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Section 1: 10-K (ESND-10K-20161231)

esnd-10k_20161231.htm

 

 

United States

Securities and Exchange Commission

Washington, DC 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 0-10653

 

ESSENDANT INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware

 

36-3141189

(State or Other Jurisdiction of
Incorporation or Organization)

 

(I.R.S. Employer
Identification No.)

One Parkway North Boulevard

Suite 100

Deerfield, Illinois 60015-2559

(847) 627-7000

(Address, Including Zip Code and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Securities registered pursuant to
Section 12(b) of the Act:
Common Stock, $0.10 par value per share

 

Name of Exchange on which registered:
NASDAQ Global Select Market

(Title of Class)

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes       No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes       No  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes       No  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 and Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes       No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes        No  

The aggregate market value of the common stock of Essendant Inc. held by non-affiliates as of June 30, 2016 was approximately $0.68 billion.

On February 21, 2017, Essendant Inc. had 37,472,971 shares of common stock outstanding.

Documents Incorporated by Reference:

Certain portions of Essendant Inc.’s definitive Proxy Statement relating to its 2017 Annual Meeting of Stockholders, to be filed within 120 days after the end of Essendant Inc.’s fiscal year, are incorporated by reference into Part III.

 


ESSENDANT INC.

FORM 10-K

For The Year Ended December 31, 2016

TABLE OF CONTENTS

 

 

 

 

  

Page No.

 

 

Part I

  

 

 

 

 

Item 1.

 

Business

  

1

 

 

Executive Officers of the Registrant

  

4

Item 1A.

 

Risk Factors

  

7

Item 1B.

 

Unresolved Comment Letters

  

7

Item 2.

 

Properties

  

11

Item 3.

 

Legal Proceedings

  

11

Item 4.

 

Mine Safety Disclosure

  

11

 

 

Part II

  

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

  

12

Item 6.

 

Selected Financial Data

  

14

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

15

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

  

27

Item 8.

 

Financial Statements and Supplementary Data

  

28

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

  

66

Item 9A.

 

Controls and Procedures

  

66

Item 9B.

 

Other Information

  

66

 

 

Part III

  

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

  

68

Item 11.

 

Executive Compensation

  

68

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  

68

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

  

68

Item 14.

 

Principal Accounting Fees and Services

  

68

 

 

 

 

 

Part IV

  

 

Item 15.

 

Exhibits and Financial Statement Schedules

  

69

 

 

 

 

 

Signatures

  

73

 

 

Schedule II—Valuation and Qualifying Accounts

  

74

 

 

 


PART I

ITEM  1.

BUSINESS.

General

Essendant Inc. (formerly known as United Stationers, Inc.) is a leading national wholesale distributor of workplace items including janitorial, foodservice and breakroom supplies (JanSan), technology products, traditional office products, industrial supplies, cut sheet paper products, automotive products and office furniture. Except where otherwise noted, the terms “Essendant” and “the Company” refer to Essendant Inc. and its consolidated subsidiaries. The parent holding company, Essendant Inc. (ESND), was incorporated in 1981 in Delaware. ESND’s only direct wholly owned subsidiary and principal operating company is Essendant Co. (ECO) incorporated in 1922 in Illinois. Essendant has one reportable segment and operates principally within the United States, with additional operations in Canada and Dubai, United Arab Emirates (“UAE”).

Essendant’s goal is to power our partners to reach the modern workplace through smarter operations, business growth and category expansion. To achieve this goal, Essendant leverages its product portfolio, fulfillment network and industry specific sales, marketing, digital and strategic services.

The Company has begun implementing six actions to improve the value of our business, which include:

 

Merchandising excellence through supplier negotiation to reduce cost of goods sold, driving Essendant brand strategies and assortment optimization to increase profitability.

 

Alignment of pricing with cost to serve through the standardization of contracts and reevaluation of pricing.

 

Stabilization of the JanSan sales channel by improving the customer experience and comprehensive sales, marketing and care programs to regain lost sales.

 

Industrial growth through continued diversification and leveraging of the product set to a broader customer base and focus on online and governmental growth initiatives.

 

Additional cost reductions through network optimization, productivity improvements and in-bound freight management activities.

 

Reduce working capital through reductions in inventory and continued debt reductions through free cash flow generation.

 

Broad and Diverse Product Portfolio

Essendant sells over 190,000 products and is a leading national wholesale distributor in the following product categories:

Janitorial, Foodservice and Breakroom Supplies (“JanSan”). The Company provides access to over 22,000 items in these lines: janitorial supplies (cleaners and cleaning accessories), breakroom items (food and beverage products), foodservice consumables (such as disposable cups, plates and utensils), safety and security items, and paper and packaging supplies. This product category provided 26.7% of net sales in 2016.

Technology Products. The Company provides access to approximately 11,000 items, including imaging supplies, data storage, digital cameras, computer accessories and computer hardware items such as printers and other peripherals. Essendant provides these products to value-added computer resellers, office products dealers, drug stores, grocery chains and online merchants. The technology product category generated 25.1% of the Company’s 2016 consolidated net sales.

Traditional Office Products. The Company provides access to a broad range of office supplies. It carries over 20,000 brand-name and Essendant brand products, such as filing and record storage products, business machines, presentation products, writing instruments, shipping and mailing supplies, calendars and general office accessories. This product category contributed 16.0% of net sales during 2016.

Industrial Supplies. Essendant provides access to over 130,000 items including hand and power tools, safety and security supplies, janitorial equipment and supplies, other various industrial MRO (maintenance, repair and operations) items, oil field and welding supplies. In 2016, the industrial product category accounted for 10.4% of the Company’s net sales.

Cut Sheet Paper Products. Essendant provides access to a broad range of cut sheet paper products including brand-name and Essendant brand copy paper with a wide assortment of styles and types. In 2016, the cut sheet paper product category accounted for 7.4% of the Company’s net sales.

