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SYX > SEC Filings for SYX > Form 10-Q on 5-Nov-2013All Recent SEC Filings

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Form 10-Q for SYSTEMAX INC


5-Nov-2013

Quarterly Report


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

Forward Looking Statements

This report contains forward looking statements within the meaning of that term in the Private Securities Litigation Reform Act of 1995 (Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). Additional written or oral forward looking statements may be made by the Company from time to time, in filings with the Securities and Exchange Commission or otherwise. Statements contained in this report that are not historical facts are forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements may include, but are not limited to, projections of revenue, income or loss and capital expenditures, statements regarding future operations, financing needs, compliance with financial covenants in loan agreements, plans for acquisition or sale of assets or businesses and consolidation of operations of newly acquired businesses, and plans relating to products or services of the Company, assessments of materiality, predictions of future events and the effects of pending and possible litigation, as well as assumptions relating to the foregoing. In addition, when used in this discussion, the words "anticipates," "believes," "estimates," "expects," "intends," "plans" and variations thereof and similar expressions are intended to identify forward looking statements.

Forward-looking statements in this report are based on the Company's beliefs and expectations as of the date of this report and are subject to risks and uncertainties which may have a significant impact on the Company's business, operating results or financial condition. Investors are cautioned that these forward-looking statements are inherently uncertain. Should one or more of the risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein. Statements in this report, particularly in "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Notes to Condensed Consolidated Financial Statements, describe certain factors, among others, that could contribute to or cause such differences.

Readers are cautioned not to place undue reliance on any forward looking statements contained in this report, which speak only as of the date of this report. We undertake no obligation to publicly release the result of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unexpected events.

Overview

Systemax is primarily a direct marketer of brand name and private label products. Our operations are organized in two reportable business segments - Technology Products and Industrial Products.

Our Technology Products segment sells computers, computer supplies and consumer electronics which are marketed in North America, Puerto Rico and Europe. Most of these products are manufactured by other companies; however, we do offer a selection of products that are manufactured for us to our own design and marketed on a private label basis. For the three and nine month periods ended September 30, 2013 and 2012, Technology products accounted for 84% and 87% of our net sales, respectively.

Our Industrial Products segment sells a wide array of industrial products and supplies which are marketed in North America. Most of these products are manufactured by other companies. Some products are manufactured for us to our own design and marketed on a private label basis. For the three and nine month periods ended September 30, 2013 and 2012, Industrial products accounted for 16% and 13% of our net sales, respectively. In both of our Technology Products and Industrial Products segments, we offer our customers a broad selection of products, prompt order fulfillment and extensive customer service.

Our Industrial Products and Technology Products segments sell dissimilar products. Industrial products are generally higher in price, lower in volume and higher in product margin. Technology products are generally higher in volume, lower in price and lower in product margin. This results in higher operating margin for the Industrial Products segment. Each segment incurs specifically identifiable selling, general and administrative expenses, with the selling, general and administrative expenses for the Industrial Products segment being higher as a percentage of sales than those of the Technology Products segment primarily, as a result of the Industrial Products segment spending more on advertising and promotion than the Technology Products segment. Additionally, the Industrial Products segment's vendors generally do not provide funding to offset its marketing expenses.


The market for computer products and consumer electronics is subject to intense price competition and is characterized by narrow gross profit margins. The North American industrial products market is highly fragmented and we compete against multiple distribution channels. Distribution is working capital intensive, requiring us to incur significant costs associated with the warehousing of many products, including the costs of maintaining inventory, leasing warehouse space, inventory management systems, and employing personnel to perform the associated tasks. We supplement our on-hand product availability by maintaining relationships with major distributors and manufacturers, utilizing a combination of stock and drop-shipment fulfillment.

Historically, the primary component of our operating expenses has been employee related costs, which includes items such as wages, commissions, bonuses, employee benefits and stock option expenses. We continually assess our operations to ensure that they are efficient, aligned with market conditions and responsive to customer needs.

