GLOBAL INDUSTRIAL Co annual report, FY2018

Business context and reporting period

Systemax Inc. (the filing entity; its continuing business markets products under the Global Industrial brand) filed this Form 10-K for the fiscal year ended December 31, 2018. The company now operates primarily through its North American Industrial Products Group (IPG), selling industrial, MRO and general business supplies through e-commerce and relationship sales. The fiscal year comprised 52 weeks; fourth-quarter figures below are unaudited and exclude discontinued operations unless noted.

Systemax sold its France-based IT reseller business on August 31, 2018. Its results and sale gain are reported in discontinued operations, leaving North American IPG as the core continuing business.

Key financial metrics

Continuing sales rose 13.3%; operating income increased 35.0%. Gross margin slipped 0.2 percentage points, as improved product margins were offset by weaker freight margins. Continuing net income fell 24.4%, in part because 2017 included a $20.0 million tax benefit. 2018 total earnings included a $178.9 million pretax gain on the France sale; the sale gain and discontinued operations should not be treated as recurring operating performance.

Fourth-quarter continuing sales were $217.7 million versus $194.5 million in 2017; gross profit was $73.0 million versus $65.3 million; and continuing net income was $12.3 million versus $32.6 million. The prior-year quarter included substantial tax benefits.

Operating cash flow from continuing operations was $9.8 million, down from $44.1 million. Working-capital movements used $56.1 million, mainly from higher receivables and inventory and changes in payables and accruals. Continuing capital expenditures were $4.5 million. Cash at year-end was $295.4 million, compared with $184.5 million; working capital was $117.8 million, down from $178.3 million, principally reflecting the declared special dividend.

The company had no revolving-credit borrowings at year-end, with $71.1 million of excess availability under its $75 million secured facility after letters of credit. It reported $137.7 million of shareholders’ equity and $392.3 million of total liabilities. The $243.5 million special dividend payable at year-end was paid January 3, 2019, so reported year-end cash preceded that payment.

Material changes versus the prior comparable period

• IPG sales advanced 13.3%, reflecting growth across product categories and sales channels. U.S. revenue rose 12.5%; Canada sales increased approximately 30.8% (30.7% constant currency).
• IPG operating income increased to $82.6 million from $69.6 million. Operating margin improved to 9.2% from 8.8%, supported by sales growth and expense leverage.
• IPG gross margin decreased to 34.3% from 34.5%. Management cited higher carrier costs and freight-margin pressure; product margins improved as sourcing shifted toward stocked goods.
• Cash from continuing operations declined amid increased working-capital investment. Inventory was $107.3 million versus $88.2 million; receivables were $84.1 million versus $73.1 million.
• Continuing business scope narrowed following the France sale. Continuing net sales exclude $352.0 million of 2018 sales from discontinued operations.

Outlook, commentary, risks and unusual items

• Management anticipated 2019 capital expenditures of $8–$12 million, including a planned distribution-footprint expansion and new distribution center in the second half of 2019. It expected cash, operating cash flow and credit availability to meet requirements for at least the next 12 months.
• The board declared a regular quarterly dividend of $0.12 per share payable in March 2019. Future dividends are subject to business needs and credit-facility restrictions. The 2018 declared dividends included a $6.50-per-share special dividend.
• Tariffs on China-sourced goods increased procurement costs. The company planned selective price increases and alternative sourcing, but warned these steps may not fully offset tariffs and could affect demand or supply continuity. An industry anti-dumping investigation involving Chinese steel racks may result in duties; the amount and timing were uncertain.
• Other material operating risks include freight and labor cost increases, supplier and carrier disruptions, inventory obsolescence, intense competition, distribution capacity, IT/cloud outages and cybersecurity breaches, and currency movements. A 10% exchange-rate change would have changed 2018 sales by approximately $4.2 million and pretax income by approximately $0.05 million.
• Remaining NATG and SARL wind-down costs were estimated at $1–$2 million during 2019 or later, primarily in discontinued operations. Additional France-sale tax-indemnity costs were possible. Litigation and state unclaimed-property and tax matters remained pending; management did not expect reasonably possible losses beyond recorded accruals to be material, but outcomes were uncertain.
• Other unusual items included a $3.1 million net benefit from state audit settlements, offset by an intangible-asset impairment in continuing operations; the company also wrote off approximately $1.9 million of C&H Distributors intangible assets. The France disposal generated the large, nonrecurring discontinued-operations gain.
• Management reported effective disclosure controls and internal control over financial reporting; the independent auditor gave unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

• Reconcile recurring IPG performance with reported total earnings, which were materially affected by the France-sale gain and the prior-year tax benefit.
• Track operating cash conversion and working-capital needs, particularly receivables, inventory, payables and cash flow after payment of the special dividend.
• Assess the cost, timing and execution risks of the planned 2019 distribution-center expansion and projected capital spending.
• Monitor tariff exposure, alternative sourcing, freight costs and the potential outcome of the steel-rack trade investigation.
• Review the status of France-sale tax indemnities, NATG lease exits and remaining litigation, tax and unclaimed-property proceedings.
• Consider that the reported $295.4 million year-end cash balance was before the $243.5 million special-dividend payment on January 3, 2019; the filing does not provide a post-payment cash balance.