Automotive Products. The Company has a broad portfolio of automotive aftermarket tools and equipment. In 2016, this product category accounted for 5.9% of the Company’s net sales.

Office Furniture. Essendant provides access to approximately 4,000 products including desks, filing and storage solutions, seating and systems furniture, along with a variety of products for niche markets such as education, government, healthcare and professional services. This product category represented 5.6% of net sales for the year.

1


The remainder of the Company’s consolidated net sales came from freight, services, advertising and other revenues.

Essendant brand products within each of the Company’s product categories help resellers provide quality value-priced items to their customers. These include Universal® office products, Boardwalk® janitorial, foodservice and breakroom products, Alera® office furniture, Innovera® technology products, Windsoft® paper products, and Anchor Brand® and Best Welds® welding, industrial, safety and oil field pipeline products. Essendant also offers the following automotive brand products: Advanced Tool Design (ATD), Finish Pro, Painters Pride, Quipall, Nesco, Performance One, and AIM.

During 2016, Essendant brand products accounted for approximately 15.5% of Essendant’s net sales.

 

Extensive Fulfillment Network

Essendant’s fulfillment and distribution network enables the Company to ship most products on an overnight basis to more than 90% of the U.S. with an average line fill rate of approximately 97%. Essendant’s domestic operations generated approximately $5.3 billion of its $5.4 billion in 2016 consolidated net sales, with its international operations contributing an additional $0.1 billion to 2016 net sales.

The Company’s network of 70 distribution centers is spread across the nation to facilitate delivery. Essendant has a dedicated fleet of approximately 480 trucks. This enables Essendant to make direct deliveries to resellers from regional distribution centers and local distribution points.

In addition to providing a broad product selection that allows resellers to offer products to their customers that they do not physically stock, the company also offers the “Wrap and Label” program. “Wrap and Label” gives resellers the option to receive individually packaged orders ready to be delivered to their end consumers. For example, when a reseller places orders for several individual consumers, Essendant can pick and pack the items separately, placing a label on each package with the consumer’s name, ready for delivery to the end consumer by the reseller. Resellers benefit from the “Wrap and Label” program because it eliminates the need to break down bulk shipments and repackage orders before delivering them to consumers.

Sales, Marketing, Digital and Strategic Services

Essendant’s sales, marketing, digital and strategic services, including customer care capabilities, are key to its position as a value-add distributor. Essendant provides its resellers a variety of digital tools to enhance their ability to compete online. These tools include digitized product content, website development, digital analytics, and marketing and merchandising tools to drive the performance of resellers’ websites. An important component of the value proposition is that the Company produces integrated print and digital tools in return for a deeper commercial relationship with its resellers.

Essendant also provides specific services that enable resellers to improve their operating and strategic business models. These services include primary research efforts, brand strategy and development, campaign development, customer segmentation and cost management, and training programs designed to help resellers improve their sales and marketing techniques.

Customers

Essendant serves a diverse group of approximately 29,000 reseller customers. They include office and workplace dealers; facilities and maintenance distributors; technology, military, automotive aftermarket, national big-box retailers and healthcare and vertical suppliers; industrial distributors and internet retailers.

To help its customers, Essendant leverages its common operations and IT platform for JanSan, traditional office products, cut sheet paper products and office furniture. The Company offers an extensive national fulfillment and logistics network, enhanced digital solutions, integrated marketing tools, broad product portfolio, and the Company’s long-standing industry expertise and dedicated support team with intimate knowledge of what customers need. The Company also operates CPO Commerce which sells tools, do-it-yourself equipment and other items online to the consumer market.

During 2016 the Company’s net sales were to independent resellers (76% of consolidated net sales), national big-box retailers (9%) and internet retailers (15%). One customer, W.B. Mason Co., Inc., accounted for approximately 11% of its 2016 consolidated net sales. No other single customer accounted for more than 10% of 2016 consolidated net sales.

2


Purchasing and Merchandising Strategy

As a leading wholesale distributor of workplace items, Essendant leverages its broad product selection as a key merchandising strategy. Based on Essendant’s purchasing volume it receives substantial supplier allowances and can realize significant economies of scale in its logistics and distribution activities. In 2016, the Company’s largest supplier was Hewlett-Packard Company, which represented approximately 20% of the Company’s total purchases.

The Company’s merchandising department is responsible for selecting merchandise and for managing the entire supplier relationship throughout each of the product categories. Product selection is based on three factors: end-consumer acceptance; anticipated demand for the product; and the manufacturer’s total service, price and product quality.

Competition

The markets in which the Company participates are highly competitive. Historically, the Company competed with other wholesale distributors, manufacturers of the products the Company sells, warehouse clubs and the business-to-business sales divisions of national business products resellers, but as the competitive landscape continues to evolve, the Company has experienced increased competition from internet retailers selling to the Company’s resellers, especially in the JanSan, technology and office product categories. Essendant competes primarily on the basis of diversity and breadth of category and product lines, reliability, variety and availability of products, nationwide next day delivery, product affordability, and the quality of industry specific sales support, marketing, digital and strategic services.

 

Employees

As of January 31, 2017, Essendant employed approximately 6,600 associates.

Approximately 660 of the shipping, warehouse and maintenance associates at certain of the Company’s Baltimore, Los Angeles and New Jersey distribution centers are covered by collective bargaining agreements. The bargaining agreements in the Los Angeles and New Jersey distribution centers were renegotiated in 2014. The bargaining agreement in Baltimore was renegotiated in August 2015.