The discussion of our results of operations and financial condition that follows provides information that will assist in understanding our financial statements, the factors that we believe may affect our future results and financial condition as well as information about how certain accounting principles and estimates affect the consolidated financial statements. This discussion should be read in conjunction with the condensed consolidated financial statements included herein and in conjunction with the audited financial statements as of December 31, 2012 and the other information provided in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

In the discussion of our results of operations we refer to business to business sales, consumer channel sales and period to period constant currency comparisons. Business to business sales are sales made direct to other businesses through managed business relationships, outbound call centers and extranets. Sales in the Industrial Products segment and Corporate and other are considered to be business to business sales. Consumer channel sales are sales from retail stores, consumer websites, inbound call centers and television shopping channels. Constant currency refers to the adjustment of the results of our foreign operations to exclude the effects of period to period fluctuations in currency exchange rates.

Recent developments

In August 2013 the Company's Board of Directors approved the expansion of the administrative and back office services that its recently opened European shared services center will offer to certain of the Company's operating subsidiaries in Europe. As a result of this expansion the Company anticipates incurring workforce reduction and exit costs and startup costs of approximately $11.0 million during the last quarter of 2013 and through the end of 2014. This amount includes approximately $9.0 million for workforce reduction costs and approximately $2.0 million in other tax, legal and recruiting fees. The Company anticipates that all of these costs will result in future cash expenditures which will be incurred during the last quarter of 2013 and through the end of 2014. Not all of the components of this expansion initiative are finalized, and the actual costs and specific timing of the costs could change from the Company's estimate as the scope of the initiative and underlying assumptions may change.

The Company exited the PC manufacturing business during the fourth quarter of 2012 after conducting an evaluation of its operations and concluding that the Company's North American technology results would be enhanced by exiting the computer manufacturing business.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and revenues and expenses during the period. Significant accounting policies employed by the Company, including the use of estimates, were presented in the Notes to Consolidated Financial Statements of the Company's 2012 Annual Report on Form 10-K.

Critical accounting policies are those that are most important to the presentation of our financial condition and results of operations, require management's most difficult, subjective and complex judgments, and involve uncertainties. The accounting policies that have been identified as critical to our business operations and understanding the results of operations pertain to revenue recognition; accounts receivable and allowance for doubtful accounts; inventories; goodwill and intangible assets; long-lived assets; accruals; income taxes; and special charges. The application of each of these critical accounting policies and estimates was discussed in Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2012. There have been no significant changes in the application of critical accounting policies or estimates during 2013. Management believes that full consideration has been given to all relevant circumstances that we may be subject to, and the condensed consolidated financial statements of the Company accurately reflect management's best estimate of the consolidated results of operations, financial position and cash flows of the Company for the periods presented. Because of the uncertainty in these estimates, actual results could differ from estimates used in applying the critical accounting policies. We are not aware of any reasonably likely events or circumstances which would result in different amounts being reported that would materially affect the Company's financial condition or results of operations.

Recent Accounting Pronouncements

Public companies in the United States are subject to the accounting and reporting requirements of various authorities, including the Financial Accounting Standards Board ("FASB") and the Securities and Exchange Commission ("SEC"). These authorities issue numerous pronouncements, most of which are not applicable to the Company's current or reasonably foreseeable operating structure. There are no new authoritative pronouncements that management believes are relevant to the Company's current operation.


Results of Operations


Three and Nine Months Ended September 30, 2013 compared to the Three and Nine
Months Ended September 30, 2012

Key Performance Indicators* (in millions):


