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SYX > SEC Filings for SYX > Form 10-Q on 5-Aug-2014All Recent SEC Filings

Show all filings for SYSTEMAX INC

Form 10-Q for SYSTEMAX INC


5-Aug-2014

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 reorganizing our European operations, including timely opening and integration of our new shared services center in Hungary, plans for transitioning certain sales, procurement and other management information systems functions from our existing information technology platforms to a new platform specifically developed for our needs, 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 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 as a result of the Industrial Products segment having a longer selling cycle for its business customers than the Technology Products segment. Additionally, the Industrial Products segment's vendors generally do not provide funding to offset its marketing expenses.

Operating Conditions

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.

The primary component of our operating expenses historically 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 will provide 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, 2013 and the other information provided in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

In the discussion of our results of operations we refer to business to business channel sales, consumer channel sales and period to period constant currency comparisons. Business to business ("B2B") channel sales are sales made direct to other businesses through managed business relationships, outbound call centers and extranets. Sales in the Industrial Products segment, European Technology Products and Corporate and other are considered to be business to business sales. Consumer ("B2C") 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:

On June 12, 2014, the Company acquired SCC Services B.V. ("SCC"), a supplier of business-to-business IT products and services with operations in the Netherlands. This acquisition expands the Company's service offerings and strengthens its existing operations within the Netherlands. The purchase price (after giving effect to the conversion of Euros to U.S. dollars) was approximately $7.3 million in cash (5.4 million Euro), $0.6 million (0.4 million Euro) of which was placed into an escrow account for one year to secure the sellers' indemnification obligations under the purchase agreement. A preliminary allocation of the purchase price was done as of the acquisition date. The Company acquired approximately $4.8 million in total assets, including approximately $0.9 million in cash, $12.3 million in receivables, $2.5 million in goodwill and other intangibles and $10.8 million in payables. The Company has determined that this is not a material acquisition for financial reporting purposes. The accounts of SCC are included in the accompanying condensed consolidated balance sheet. The operating results of SCC are included in the accompanying condensed consolidated statements of operations from the date of acquisition. SCC is included in the European operations of the Company's Technology Products business segment.


Technology Products

Our Technology Products segment primarily sells ICT and CE products. These products are marketed in North America, Puerto Rico and Europe. Most of these products are manufactured by other companies; however, the Company does offer a selection of products that are manufactured for our own design and marketed on a private label basis. For the three month periods ended June 30, 2014 and 2013, Technology products accounted for 83% and 85%, of our net sales, respectively, and for the six month periods ended June 30, 2014 and 2013, Technology products accounted for 84% and 87% of our net sales, respectively.

The Company opened a shared services center in Budapest, Hungary in 2013 to facilitate the continued growth of its European Technology Products business. This new facility provides administrative and back office services for the existing European business, will help drive operational efficiencies and better serve the Company's pan-European operating strategy, and will serve as the sales location for future business in Eastern Europe. As an incentive to locate in Hungary, the Hungarian Investment and Trade Agency ("HITA") agreed to reimburse the Company for approximately 8% of payroll costs, up to a maximum of approximately $3.1 million, for the first 505 employees hired at the shared service center. The reimbursement is limited to the first twenty four months of employment for employees hired by December 2015 with all such reimbursements being completed by December 2017. In return for this incentive, the Company has committed to maintaining certain employment levels through 2020. Failure by the Company to maintain these employment levels will result in repayment of related reimbursements with interest. The Company recognized in selling, general and administrative expenses in the Technology Products segment approximately $0.6 million in payroll reimbursements related to this agreement in the six month period ended June 30, 2014. Exit, severance and recruitment costs to implement the facility, together with other cost reduction initiatives in Europe, aggregated to $5.2 million and $1.1 million in the second quarter of 2014 and 2013, respectively, and $6.9 million and $6.1 million for the six month periods ended June 30, 2014 and 2013, respectively.

Industrial Products

Our Industrial Products segment sells a wide array of MRO products which are marketed in North and Central America. Most of these products are manufactured by other companies; however, the Company does offer a selection of products that are manufactured for our own design and marketed under the trademarks Global™, GlobalIndustrial.com™ and Nexel™. Industrial products accounted for 17% and 15% of our net sales for the three month periods ended June 30, 2014 and 2013, respectively, and 16% and 13% of our net sales for the six month periods ended June 30, 2014 and 2013, respectively. In both of these product groups, we offer our customers a broad selection of products, prompt order fulfillment and extensive customer service.

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 2013 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, net. 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, 2013. There have been no significant changes in the application of critical accounting policies or estimates during 2014. 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.

In April 2014, the FASB issued ASU 2014-08, "Presentation of Financial Statements and Property, Plant and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity". This ASU provides new guidance related to the definition of a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. This new guidance is effective for annual periods beginning on or after December 15, 2014 and interim periods within those years. Beginning in 2015, the Company will apply this new guidance, as applicable, to future disposals of components or classifications held for sale.