3


Executive Officers Of The Registrant

The executive officers of the Company are as follows:

 

Name, Age and Position with the Company

  

Business Experience

Robert B. Aiken
  54, President, Chief Executive Officer

  

Robert B. Aiken, Jr. was elected to the Company’s Board of Directors in February 2015 and was then named interim CEO in May 2015, followed by CEO in July 2015. He previously served on the Company’s Board of Directors from December 2010 to May 2014, at which time he stepped down from the Board due to the demands of his position as the Chief Executive Officer of Feeding America, the nation’s leading hunger relief organization. Mr. Aiken was appointed CEO of Feeding America in November 2012. Prior to this role, Mr. Aiken was the CEO of the food company portfolio at Bolder Capital, a private equity firm. Mr. Aiken previously served as Managing Director of Capwell Partners LLC, a private-equity firm focused on companies offering health and wellness products and services. Mr. Aiken was the President and Chief Executive Officer of U.S. Foodservice from 2007 to 2010, one of the country’s premier foodservice distributors. Mr. Aiken joined U.S. Foodservice in 2004 and held several senior executive positions including President and Chief Operating Officer and Executive Vice President of Strategy and Governance. From 2000 until 2004, Mr. Aiken served as President and Principal of Milwaukee Sign Co., a privately-held manufacturing firm. From 1994 to 2000, Mr. Aiken was an executive with Specialty Foods Corporation, where he held several positions, including President and Chief Executive Officer of Metz Baking Company. Early in Mr. Aiken’s career, he worked as a business lawyer. Mr. Aiken also serves as a director of Red Robin Gourmet Burgers.

 

 

Earl C. Shanks
  60, Senior Vice President, Chief Financial Officer

  

Earl C. Shanks was appointed Senior Vice President and Chief Financial Officer in November 2015. Prior to joining Essendant, Mr. Shanks served as the Chief Financial Officer at Convergys Corporation from 2003 to 2012, a global leader in relationship management solutions and a major provider of outsourced business services. Prior to that, Mr. Shanks was the Chief Financial Officer between 2001 and 2003, and held various other financial leadership roles from 1996 to 2001 with NCR Corporation. Mr. Shanks also serves as a director of Verint, a global leader in actionable intelligence solutions.  

 

 

Eric A. Blanchard
  60, Senior Vice President, General Counsel and Secretary

  

Eric A. Blanchard has served as the Company’s Senior Vice President, General Counsel and Secretary since 2006. From 2002 until 2005, he served as the Vice President, General Counsel and Secretary at Tennant Company. Previously Mr. Blanchard was with Dean Foods Company where he held the positions of Chief Operating Officer, Dairy Division in 2002, Vice President and President, Dairy Division from 1999 to 2002 and General Counsel and Secretary from 1988 to 1999.  

 

 

Elizabeth H. Meloy

  39, Senior Vice President, Strategy and Corporate      Development

  

Elizabeth H. Meloy was named Senior Vice President of Strategy & Corporate Development in August 2016. She joined Essendant in 2013 and served as Vice President of Strategy & Corporate Development as well as Director of Corporate Development. Prior to joining Essendant, Ms. Meloy had a career in investment banking. She reached the role of Executive Director at UBS, where she was employed from 2005 to 2013.

 

 

Richard D. Phillips

  46, President, Industrial

 

Richard D. Phillips was named President, Industrial (formerly ORS Industrial) in 2015.  Prior to this position he served as President, Online and New Channels. Prior to joining the Company in 2013, Mr. Phillips spent 14 years at McKinsey & Company, where he was elected Partner in 2005. Prior to joining McKinsey, he spent six years at Baxter Healthcare in finance and sales.

 

 

4


Name, Age and Position with the Company

  

Business Experience

Harry A. Dochelli

  57, President, Office and Facilities

 

Harry A. Dochelli was named as the Company’s President, Office and Facilities (formerly Business & Facility Essentials) in August 2016. Previously, from 2013 to 2016, Mr. Dochelli served as Vice President IDC Sales and Senior Vice President Sales and Customer Care. Prior to joining Essendant, Mr. Dochelli held multiple roles over five years with Lawson Products, most recently serving as EVP and Chief Operating Officer. Prior to joining Lawson Products, Mr. Dochelli spent more than 20 years in various management positions in sales and operations at Boise Cascade Corporation (now known as OfficeMax/Office Depot, Inc.), most recently serving as Executive Vice President of North America Contract Sales. Mr. Dochelli has recently been elected to the International Sanitary Supply Association Board (“ISSA”), as a Distributor Director for a three-year term commencing in October 2016.

 

 

Keith J. Dougherty

  46, Senior Vice President, Merchandising, Inventory and Pricing

 

Keith J. Dougherty joined Essendant in August 2016 as Senior Vice President, Merchandising, Inventory and Pricing. Before joining Essendant, Mr. Dougherty served in various roles during a 17 year tenure with U.S. Foods, most recently as Senior Vice President, Category Management, Indirect Spend and National Accounts. Prior to US Foods, Mr. Dougherty spent seven years with the investment banks Smith Barney and Salomon Brothers. 

 

 

 

Kirk Armstrong

  52, Senior Vice President, Distribution Operations and Logistics

 

Kirk Armstrong has served as the Company’s Senior Vice President, Distribution Operations and Logistics since 2011. From 2003 until 2011, he served as Vice President of Operations for the East Region. Prior to joining Essendant, Mr. Armstrong spent 13 years at W.W. Grainger, lastly serving as Regional Vice President, Distribution Operations.

 

 

Carole Tomko
  62, Senior Vice President, Chief Human Resources Officer

  

Carole Tomko has served as the Company’s Senior Vice President, Chief Human Resources Officer since 2014. Before joining Essendent, Ms. Tomko was a partner in an executive search and human resources consulting firm.  Prior to launching her consulting practice, Ms. Tomko held the role of Senior Vice President, Human Resources for Cardinal Health where she led the function for nine years. Additionally, Ms. Tomko has held Human Resources leadership positions for The Chemlawn Corporation, The Standard Register Company and Federated Department Stores. Ms. Tomko has also served in leadership positions on several non-profit boards over the last twenty years.

 

 

 

Janet Zelenka

  58, Senior Vice President, Chief Information Officer

 

Janet Zelenka was named SVP and CIO in April 2015. Ms. Zelenka joined Essendant in 2006 and has held leadership positions in business integration, finance, and pricing. Before joining Essendant, she held a variety of executive positions at SBC/Ameritech (now AT&T) including Chief Financial Officer of the IT division and Vice President of IT, as well as leadership roles in several areas including customer care, operations, financial planning/analytics, activity-based management, and internal audit. Ms. Zelenka has also served as President of the Essendant Charitable Foundation since January 2016.

