Systemax Inc. — Q3 2018 Form 10-Q
Business context and period. The quarter ended September 30, 2018 (actual fiscal quarter ended September 29). Following the August 31 sale of its France-based IT reseller, continuing operations consist primarily of the North American Industrial Products Group (IPG), selling industrial and MRO supplies. The filing reports the France business and certain previously sold businesses as discontinued operations.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Continuing-operations sales | $235.8 million | $204.4 million | $679.2 million | $597.3 million |
| Gross margin | 34.9% | 34.8% | 34.6% | 34.8% |
| Operating income, continuing operations | $18.4 million | $12.5 million | $47.8 million | $34.5 million |
| Operating margin, continuing operations | 7.8% | 6.1% | 7.0% | 5.8% |
| Net income, continuing operations | $15.1 million | $11.3 million | $37.2 million | $32.9 million |
| Net income (loss), discontinued operations | $163.7 million | $0.0 million | $174.4 million | ($26.3 million) |
| Total net income | $178.8 million | $11.3 million | $211.6 million | $6.6 million |
| Diluted EPS, continuing operations | $0.40 | $0.30 | $0.98 | $0.88 |
Cash, liquidity and obligations. Cash was $302.8 million at September 30, up $118.3 million from year-end 2017; working capital was $346.7 million. Nine-month operating cash flow was $15.2 million from continuing operations, but $19.9 million used on a consolidated basis after $35.1 million of outflows from discontinued operations. Investing activities provided $246.7 million, primarily reflecting the France sale; financing activities used $111.5 million, including $105.2 million of dividends. The company had no revolver borrowings, with $71.1 million of excess availability under its $75 million facility, and reported covenant compliance. Contractual obligations totaled $117.0 million, including $93.2 million of operating leases. Former NATG facilities carried $17.5 million of lease obligations and a $6.7 million reserve.
Material changes and unusual items
- Continuing sales increased 15.4% in Q3 and 13.7% year to date. Management cited strong demand, digital customer acquisition and growth in managed sales channels. Canada sales grew 32.2% in Q3 and 33.0% year to date; U.S. sales grew 14.7% and 12.9%, respectively.
- Continuing operating income increased 47.2% in Q3 and 38.6% year to date. Q3 gross margin edged up 0.1 percentage point; nine-month margin declined 0.2 point. Lower SD&A as a share of sales supported operating leverage.
- Total net income includes a $178.2 million pre-tax gain on the France sale. Sale proceeds were approximately $267.3 million, offset by $82.5 million of net assets sold and $6.6 million of related expenses. Discontinued operations contributed $163.7 million of Q3 net income after tax; total net income therefore is not a measure of ongoing operating performance.
- Nine-month dividends paid were $105.2 million, including a $37.2 million special dividend. The company also repurchased 232,550 shares for $9.1 million under a 2-million-share authorization.
- The Q3 effective tax rate on continuing operations was 19.3%, versus 8.1% a year earlier; the nine-month rates were 22.5% and 5.2%. The company had not completed its analysis of certain Tax Cuts and Jobs Act effects and expected to finalize it in Q4 2018.
Outlook, risks and contingencies
No quantified sales or earnings guidance was provided. Management said cash and credit availability should fund working capital and other requirements for at least 12 months, anticipated 2018 capital expenditures of up to $8 million, and expressed confidence in continued long-term profitability improvement. It expected Q4 gross margin to be slightly below Q2 and Q3 levels, largely due to product mix.
Management cited freight capacity and costs, labor tightness, and tariffs as pressures. The expanded third tariff list, effective at quarter-end, affects some products sourced directly from China; the company planned selective price increases and alternative sourcing, but said mitigation was not assured. Further adjustments to NATG lease reserves may be needed if projected sublease income does not materialize. The filing also describes ordinary-course litigation and state unclaimed-property inquiries; management did not expect reasonably possible losses beyond accruals to be material, but outcomes remain uncertain. The company estimated adoption of the new lease accounting standard would increase right-of-use assets and lease liabilities by more than $50 million, subject to the lease portfolio at adoption.
Investor verification priorities
- Separate the recurring IPG results from the France disposal gain and other discontinued-operation results when assessing earnings and EPS.
- Verify the final tax accounting for the France sale and remaining TCJA measurement-period adjustments.
- Track cash conversion and working-capital needs, given the gap between continuing operating income and nine-month continuing operating cash flow.
- Monitor tariff-related sourcing, pricing and margin effects, particularly as pre-tariff inventory sells through.
- Reassess NATG lease reserves, sublease assumptions, remaining contractual obligations and future cash costs.