                             Three Months Ended September 30,                Nine Months Ended September 30,
                                                              %                                            %
                           2013              2012          Change           2013           2012          Change
Net sales by segment:
Technology Products     $    665.0        $    735.4           (9.6 )%    $ 2,124.3      $ 2,302.2           (7.7 )%
Industrial Products          125.7             110.4           13.9 %         349.9          303.6           15.3 %
Corporate and other            1.1               1.2           (8.3 )%          4.1            3.6           13.9 %
Consolidated net         $   791.8        $    847.0           (6.5 )%    $ 2,478.3      $ 2,609.4           (5.0 )%
sales
Net sales by channel:
Business to business     $   528.3         $   527.5            0.2 %     $ 1,599.6      $ 1,583.2            1.0 %
Consumer                     263.5             319.5          (17.5 )%        878.7        1,026.2          (14.4 )%
  Consolidated net       $   791.8         $   847.0           (6.5 )%    $ 2,478.3      $ 2,609.4           (5.0 )%
sales
Consolidated gross            14.9 %            14.0 %          0.9 %          14.4 %         14.1 %          0.3 %
margin
Consolidated SG&A
costs**                 $    121.5        $    120.9            0.5 %    $    376.7      $   360.8            4.4 %
Consolidated SG&A
costs** as a % of
net sales                     15.3 %            14.3 %          1.0 %          15.2 %         13.8 %          1.4 %
Operating income
(loss) from
continuing operations
by segment:**
Technology Products     $     (9.9 )      $     (3.8 )        160.5  %   $    (33.4 )    $     1.6       (2,187.5 )%
Industrial Products           10.8               7.6           42.1  %         30.4           22.9           32.8 %
Corporate and other           (4.7 )            (5.7 )        (17.5 )%        (16.3 )        (17.6 )         (7.4 )%
Consolidated
operating income
(loss)                  $     (3.8 )      $     (1.9 )        100.0 %    $    (19.3 )    $     6.9         (379.7 )%
Operating margin from
continuing operations
by segment**
Technology Products           (1.5 )%           (0.5 )%        (1.0 )%         (1.6 )%         0.1 %         (1.7 )%
Industrial Products            8.6 %             6.9 %          1.7 %           8.7 %          7.5 %          1.2 %
Consolidated
operating margin from
continuing operations         (0.5 )%           (0.2 )%        (0.3 )%         (0.8 )%         0.3 %         (1.1 )%
Income (loss) from
continuing operations   $    (11.6 )      $     14.0         (182.9 )%   $    (24.0 )    $    19.0         (226.3 )%
Net margin from
continuing operations         (1.5 )%            1.7 %         (3.2 )%         (1.0 )%         0.7 %         (1.7 )%

*excludes discontinued operations
**includes special charges, net (See Note 4 of Notes to Condensed Consolidated Financial Statements).

NET SALES

SEGMENTS

The Technology Products net sales decrease in the quarter and year to date is attributable to declines in all product category sales within North America and European markets. Within the quarter, North American sales declined due to continued weakness in consumer channels sales, principally internet and retail sales and business to business sales declined, in part, due to our exit from the PC manufacturing business. Within Europe for the quarter, business to business sales were flat and consumer channel sales declined and year over year in Europe, business to business and consumer channel sales declined. Strong computer sales year to date in Europe were more than offset by weak sales of computer accessories and software, consumer electronics, and computer components in North America and Europe. On a constant currency basis, Technology Products net sales would have decreased 10.0% and 7.8%, respectively, for the three and nine month periods ended September 30, 2013.

The Industrial Products net sales increase is attributable to the addition of products offered and newer product categories on the Company's website, broadening of key product categories, continued growth in Canadian website sales and the addition of sales personnel.


CHANNELS

The modest growth in consolidated business to business channel sales was driven by the Industrial Products segment's 13.9% growth for the third quarter and 15.3% growth for the nine month period ended September 30, 2013 that resulted from the sales initiatives mentioned above. Tepid business demand in Technology Products offset the gain in Industrial Products. The Company is taking proactive measures to improve Technology Products business to business operations in Europe and North America, including making investments to strengthen and expand our sales teams, realigning certain sales offices and implementing cost reduction initiatives. On a constant currency basis, worldwide business to business channel sales declined 0.5% for the third quarter of 2013 and increased 1.0% for the nine month period ended September 30, 2013.

The decline in consolidated consumer-channel sales for the three and nine month periods ended September 30, 2013 resulted from weakness in internet and retail store sales, in North America and in consumer channel sales declines in Europe. On a constant currency basis, worldwide consumer channel sales decreased 17.3% and 14.3%, respectively, for the three and nine month periods ended September 30, 2013.