 

Executive officers are elected by the Board of Directors. Except as required by individual employment agreements between executive officers and the Company, there exists no arrangement or understanding between any executive officer and any other person pursuant to which such executive officer was elected. Each executive officer serves until his or her successor is appointed and qualified or until his or her earlier removal or resignation.

 

5


Availability of the Company’s Reports

The Company’s principal website address is www.Essendant.com. This site provides Essendant’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as amendments and exhibits to those reports filed or furnished under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) for free as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (SEC). In addition, copies of these filings (excluding exhibits) may be requested at no cost by contacting the Investor Relations Department:

Essendant Inc.

Attn: Investor Relations Department

One Parkway North Boulevard

Suite 100

Deerfield, IL 60015-2559

Telephone: (847) 627-7000

E-mail: IR@essendant.com

 

 

 

6


ITEM  1A.  RISK FACTORS.

Any of the risks described below could have a material adverse effect on the Company’s business, financial condition or results of operations. These risks are not the only risks facing Essendant; the Company’s business operations could also be materially adversely affected by risks and uncertainties that are not presently known to Essendant or that Essendant currently deems immaterial.

The loss of one or more significant customers could significantly reduce Essendant’s revenues and profitability.

In 2016, Essendant’s largest customer accounted for approximately 11% of net sales and Essendant’s five largest customers accounted for approximately 25% of net sales. Several of Essendant’s current and potential customers were involved in business combinations in 2016 and 2015 and the Company expects increased customer consolidation in the future. Following business combinations, the surviving companies often review their supply chain and sourcing options, which can result in the companies altering their sourcing relationships. The Company generally does not have long-term contracts with its customers, which are typically free to reduce or terminate their purchases from the Company on little or no notice. Increasing direct purchases by major customers from manufacturers, as well as the loss of one or more key customers, changes in the sales mix or sales volume to key customers, or a significant downturn in the business or financial condition of any of them could significantly reduce Essendant’s sales and profitability.

 

Price transparency, customer consolidation, and changes in product sales mix may result in lower margins.

The Company faces price and margin pressure due to a number of factors, including:

 

Increased price transparency, driven by online resellers;

 

Customer consolidation resulting in some customers increasing their buying power and seeking economic concessions from the Company;

 

Shift in customer mix from higher to lower margin channels and vertical markets;

 

Shift in category mix to a larger share of lower margin categories;

 

Secular decline in office products categories leading to unfavorable product mix; and

 

Supplier consolidation.

If Essendant is unable to reduce expenses, grow sales to existing and new customers, and increase sales of higher margin products as a percentage of total sales, the Company’s results of operations and financial condition may be adversely affected.

For example, during 2016, despite the Company’s success at converting customers, profitability was adversely affected by margin pressure resulting from a shift in customer mix to lower margin customers and in product category mix to lower margin products. The transparency of pricing online also caused margin pressure.

 

Essendant relies on independent resellers for a significant percentage of its net sales.

Sales to independent resellers account for a significant portion of Essendant’s net sales. Independent resellers compete with national distributors and retailers that have substantially greater financial resources and technical and marketing capabilities. Financial, technical, and commercial constraints are challenging as business increasingly shifts online. Over the years, several of the Company’s independent reseller customers have been acquired by competitors or have ceased operation, and the Company expects independent reseller customers to continue to consolidate. If Essendant’s customer base of independent resellers declines and the Company is not able to replace resulting sales declines, the Company’s business and results of operations will be adversely affected.

 

Essendant’s reliance on supplier allowances and promotional incentives could impact profitability.

Supplier allowances and promotional incentives that are often based on the volume of Company product purchases contribute significantly to Essendant’s profitability. If Essendant does not comply with suppliers’ terms and conditions, or does not make requisite purchases to achieve certain volume hurdles, Essendant may not earn certain allowances and promotional incentives. For example, in 2016, as the Company executed its strategy to improve cash flow in part through lower inventory balances, a reduction in purchases from suppliers resulted in lower supplier allowances and promotional incentives, which contributed to unfavorable gross margin changes. Additionally, suppliers may reduce the allowances they pay Essendant if they conclude the value Essendant creates does not justify the allowances. If Essendant’s suppliers reduce or otherwise alter their allowances or promotional incentives, Essendant’s profit margin for the sale of the products it purchases from those suppliers may decline. The loss or diminution of supplier allowances and promotional support could have an adverse effect on the Company’s results of operations. As part of the Company’s multi-year transformation program, the Company has undertaken merchandising and sourcing initiatives to more effectively leverage supply relationships and enhance profitability. Failure to complete the process, incomplete attainment or ineffective management of the initiatives could cause declines in profitability and results of operations.

 

7


Essendant is exposed to the credit risk of its customers.

Essendant extends credit to its customers. The failure of a significant customer or a significant group of customers to timely pay all amounts due Essendant could have a material adverse effect on the Company’s financial condition and results of operations. The Company’s trade receivables are generally unsecured or subordinated to other lenders, and many of the Company’s customers are highly leveraged. The extension of credit involves considerable judgment and is based on management’s evaluation of a variety of factors, including customers’ financial condition and payment history, the availability of collateral to secure customers’ receivables, and customers’ prospects for maintaining or increasing their sales revenues. There can be no assurance that Essendant has assessed and will continue to assess the creditworthiness of its existing or future customers accurately.

For example, as of December 31, 2016, the Company recognized a $13.3 million allowance on prepaid rebates and receivables from one customer. This customer has timely paid all amounts due to Essendant; however, the collectability of the receivables over the long-term is in doubt. As of February 21, 2017, the Company had further exposure to this customer related to 2017 activity totaling approximately $18.0 million.

 

Essendant operates in a changing competitive environment.