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers". This ASU provides new guidance related to how an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In addition, this ASU specifies new accounting for costs associated with obtaining or fulfilling contracts with customers and expands the required disclosures related to revenue and cash flows from contracts with customers. This new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and can be adopted either retrospectively to each reporting period presented or as a cumulative effect adjustment as of the date of the adoption, with early application not permitted. The Company is currently determining its implementation approach and assessing the impact, if any, on the condensed consolidated financial statements.


Results of Operations

Three and Six Months Ended June 30, 2014 compared to the Three and Six Months
Ended June 30, 2013

Key Performance Indicators* (in millions):


                               Three Months Ended June 30,             Six Months Ended June 30,
                                                         %                                   %
                             2014         2013         Change        2014       2013      Change
Net sales by segment:
Technology Products            $687.6       $ 685.8         0.3%    $1,430.4   $ 1,459.3    (2.0)%
Industrial Products             142.1         118.6        19.8%       271.2       224.2     21.0%
Corporate and other               1.4           1.3         7.7%         2.9         2.8      3.6%
Consolidated net sales         $831.1       $ 805.7         3.2%    $1,704.5   $ 1,686.3      1.1%
Net sales by channel:
Technology Products -                                       9.1%                              9.5%
EMEA                           $277.1       $ 254.1                   $600.1      $548.2
Technology Products - NA                                    5.5%                              3.5%
(B2B)                           205.5         194.8                    400.9       387.2
Industrial Products             142.1         118.6        19.8%       271.2       224.2     21.0%
Corporate and other               1.4           1.3         7.7%         2.9         2.8      3.6%
Total B2B                      $626.1        $568.8        10.1%    $1,275.1    $1,162.4      9.7%
Technology Products - NA
(Consumer)                      205.0         236.9      (13.5)%       429.4       523.9   (18.0)%
  Consolidated net sales       $831.1       $ 805.7         3.2%    $1,704.5   $ 1,686.3      1.1%
Consolidated gross              14.8%         14.4%         0.4%       14.7%       14.1%      0.6%
margin
Consolidated SG&A costs*       $128.7       $ 123.1         4.5%      $257.9     $ 253.4      1.8%
Consolidated SG&A costs*
as a % of net sales             15.5%         15.3%         0.2%       15.1%       15.0%      0.1%
Operating income (loss)
by segment:*
Technology Products           $(13.2)      $ (12.1)         9.1%     $(19.8)    $ (23.3)   (15.0)%
Industrial Products              12.4          11.1        11.7%        22.1        19.6     12.8%
Corporate and other             (4.6)         (5.8)      (20.7)%       (9.0)      (11.8)   (23.7)%
Consolidated operating
income (loss)                  $(5.4)       $ (6.8)      (20.6)%      $(6.7)    $ (15.5)   (56.8)%
Operating margin by
segment*
Technology Products            (1.9)%        (1.8)%       (0.1)%      (1.4)%      (1.6)%      0.2%
Industrial Products              8.7%          9.4%       (0.7)%        8.1%        8.7%    (0.6)%
Consolidated operating
margin                         (0.6)%        (0.8)%         0.2%      (0.4)%      (0.9)%      0.5%
Effective income tax
rate                             7.5%         14.1%       (6.6)%        4.5%       23.9%   (19.4)%
Net income (loss)              ($6.2)       $ (6.1)         1.6%      $(9.2)    $ (12.4)   (25.8)%
Net margin                     (0.7)%        (0.8)%         0.1%      (0.5)%      (0.7)%      0.2%

*includes special charges, net. See Note 5 of Notes to Condensed Consolidated Financial Statements.

NET SALES

SEGMENTS

The Technology Products segment, which includes our European and North American technology operations, showed slight sales improvement during the quarter, benefiting from the SCC acquisition and improved B2B sales from both European and North American markets. However, sales declined for the six month period ended June 30, 2014 primarily the result of continued softness in North American consumer channels, principally internet and retail sales. The Company believes the major drivers of the decline in North American consumer channel net sales is attributable to web, television and retail store sales declines, resulting from sales volume and selling price erosion in certain core product categories such as personal computers and televisions. The Company believes the decline in sales and price pressures for consumer electronics are attributable to a variety of well publicized industry and market trends, including consumer preferences for new generation tablets, which erode laptop and desktop PC sales, the market share for tablets held by a major manufacturer, which does not sell to the Company for U.S. markets, the consolidation of prior generations of separate devices and functions into a single integrated device (such as GPS and cameras being integrated with smart phones), the ongoing movement of traditional brick and mortar store sales to online/ecommerce vendors, and the increasing influence of a dominant company in the online/ecommerce marketplace. The revenue growth within the EMEA technology business was more than offset by weak sales from the North American operations. On a constant currency basis, Technology Products net sales decreased 1.8% and 3.8%, respectively, for the three and six month periods ended June 30, 2014.

The Industrial Products net sales increase is attributable to broad based growth across both new and core product categories and the continued expansion of our private label and brand name selections as well as the hiring of additional sales personnel. On a constant currency basis, Industrial Products net sales increased 20.2% and 21.3%, respectively, for the three and six month periods ended June 30, 2014.


CHANNELS

Business to business sales:

The Company experienced growth in worldwide business to business channel sales for the quarter as well as six months period ended June 30, 2014.

