foreign exchange policy prohibits the use of speculative transactions.


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Net foreign exchange loss for the quarter ended September 30, 2012 totaled $0.1 million, which was $3.5 million lower than the prior year. In the prior year, we incurred a $2.5 million loss in conjunction with an unfavorable forward exchange contract to purchase Brazilian reais. In August 2011, we decided to pre-fund a portion of the estimated earnout payments associated with the CDC acquisition and finance current operations as mentioned above. This contract was designed to preserve the currency exchange for the few weeks required to transfer the cash to Brazil. From the time we entered into the contract through settlement, the real devalued from the contractual rate by 11.8%, ultimately resulting in a $2.5 million loss. Further contributing to the prior year quarter foreign exchange loss, our Brazilian business incurred significant losses on the remeasurement of U.S. dollar denominated transactions that were not hedged at the time. Subsequently, the Company has been including these exposures in its ongoing hedging activities.

Provision for Income Taxes

For the quarter ended September 30, 2012, income tax expense was $9.1 million, reflecting an effective tax rate of 34.0%, which was lower than the 34.5% effective tax rate of the corresponding prior year period. The decrease in the effective tax rate from the prior year period is due primarily to a reduction in non-deductible expenses.

Liquidity and Capital Resources

Our primary sources of liquidity are cash flow from operations, borrowings under our $300 million revolving credit facility (the "Revolving Credit Facility"), industrial development revenue bond, and borrowings under our European subsidiary's 6 million line of credit. As a distribution company, our business requires significant investment in working capital, particularly accounts receivable and inventory, partially financed through our accounts payable to vendors and revolving lines of credit. Overall, as our sales volume increases, our net investment in working capital typically increases, which, in general, results in decreased cash flow from operating activities. Conversely, when sales volume decreases, our net investment in working capital typically decreases, which, in general, results in increased cash flow from operating activities.

The Company's cash and cash equivalent balance totaled $38.7 million at September 30, 2012, compared to $29.2 million at June 30, 2012, of which $20.5 million and $18.7 million were held outside of the United States as of September 30, 2012 and June 30, 2012, respectively.

Cash balances are generated and used in many locations throughout the world. Management's intent is to permanently reinvest these funds in our businesses outside the United States to continue to fund growth in our international operations. Furthermore, our current plans do not require repatriation of funds from our international operations to fund operations in the United States. If these funds were needed in the operations of the United States, we would be required to record and pay significant income taxes upon repatriation of these funds.

As mentioned above, our business model typically yields an inverse relationship between cash flows from operating activities and the change in our sales volumes. Compared to the sequential quarter, sales decreased 2.8%. As such, we have generated $2.4 million from operating activities as opposed to using $33.6 million in the prior year quarter when sales had increased 5.0% sequentially.

Our net investment in working capital has increased to $566.1 million at September 30, 2012 from $533.5 million at June 30, 2012. With declining sales, our net investment in working capital typically decreases; however, in the current quarter, net working capital increased. Our net investment in working capital is affected by several factors such as fluctuations in sales volume, net income before non-cash charges, timing of collections from customers, movement of inventory, payments to vendors as well as cash generated or used by other financing and investing activities. In the sequential quarter, we had paid off all of our outstanding borrowings on our $300 million revolving credit facility, which lowered our cash balance on hand as of June 30, 2012 and ultimately our net working capital.


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The number of days sales in receivables (DSO) was 58 at September 30, 2012, compared to 56 days at both June 30, 2012 and September 30, 2011. Inventory turned over 5.6 times during the first quarter of the fiscal year 2013 versus 5.6 and 5.8 times in the sequential and prior year quarters, respectively.

We are in the process of designing and developing a new ERP system. We have incurred approximately $35.8 million on the project from inception through September 30, 2012. Of the total amount incurred, $26.9 million has been capitalized, which includes estimates for amounts incurred but not yet paid. In the last quarter, we revised our projections for the project and believe that total spend could range from $58 million to $72 million and extend past fiscal year 2013. Capital expenditures for fiscal 2013 could range from $9 million to $15 million for a total capital expenditure of up to $41.9 million.

Cash used in investing activities for the quarter ended September 30, 2012 was $2.0 million, compared to $2.3 million used in the prior year quarter. Current quarter investing cash flows are primarily attributable to the investment in our new ERP system.

On October 11, 2011, we entered into a five-year, $300 million multi-currency senior secured revolving credit facility pursuant to the terms of an Amended and Restated Credit Agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A., as administrative agent and a syndicate of lenders named therein. The Credit Agreement allows for the issuance of up to $50 million for letters of credit and has a $150 million accordion feature that allows the Company to increase the availability to $450 million subject to obtaining commitments for the incremental capacity from existing or new lenders.

At our option, loans denominated in U.S. dollars under the Revolving Credit Facility, other than swingline loans, shall bear interest at a rate equal to a spread over the London Interbank Offered Rate ("LIBOR") or prime rate depending upon the our ratio of total debt (excluding accounts payable and accrued liabilities). measured as of the end of the most recent quarter, to adjusted earnings before interest expense, taxes, depreciation and amortization ("EBITDA"), for the most recently completed four quarters (the "Leverage Ratio"). The Leverage Ratio excludes the Company's subsidiary in Brazil. This spread ranges from 1.00% to 2.25% for LIBOR-based loans and 0.00% to 1.25% for prime rate-based loans. The spread in effect as of September 30, 2012 was 1.00% for LIBOR-based loans and 0.00% for Prime rate-based loans. Additionally, we are assessed commitment fees ranging from 0.175% to 0.40%, depending upon the Leverage Ratio, on non-utilized borrowing availability, excluding swingline loans. Borrowings under the Revolving Credit Facility are guaranteed by substantially all of our domestic assets as well as certain foreign subsidiaries determined to be material under the Revolving Credit Facility and a pledge of up to 65% of capital stock or other equity interest in each Guarantor. We were in compliance with all covenants under the Revolving Credit Facility as of September 30, 2012.

In the current quarter, cash provided by financing activities amounted to $9.0 . . .

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