The Company operates in a competitive and changing environment. Historically, the Company has competed with other wholesale distributors, manufacturers of the products the Company sells, warehouse clubs, the business-to-business sales divisions of national business products resellers. The Company is also increasingly competing with internet retailers that are selling to resellers, putting price and margin pressures on the Company. If the Company is unable to compete effectively with internet retailers and others in a changing market, the Company’s business, financial condition and results of operations will be adversely affected.

 

Supply chain disruptions or changes in key suppliers’ distribution strategies could decrease Essendant’s revenues and profitability.

Essendant believes its ability to offer a combination of well-known brand name products, competitively priced Essendant brand products, and support services is an important factor in attracting and retaining customers. The Company’s ability to offer a wide range of products and services is dependent on obtaining adequate product supply and services from manufacturers or other suppliers. Essendant’s agreements with its suppliers are generally terminable by either party on limited notice. The loss of, or a substantial decrease in the availability of products or services from key suppliers (in particular a large supplier, for example, the Hewlett Packard Company which represents approximately 20% of the Company’s total purchases in 2016) at competitive prices could cause the Company’s revenues and profitability to decrease. In addition, supply interruptions could arise due to transportation disruptions, labor disputes or other factors beyond Essendant’s control. Disruptions in Essendant’s supply chain could result in a decrease in revenues and profitability.

 

Some manufacturers refuse to sell their products to wholesalers like Essendant. Other manufacturers only allow Essendant to sell their products to specified customers. If changes in key suppliers’ distribution strategies or practices reduce the breadth of products the Company is able to purchase or the number of customers to whom Essendant can sell products, the Company’s results of operations and financial condition could be adversely affected.

 

Many of the Company’s independent resellers use third party technology vendors (“3PVs”) to automate their business operations. The 3PVs play an important role in the independent dealer channel, as most purchase orders, order confirmations, stock availability checks, invoices, and advanced shipping notices are exchanged between Essendant and its independent resellers over 3PV networks. The 3PVs also provide e-commerce portals that Essendant’s customers use to transact online business with their customers. If Essendant is unable to transact business with its customers through one or more 3PVs on terms that are acceptable to Essendant, or if a 3PV fails to provide quality services to Essendant’s customers, Essendant’s business, financial condition, and results of operations could be adversely affected.

 

Demand for office products is expected to continue to decline.

The overall demand for certain office products has weakened and is expected to continue to decline as consumers increasingly create, share, and store documents electronically, without printing or filing them. Furthermore, many of the products that have experienced increased demand in recent years have lower margins than the products for which demand has declined. If demand continues to decline and Essendant is unable to offset lower aggregate demand by increasing market share for these products, finding new markets for these products, increasing sales of products in other product categories, and reducing expenses, the Company’s results of operations and financial condition may be adversely affected.

 

8


Essendant may experience financial cycles related to broad economic factors due to secular consumer demand, recession or other events.

Sales of Essendant’s products have been affected by secular market pressures and are subject to cyclical fluctuations of material economic factors. Cyclical effects have been particularly notable in Industrial and Automotive. For example, in 2015, challenges in the oil and gas industries impacted the Company’s oilfield and welding sectors within its Industrial business, and these industries have not yet fully recovered. Cyclical changes in demand for the products the Company sells have affected and could continue to detrimentally affect the Company’s business, financial condition and results of operations.

 

Essendant may not be successful in implementing strategic objectives.

The Company is undertaking a comprehensive, multi-year transformation program that includes enhancements in merchandising, closer alignment of pricing with the cost to serve, stabilization of the JanSan sales channel, Industrial growth, additional cost reductions and reductions in working capital and debt. If Essendant is unable to efficiently, effectively and timely implement the program, the Company could experience diminished operating results as a result of the diversion of management’s time, attention and resources from managing the Company’s continuing operations, the incurrence of additional costs in connection with the program, disruption to customers and suppliers, or other factors. In addition, the Company’s merchandising efforts may result in changes in the product assortment offered by the Company and changes in or termination of relationships with certain suppliers. Suppliers adversely affected by the Company’s merchandising efforts may increase their direct sales to the Company’s customers or take other actions that adversely affect the Company. In addition, certain of our customers have preferences for products from suppliers whose products may not be part of our future core supply chain and merchandising strategy. If we are not able to, or choose not to, offer products from the suppliers our customers prefer, we may lose customer business, which could adversely impact our results of operation. The Company’s efforts to align pricing with the cost to serve may result in decreased sales to some customers.  

Essendant must manage inventory effectively while minimizing excess and obsolete inventory.

To maximize supplier allowances and minimize excess and obsolete inventory, Essendant must project end-consumer demand for approximately 190,000 items. If Essendant underestimates demand for a particular manufacturer’s products, the Company will lose sales, reduce customer satisfaction, and earn a lower level of allowances from that manufacturer. If Essendant overestimates demand, it may have to liquidate excess or obsolete inventory at a price that would produce a lower margin, no margin, or a loss.

Essendant is focusing on increasing its sales of Essendant brand products. These products can present unique inventory challenges. Essendant sources some of its Essendant brand products overseas, resulting in longer order-lead times than for comparable products sourced domestically. These longer lead-times make it more difficult to forecast demand accurately and require larger inventory investments to support high service levels.

 

The Company relies heavily on the ability to recruit, retain, and develop high-performing managers and the lack of execution in these areas could harm the Company’s ability to carry out its business strategy.

Essendant’s ability to implement its business strategy depends largely on the efforts, skills, abilities, and judgment of the Company’s executive management team. Essendant’s success also depends to a significant degree on its ability to recruit and retain sales and marketing, operations, and other senior managers. For the last several years, the Company’s incentive compensation plans have paid out substantially below target. Our compensation arrangements, such as our management incentive plans, long-term incentive plans, and other compensatory arrangements, may not be successful in retaining and motivating our existing employees and attracting new employees or the Company may need to take more costly actions to attract and retain the talent needed to lead the Company’s transformation plan.