GROSS MARGIN

The increase in consolidated gross margin for the three and nine month periods ended September 30, 2013 was primarily due to increased Industrial Products sales, which are typically higher margin than Technology Products, contributing a larger percentage of gross profit dollars in 2013 as compared to the same period in 2012. Gross margin benefited from increased efficiencies from the Industrial Products distribution center opened in 2012 and additional improvement in freight processes. Technology Products margin benefited from gross margin expansion in Europe yet was partially offset by a small decline in North American Technology segment due to continued competitive pricing pressures. Gross margin is dependent on variables such as product mix, price protection and other sales incentives offered by the Company's vendors, competition, pricing strategy, co-operative advertising funds required to be classified as a reduction to cost of sales, freight discounting and other variables, any or all of which may result in fluctuations in gross margin.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

The decrease in selling, general and administrative expenses for the three months ended September 30, 2013 as compared to the same period in 2012 was primarily the result of (i) decreases in salary and related costs in the North America Technology Products segment and corporate overhead departments offset by increases of sales and sales related personnel costs in the Industrial and European Technology Products segments, (ii) a temporary overlap of costs in Europe as we transition functions to our European shared services center, and
(iii) decreased catalog and store advertising costs in the North America Technology and Industrial Products segments offset by increases in internet advertising expenses in the Industrial Products segment. Significant expense decreases for the three months ended September 30, 2013 include approximately $0.9 million of decreased catalog and store advertising costs offset by decreased vendor co-operative funding, $0.9 million of decreased salary and related expenses, $0.5 million of decreased temporary labor costs, $0.4 million of decreased credit card fees, and decreases in various other operating expenses offset by $0.4 million of increased internet advertising expense.

The increase in selling, general and administrative expenses for the nine month period ended September 30, 2013 was primarily the result of increases in salary and related costs in the European Technology and Industrial Products segments as mentioned above, increased internet advertising costs in the Industrial Products segment, and increased rent and related costs in the European Technology segment. Significant expense increases for the nine month period ended September 30, 2013 include approximately $3.6 million of increased salary and related expenses, $3.5 million of increased internet advertising, increased rent and related costs of $0.8 million, and decreased vendor co-operative funding of $2.1 million offset by a decrease of approximately $2.0 million of legal, professional and consulting expenses, $1.6 million in catalog and store advertising costs and decreased credit card fees of $1.2 million.

SPECIAL CHARGES, NET

The Company's Technology Products segment incurred special charges in the third quarter of 2013 of approximately $3.8 million for lease termination costs and $1.5 million for fixed asset write offs related to the closing of underperforming retail stores, approximately $0.2 million in workforce reduction costs, approximately $0.2 million of additional legal and professional fees related to the previously disclosed completed investigation and settlement with a former officer and director and approximately $0.1 million in continuing recruitment costs of the European shared services center.

For the nine month period ended September 30, 2013, the Technology Products segment incurred approximately $16.5 million of special charges. These included approximately $4.8 million for lease termination costs and $2.0 million for fixed asset write offs related to the closing of underperforming retail stores, approximately $4.5 million of workforce reductions and other exit costs related to the shared services center implementation, $2.2 million of workforce reduction charges for senior management changes, $1.9 million of startup costs related to our European shared services center, $0.6 million from reserve adjustments related to the facility closing and exit from the PC manufacturing business and approximately $0.5 million of additional legal and professional fees related to the previously disclosed completed investigation and settlement with a former officer and director. For the nine months ended September 30, 2013, the Company's Industrial Products segment incurred minimal reserve adjustments related to the closing and relocation of a small distribution center to a new, significantly larger distribution and call center.