The European Technology Products sales increase is attributable to continued sales growth in France, sales from the SCC acquisition, and favorable currency movements in the three and six month periods ended June 30, 2014. On a constant currency basis, European Technology Products sales grew 2.4% and 3.4%, respectively, for the three and six month periods ended June 30, 2014.

The North American Technology Products business to business sales increase is attributable to an increase in the sale of commercial desktops and laptops during the quarter and sales of motherboards/CPU's and refurbished computers for the six month period ended June 30, 2014. On a constant currency basis, North American Technology Products business to business sales grew 6.2% and 4.4%, respectively, for the three and six month periods ended June 30, 2014.

The Industrial Products net sales increase is attributable to broad based growth across both new and core product categories and the continued expansion of our private label and brand name selections. On a constant currency basis, Industrial Products net sales increased 20.2% and 21.3%, respectively, for the three and six month periods ended June 30, 2014.

Consumer sales:

The North American Technology Products consumer sales decline resulted from $11.6 million and $25.0 million in revenue from retail stores closed in 2013 for the three and six month periods ended June 30, 2014, respectively, and from continued softness in television shopping, internet and retail sales. Consumer channel sales declines were primarily the result of declines in sales of personal computers and televisions driven by both volume and selling price erosion. On a constant currency basis, North American Technology Products consumer sales declined 12.9% and 17.4%, respectively, for the three and six month periods ended June 30, 2014.

GROSS MARGIN

The consolidated gross margin increase is primarily due to the Industrial Products segment sales contributing a larger percentage to gross profit dollars as compared to 2013 as well as moderate improvement in gross margin in both our North American and European Technology businesses. Gross margin is dependent on variables such as product mix, vendor price protection and other sales incentives, competition, pricing strategy, cooperative advertising funds 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 ("SG&A"), EXCLUDING SPECIAL CHARGES

SG&A expense increases for the three and six month periods ended June 30, 2014 is primarily attributable to our Industrial and European Technology Products B2B business partially offset by expense decreases in North America Technology Products. Significant expense increases related to the Industrial Products segment for the three and six months periods ended June 30, 2014 include salary and related costs of approximately $1.6 million and $3.5 million, respectively, and internet advertising spending of approximately $0.8 million and $3.3 million, respectively. The Industrial Products segment continues to increase its advertising spend, in particular internet advertising, as it continues to expand its online product offerings. In Europe, the Technology Products segment also had increased SG&A expenses due primarily to a temporary overlap in costs as we transition functions from individual country operations to our new European shared services center. The significant expense increases for the three and six month periods ended June 30, 2014 for Europe include approximately $1.6 million and $3.1 million, respectively, of salary and related costs of additional sales personnel and additional headcount for the shared services center, partially offset by $0.6 million in reimbursements for shared service center salaries under the incentive agreement with HITA, and $0.3 million and $0.3 million, respectively, of increased rent and related costs. The Technology Products segment in North America had reduced SG&A expenses due primarily to the closing of underperforming retail stores which started in the second quarter of 2013. Significant expense decreases for the three and six month periods ended June 30, 2014 for North America Technology Products include approximately $2.9 million and $6.3 million, respectively, in reduced salary and related costs, $0.6 million and $1.7 million of reduced rent and related costs, offset by increased internet advertising spending of approximately $0.9 million and $1.4 million, respectively.


SPECIAL CHARGES, NET

The Company's Technology Products segment incurred special charges of approximately $6.0 million in the second quarter of 2014. These charges included approximately $5.0 million in workforce reductions related to the restructuring of our European operations, $0.2 million in continued recruitment costs for the European shared services center, $0.2 million for changes in the estimate of lease valuation accruals for closed retail stores, $0.2 million in charges related to the final sale of the facility which had been used in connection with our previously exited PC manufacturing business and $0.4 million of additional legal and professional fees related to the previously disclosed completed investigation and settlement with former officers and employees. For the six month periods ended June 30, 2014, the Company's Technology Products segment incurred $8.4 million in special charges. These charges included approximately $6.5 million in workforce reductions related to the restructuring of our European operations, $0.4 million in continued recruitment costs for the European shared services center, $0.5 million for changes in the estimate of lease valuation accruals and $0.2 million in other costs related to the retail stores that were closed in 2013 and $0.2 million in charges related to the final sale of the facility which had been used in connection with our previously exited PC manufacturing business and $0.6 million of additional legal and professional fees related to the previously disclosed completed investigation and settlement with former officers and employees. The Company expects to incur additional charges of approximately $5 to $6 million and expend additional cash of approximately $13 to $14 million, including the costs accrued at June 28, 2014, in the future to complete the implementation of the European shared services center. Expected impacts on future costs, when the shared service center is fully implemented, are expected to be a reduction in our annual cost structure in the $9 to $11 million range, pre-tax.

The Company's Technology Products segment recorded, in the second quarter of 2013, $1.5 million related to the closing of underperforming retail stores, $1.1 million related to initial startup costs for the European shared services center, approximately $0.8 million of reserve adjustments related to the . . .

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