 

The Company is subject to costs and risks associated with laws, regulations, and industry standards affecting Essendant’s business.

Essendant is subject to a wide range of state, federal, and foreign laws and industry standards, including laws and standards regarding labor and employment, government contracting, product liability, the storage and transportation of hazardous materials, privacy and data security, imports and exports, tax, and intellectual property, as well as laws relating to the Company’s international operations, including the Foreign Corrupt Practices Act and foreign tax laws. These laws, regulations, and standards may change, sometimes significantly, as a result of political or economic events. The complex legal and regulatory environment exposes Essendant to compliance and litigation costs and risks that could materially affect Essendant’s operations and financial results.

 

For example, the Company has been named as a defendant in two lawsuits alleging that the Company sent unsolicited fax advertisements to certain named plaintiffs, as well as other persons and entities, in violation of various consumer protection acts. Although the Company is vigorously contesting and denies that any violations occurred, the Company’s ultimate liability may be material. See Part II, Item 8, Note 18 – “Legal Matters.”

 

9


A significant disruption or failure of the Company’s information technology systems could disrupt Essendant’s business, result in increased costs and decreased revenues, harm the Company’s reputation, and expose the Company to liability.

The Company relies on information technology in all aspects of its business, including managing and replenishing inventory, filling and shipping customer orders, and coordinating sales and marketing activities. The Company regularly refreshes, enhances and adds information technology systems and infrastructure, and any such changes create a possibility for disruption or failure of the Company’s existing information technology, which could put the Company at a competitive disadvantage and could adversely affect the Company’s results of operations. Additionally, further efforts to align portions of its business on common platforms, systems and processes could result in unforeseen interruptions, increased costs, decreased revenues, diminished Company reputation to its customers and suppliers, increased liability and other negative effects.

 

A breach of the Company’s information technology systems could result in costly enforcement actions and litigation and could harm the Company’s reputation and relationships.

Through Essendant’s sales, marketing, and e-commerce activities, the Company collects and stores personally identifiable information and credit card data that customers provide when they buy products or services, enroll in promotional programs, or otherwise communicate with Essendant. Essendant also gathers and retains information about its employees in the normal course of business. Essendant uses suppliers to assist with certain aspects of Essendant’s business and, to enable the suppliers to perform services for Essendant, the Company shares some of the information provided by customers and employees. Similarly, to enable Essendant to provide goods and services customer information is shared. Essendant has, from time to time, experienced attempts to breach its systems, and these attempts are expected to continue. Any loss, unauthorized access to or misuse of the Company’s information technology systems could disrupt the Company’s operations, expose Essendant to claims from customers, financial institutions, regulators, payment card associations, and other persons, and damage the Company’s reputation. In addition, compliance with more stringent privacy and information security laws and standards may result in significant expense due to increased investment in technology and the development of new operational processes.  

 

Essendant’s financial condition and results of operations depend on the availability of financing sources to meet its business needs.

The Company depends on various external financing sources to fund its operating, investing, and financing activities. The Company’s maximum revolving borrowings at any time under the 2017 Credit Agreement (defined below) is the lesser of the lenders’ revolving commitments thereunder or the value of the Company’s borrowing base. The borrowing base for the revolving commitments is comprised of a certain percentage of eligible accounts receivables, real estate and equipment, plus a certain percentage of eligible inventory, minus reserves and the borrowing base for the term loan commitments is comprised of a certain percentage of eligible real property and equipment. If borrowing availability under the 2017 Credit Agreement falls below a certain threshold, the Company must comply with certain obligations and restrictions, including additional restrictions on the Company’s ability to make acquisitions and investments, dispose of assets, repurchase shares of the Company’s stock, and pay dividends.

 

If the Company violates a covenant or otherwise defaults on its obligations under a financing agreement, the Company’s lenders may refuse to extend additional credit, demand repayment of outstanding indebtedness, terminate the financing agreements, and exercise their rights and remedies including, with respect to the lenders under the 2017 Credit Agreement, their rights as secured creditors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” included below under Item 7.

 

Essendant may not be successful in identifying or consummating future acquisitions.

Historically, part of Essendant’s growth and expansion into new product categories or markets has come from targeted acquisitions. Essendant may not be able to identify attractive acquisition candidates or complete the acquisition of any identified candidates at favorable prices and upon advantageous terms. In addition, some of the Company’s acquisitions have included foreign operations, and future acquisitions or other strategic alternatives may increase Essendant’s international presence. International operations present a variety of unique risks, including the costs and difficulties of managing foreign enterprises, limitations on the repatriation and investment of funds, currency fluctuations, cultural differences that affect customer preferences and business practices, and unstable political or economic conditions.

Unexpected events could disrupt normal business operations, which might result in increased costs and decreased revenues.

Unexpected events, such as hurricanes, fire, war, terrorism, and other natural or man-made disruptions, may adversely impact Essendant’s ability to serve its customers and increase the cost of doing business or otherwise impact Essendant’s financial performance. In addition, damage to or loss of use of significant aspects of the Company’s infrastructure due to such events could have an adverse effect on the Company’s operating results and financial condition.

 

 

10


ITEM  1B.

UNRESOLVED COMMENT LETTERS.

None.

 

ITEM  2.

PROPERTIES.

The Company considers its properties to be suitable with adequate capacity for their intended uses. The Company evaluates its properties on an ongoing basis to improve efficiency and customer service and leverage potential economies of scale. As of December 31, 2016, the Company’s properties consisted of the following:

Offices. The Company leases approximately 200,000 square feet for its corporate headquarters in Deerfield, Illinois. Additionally, the Company owns 49,000 square feet of office space in Orchard Park, New York; leases 38,000 square feet of office space in Tulsa, Oklahoma; leases 12,000 square feet in Pasadena, California; and leases 11,000 square feet in Atlanta, Georgia.

Distribution Centers. The Company utilizes 70 distribution centers totaling approximately 13.1 million square feet of warehouse space, of which 2.0 million square feet are owned and 11.1 million square feet are leased.

