GLOBAL INDUSTRIAL Co annual report, FY2016

Business context and reporting period

Systemax Inc. (the filing’s registrant; its Industrial Products Group operates under Global Industrial brands) filed this Form 10-K for the fiscal year ended December 31, 2016. The company primarily markets industrial maintenance, repair and operations products in North America through IPG, and information technology and consumer electronics products in Europe through EMEA. Results are generally presented for continuing operations unless stated otherwise.

Systemax sold certain North American Technology Group (NATG) assets in December 2015 and continued winding down the remaining business. It also sold Misco Germany in September 2016 and its rebate-processing business at year-end; those two businesses remained in GAAP continuing operations because the sales did not qualify as discontinued operations.

Financial performance and liquidity

• Sales declined 9.4% year over year. IPG sales increased 2.4% to $715.6 million; EMEA sales fell 8.7% to $960.9 million. The NATG wind-down and lower EMEA sales were major factors in the consolidated decline.
• Gross margin improved 0.8 percentage point, while SG&A excluding special charges declined to $314.7 million from $338.9 million. Special charges in continuing operations were $5.9 million, down from $27.9 million.
• IPG operating income was $34.3 million, versus $43.7 million; EMEA recorded an operating loss of $12.5 million, versus $10.8 million. Corporate and other recorded a $14.9 million operating loss.
• Fourth-quarter continuing-operations sales were $414.7 million and gross profit was $81.7 million; reported quarterly net income was $0.7 million. Fourth-quarter 2015 sales were $465.3 million and net loss was $11.6 million. These quarterly figures exclude discontinued operations.
• Cash was $149.7 million at year-end, down $65.4 million. Working capital was $186.2 million, down $28.0 million; total assets were $566.1 million and shareholders’ equity was $214.4 million.
• No revolver borrowings were outstanding at year-end. The $75 million secured facility had $58.9 million available, with $5.5 million of letters of credit outstanding; the company reported covenant compliance. Capital lease obligations were $0.2 million.
• Net operating-lease commitments, after subleases, totaled $147.8 million. Total contractual obligations, including leases and purchase and other obligations, were $170.6 million.

Material changes versus prior period

• Operating income from continuing operations improved by $28.2 million, moving from a loss to a small profit, primarily alongside lower special charges and reduced NATG-related operating losses. Total net loss also narrowed, but remained substantial.
• Continuing-operations sales fell $174.6 million. IPG’s growth was more than offset by EMEA declines and the absence of NATG continuing-operations sales. The company notes that 2016 had 52 weeks versus 53 weeks in 2015.
• Operating cash flow from continuing operations swung from $135.6 million provided in 2015 to $33.3 million used in 2016. Management attributed the 2016 use principally to working-capital movements, including payments of accounts payable and accrued liabilities. Discontinued operations used a further $24.1 million.
• 2016 total discontinued-operations net loss was $24.7 million, compared with $51.5 million in 2015. The discontinued business had $11.8 million of 2016 sales, largely reflecting wind-down activity.
• The company recorded a $3.9 million gain on the sale of its rebate-processing business. Misco Germany generated $33.9 million of 2016 sales and a $6.4 million net loss, including approximately $3.7 million of intercompany charges.

Outlook, management commentary, risks and unusual items

• Management expected cash, future operating cash flows and undrawn credit availability to cover working capital and other requirements for at least the next 12 months. It anticipated up to $5.0 million of 2017 capital expenditures, not contractually committed at filing time, and $1 million to $5 million of additional NATG wind-down costs, expected in discontinued operations.
• Management described EMEA technology markets as intensely competitive, with pricing and freight discounts pressuring revenue and profit. UK operations remained challenged, including Brexit-related market pressures; France and the Netherlands had stronger performance.
• IPG’s margin was pressured by freight economics, distribution costs, staffing and system-transition costs, and a $1.7 million inventory adjustment identified during a warehouse-management-system conversion. Completion of the new system was anticipated in the first quarter of 2017.
• Other notable 2016 charges included a $1.7 million impairment of UK long-lived assets, $0.4 million of goodwill and intangible impairments, and a $0.7 million valuation allowance against European deferred tax assets. The filing also reports $9.1 million of total deferred-tax-asset valuation allowances recorded during the year.
• Key risks include foreign-exchange exposure, competitive pricing and margin pressure, reliance on key suppliers, inventory obsolescence, IT and cybersecurity disruption, execution of the NATG wind-down, and potential changes to sales-tax rules. Two vendors represented 15.2% and 13.8% of 2016 purchases.
• Legal and regulatory matters include VAT, intellectual-property, tax and unclaimed-property matters; an entity representing 43 states was conducting an unclaimed-property audit. Management did not expect reasonably possible losses above accruals to be material, but stated outcomes remain uncertain.
• A court awarded Systemax approximately $36 million in restitution from two former NATG executives; the company received approximately $1.3 million during 2016 and said it would pursue collection. The filing also describes a government investigation whose ultimate outcome could not be predicted.
• The company paid $0.10 per share in dividends in 2016 and anticipated a regular quarterly dividend subject to profitability, cash needs and credit-facility limits. It reported no conditions raising substantial doubt about its ability to continue as a going concern.

Important facts for investors to verify

1. Reconcile the reported GAAP continuing-operations results with the company’s supplemental non-GAAP presentation, which excludes specified NATG, Germany and rebate-processing results and adjusts for selected items.
2. Track operating cash flow, working-capital requirements, receivables collection and the reduction in cash; distinguish U.S.-available liquidity from $42.1 million held in foreign subsidiaries that management said was not readily available to the U.S. parent on a tax-efficient basis.
3. Assess whether IPG can sustain sales growth and recover margin after the warehouse-system transition and inventory adjustment, and whether EMEA can improve profitability amid UK market pressure.
4. Monitor remaining NATG lease obligations and wind-down costs, and whether management’s $1 million to $5 million estimate is sufficient.
5. Review vendor concentration, long-term lease commitments, revolver availability and covenants, potential legal and tax exposures, and the collectability of the restitution award.