The Company's Industrial Products segment recorded no additional charges for the third quarter of 2012 and approximately $2.2 million for the nine month period ended September 30, 2012 related to facility exit costs. The Company recorded severances and legal and professional fees related to a previously disclosed completed investigation and settlement with a former officer and director and costs associated with senior management staffing changes within the North America Technology Products segment of approximately $0.3 million and $2.1 million, respectively, for the three and nine month periods ended September 30, 2012 and $0.1 million of severance costs within the European Technology Products segment. The Company also recorded $1.7 million of patent settlements with non-practicing entities for the three and nine month periods ended September 30, 2012.


OPERATING MARGIN

The decline in Technology Products operating margin was due to the challenging consumer business in North America and Europe, a decline in business to business sales, reduced vendor co-operative funding in North America and lower sales and associated gross profit to cover fixed selling, general and administrative expenses.

The increase in Industrial Products operating margin was due to increased efficiencies from the recently opened distribution center and additional improvement in our freight results, the addition of products offered and newer product categories on the Company's website, broadening of key product categories, continued growth in Canadian website sales and the addition of sales personnel.

The decrease in Corporate and other expenses primarily resulted from savings in our overhead departments.

Consolidated operating margin was impacted by special charges of $5.8 million and $2.0 million for the three month periods ended September 30, 2013 and 2012, respectively and $16.5 million and $6.1 million for the nine month periods ended September 30, 2013 and 2012, respectively.

INTEREST EXPENSE

The interest expense decrease in 2013 is attributable to decreasing balances owed on the Recovery Zone Bond facility and outstanding capital lease obligations. Interest expense for 2012 is attributable to interest on the Recovery Zone bond facility and outstanding capital lease obligations.

INCOME TAXES

The Company's tax expense for the third quarter of 2013 was $8.4 million compared to a $16.1 million benefit in 2012. Tax expense for the nine months ended September 30, 2013 was $4.5 million compared to a benefit of $13.9 million in 2012. Tax expense in 2013 is driven by tax expense in the Company's foreign subsidiaries partially offset by the tax benefit of projected pretax losses in the United States. Additionally, the Company has approximately $8.7 million in pretax losses for which no benefit is recognized as the result of those losses being in jurisdictions where deferred tax assets, including net operating losses, are subject to a full valuation allowance.

Tax benefit for both the three and nine month periods ended September 30, 2012 is primarily due to the reversal of approximately $15.1 million of valuation allowances against deferred tax assets of a foreign subsidiary as demonstrated and projected profitable results in this subsidiary's operations caused the valuation allowances to be deemed no longer necessary at September 30, 2012.

Financial Condition, Liquidity and Capital Resources

Our primary liquidity needs are to support working capital requirements in our business, including working capital for the new distribution and call center for our Industrial Products segment, funding capital expenditures, including those related to our retail stores and information technology systems, repaying outstanding debt, funding special dividends declared by our Board of Directors and funding acquisitions. We rely principally upon operating cash flow to meet these needs. We believe that cash flow available from these sources and our availability under credit facilities will be sufficient to fund our working capital and other cash requirements for at least the next twelve months. We believe our current capital structure and cash resources are adequate for our internal growth initiatives. To the extent our growth initiatives expand, including major acquisitions, we would seek to raise additional capital. We believe that, if needed, we can access public or private funding alternatives to raise additional capital.

Selected liquidity data (in millions):

                                                      September 30,      December 31,
                                                          2013               2012           $ Change
Cash                                                 $         173.3     $       150.7     $     22.6
Accounts receivable, net                             $         287.7     $       297.4     $     (9.7 )
Inventories                                          $         284.6     $       367.2     $    (82.6 )
Prepaid expenses and other current assets            $          28.9     $        23.5     $      5.4
Accounts payable                                     $         346.4     $       405.3     $    (58.9 )
Accrued expenses and other current liabilities       $          93.6     $        83.5     $     10.1
Current portion of long term debt                    $           2.5     $         2.8     $     (0.3 )
Working capital                                      $         345.3     $       360.8     $    (15.5 )

Our working capital decreased primarily as a result of decreased inventory, accounts receivable and accounts payable balances partially offset by increased cash balances. We expect that future inventory and accounts receivable balances will continue to fluctuate with net sales and the mix of our net sales between consumer and business customers.


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