 

 

ITEM  3.

LEGAL PROCEEDINGS.

For information regarding legal proceedings, see Part II, Item 8, Note 18 - “Legal Matters.”

 

 

ITEM 4.

MINE SAFETY DISCLOSURE.

Not applicable.

 

 


11


 

PART II

 

 

ITEM  5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Common Stock Information

ESND’s common stock is quoted through the NASDAQ Global Select Market (“NASDAQ”) under the symbol ESND. The following table shows the high and low closing sale prices per share for ESND’s common stock as reported by NASDAQ:

 

 

2016

 

 

2015

 

 

High

 

 

Low

 

 

High

 

 

Low

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

January 1 - March 31

$

32.18

 

 

$

25.60

 

 

$

44.16

 

 

$

38.82

 

April 1 - June 30

 

34.56

 

 

 

29.01

 

 

42.47

 

 

 

38.50

 

July 1 - September 30

32.49

 

 

18.84

 

 

39.38

 

 

31.83

 

October 1 - December 31

21.67

 

 

15.05

 

 

36.64

 

 

31.48

 

On February 21, 2017, the closing sale price of Company’s common stock as reported by NASDAQ was $21.74 per share. For the period from January 1, 2017 to February 21, 2017, the high closing sale price during the period was $21.74, while the low closing sale price during the period was $19.86. On February 21, 2017, there were approximately 436 holders of record of common stock. A greater number of holders of ESND common stock are “street name” or beneficial holders, whose shares are held on record by banks, brokers and other financial institutions.

Stock Performance Graph

The following graph compares the performance of the Company’s common stock over a five-year period with the cumulative total returns of (1) Russell 2000 Index and (2) a group of companies included within Value Line’s Office Equipment Industry Index. The graph assumes $100 was invested on December 31, 2011 in the Company’s common stock and in each of the indices and assumes reinvestment of all dividends (if any) at the date of payment. The following stock price performance graph is presented pursuant to SEC rules and is not meant to be an indication of future performance.

 

12


Common Stock Repurchases

During 2016, the Company repurchased 0.2 million shares of common stock at an aggregate cost of $6.8 million. During 2015, the Company repurchased 1.8 million shares of common stock at an aggregate cost of $67.4 million. As of February 21, 2017, the Company had approximately $68.2 million remaining under share repurchase authorizations from its Board of Directors.

Purchases may be made from time to time in the open market or in privately negotiated transactions. Depending on market, business conditions and other factors, the Company may continue or suspend purchasing its common stock at any time without notice.

Acquired shares are included in the issued shares of the Company and treasury stock, but are not included in average shares outstanding when calculating earnings per share data.

The following table reports purchases of equity securities during the fourth quarter of fiscal year 2016 by the Company and any affiliated purchasers pursuant to SEC rules, including any treasury shares withheld to satisfy employee withholding obligations upon vesting of restricted stock and the execution of stock option exercises.

 

Period

 

Total Number

of Shares

Purchased

 

 

Average Price

Paid per Share

 

 

Total Number of

Shares Purchased as

Part of a Publicly

Announced Program

 

 

Approximate Dollar

Value of Shares that

May Yet Be

Purchased Under

the Program

 

October 1, 2016 to October 31, 2016

 

 

-

 

 

$

-

 

 

 

-

 

 

$

68,160,702

 

November 1, 2016 to November 30, 2016

 

 

-

 

 

 

-

 

 

 

-

 

 

 

68,160,702

 

December 1, 2016 to December 31, 2016

 

 

-

 

 

 

-

 

 

 

-

 

 

 

68,160,702

 

         Total Fourth Quarter

 

 

-

 

 

$

-

 

 

 

-

 

 

$

68,160,702

 

 

Stock and Cash Dividends

The Company declares and pays dividends on a quarterly basis. During 2016 and 2015, the Company declared and paid a dividend of $0.14 per share per quarter. In the aggregate, the Company declared dividends of $20.6 million and $21.1 million in 2016 and 2015, respectively. On February 22, 2017, the Board of Directors approved a dividend of $0.14 to be paid on April 14, 2017 to shareholders of record as of March 15, 2017. See Part II, Item 8, Note 11 – “Debt” for restrictions on the Company’s ability to repurchase stock or issue dividends.

 

Securities Authorized for Issuance under Equity Compensation Plans

The information required by Item 201(d) of Regulation S-K (Securities Authorized for Issuance under Equity Compensation Plans) is included in Item 12 of this Annual Report.

 

13


ITEM 6.

SELECTED FINANCIAL DATA.

The selected consolidated financial data of the Company for the years ended December 31, 2012 through 2016 have been derived from the Consolidated Financial Statements of the Company, which have been audited by Ernst & Young LLP, an independent registered public accounting firm. The adoption of new accounting pronouncements, changes in certain accounting policies, and reclassifications are reflected in the financial information presented below. The selected consolidated financial data below should be read in conjunction with, and is qualified in its entirety by, Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements of the Company included in Items 7 and 8, respectively, of this Annual Report. Except for per share data, all amounts presented are in thousands:  

 

Years Ended December 31,

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

$

5,369,022

 

 

$

5,363,046

 

 

$

5,327,205

 

 

$

5,085,293

 

 

$

5,080,106

 

Cost of goods sold

 

4,609,161

 

 

 

4,526,551

 

 

 

4,524,676

 

 

 

4,297,952

 

 

 

4,303,778

 

     Gross profit(1)

 

759,861

 

 

 

836,495

 

 

 

802,529

 

 

 

787,341

 

 

 

776,328

 

Operating expenses(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Warehousing, marketing and administrative expenses

 

629,825

 

 

 

675,913

 

 

 

595,673

 

 

 

578,958

 

 

 

573,645

 

Defined benefit plan settlement loss

 

12,510

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Impairments of goodwill and intangible assets

 

-

 

 

 

129,338

 

 

 

9,034

 

 

 

1,183

 

 

 

-

 

Loss (gain) on disposition of business

 

-

 

 

 

1,461

 

 

 

(800

)

 

 

-

 

 

 

-

 

Operating income

 

117,526

 

 

 

29,783

 

 

 

198,622

 

 

 

207,200

 

 

 

202,683

 

Interest expense

 

24,143

 

 

 

20,580

 

 

 

16,234

 

 

 

12,233

 

 

 

23,619

 

Interest income

 

(1,272

)

 

 

(996

)

 

 

(500

)

 

 

(593

)

 

 

(343

)

Income before income taxes

 

94,655

 

 

 

10,199

 

 

 

182,888

 

 

 

195,560

 

 

 

179,407

 

Income tax expense(3)

 

30,803

 

 

 

54,541

 

 

 

70,773

 

 

 

73,507

 

 

 

66,526

 

Net income (loss)

$

63,852

 

 

$

(44,342

)

 

$

112,115

 

 

$

122,053

 

 

$

112,881

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per common share—basic

$

1.75

 

 

$

(1.18

)

 

$

2.90

 

 

$

3.08

 

 

$

2.80

 

Net income (loss) per common share—diluted

$

1.73

 

 

$

(1.18

)

 

$

2.87

 

 

$

3.03

 

 

$

2.75

 

Cash dividends declared per share

$

0.56

 

 

$

0.56

 

 

$

0.56

 

 

$

0.56

 

 

$

0.53

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Working capital

$

904,715

 

 

$

956,588

 

 

$

968,894

 

 

$

829,917

 

 

$

751,327

 

Total assets

 

2,163,506

 

 

 

2,262,859

 

 

 

2,347,368

 

 

 

2,104,019

 

 

 

2,065,847

 

Total debt(4)

 

608,969

 

 

 

716,315

 

 

 

710,768

 

 

 

530,306

 

 

 

521,853

 

Total stockholders’ equity

 

781,106

 

 

 

723,734

 

 

 

843,667

 

 

 

820,146

 

 

 

733,841

 

Statement of Cash Flows Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

$

130,942

 

 

$

162,734

 

 

$

77,133

 

 

$

74,737

 

 

$

189,814

 

Net cash used in investing activities

 

(3,769

)

 

 

(67,929

)

 

 

(183,633

)

 

 

(30,273

)

 

 

(107,266

)

Net cash used in provided by financing activities

 

(135,964

)

 

 

(84,990

)

 

 

105,968

 

 

 

(53,060

)

 

 

(63,457

)

(1) 2015 — Includes $4.9 million related to Industrial obsolescence reserve.

(2) 2016 — Includes $20.5 million gain on sale of City of Industry facility, $12.5 million charge related to defined benefit plan settlement, $4.0 million charge related to litigation reserve, $1.2 million charge related to severance costs for operating leadership, $0.9 million reversal of 2015 restructuring expenses partially offset by 2016 facility charges and a $0.6 million reserve related to uncertain tax positions taken in the prior year.

      2015 — $115.8 million charge related to Industrial impairment of goodwill and intangible assets, $18.6 million charge related to workforce reductions and facility consolidations, a $17.0 million loss on sale and related costs of our Mexican subsidiary, $12.0 million intangible asset impairment charge related to rebranding and accelerated amortization related to rebranding efforts, and $10.7 million impairment of seller notes receivable related to the Company’s prior year sale of a software service provider.

     2014 — $8.2 million loss on disposition of a software service provider.

     2013 — $13.0 million charge for a workforce reduction and facility closures and a $1.2 million asset impairment charge.

     2012 — $6.2 million charge for a distribution network optimization and cost reduction program.  

(3) Includes $1.7 million related to tax effect of a dividend from a foreign subsidiary in 2016 and the tax effects for items noted above for each respective year.

(4) Total debt includes current maturities where applicable.

14


FORWARD LOOKING INFORMATION

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act. Forward-looking statements often contain words such as “expects”, “anticipates”, “estimates”, “intends”, “plans”, “believes”, “seeks”, “will”, “is likely”, “scheduled”, “positioned to”, “continue”, “forecast”, “predicting”, “projection”, “potential” or similar expressions. Forward-looking statements include references to goals, plans, strategies, objectives, projected costs or savings, anticipated future performance, results or events and other statements that are not strictly historical in nature. These forward-looking statements are based on management’s current expectations, forecasts and assumptions. This means they involve a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied here. These risks and uncertainties include, without limitation, those set forth in Item 1A under the heading “Risk Factors.”

 

Readers should not place undue reliance on forward-looking statements contained in this Annual Report on Form 10-K. The forward-looking information herein is given as of this date only, and the Company undertakes no obligation to revise or update it.

 

ITEM  7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion should be read in conjunction with the information included in this Annual Report on Form 10-K in Part I, Item 1 – Description of Business, Item 6 – Selected Financial Data and in Item 8 – Financial Statements and Supplementary Data. Please see the reconciliation of Non-GAAP Financial Measures section below for information concerning the reconciliation of GAAP to Non-GAAP financial measures.

 

Key Trends and Recent Results

Results for 2016 were negatively affected by a shift in customer mix to lower margin customers and in product category mix to lower margin products. Results were also adversely impacted by lower volumes of inventory purchases, which resulted in lower supplier allowances and promotional incentives, as well as by the recognition of an allowance on prepaid rebates and receivables from one customer. We are implementing strategies to address these market trends, but we expect the trends will continue to impact our liquidity, capital resources and results of operations in subsequent periods, with 2017 net sales expected to be flat to down 4% compared to 2016. We expect net sales in 2017 to be adversely affected by the decision of a large national big-box retailer to shift its purchases of JanSan products to other sources and by Staples’ acquisition of a large regional customer.

 

Recent Results

 

 

Diluted earnings (loss) per share for 2016 were $1.73 compared to $(1.18) in 2015, including impacts of the Actions discussed below. Non-GAAP adjusted diluted earnings per share in 2016 were $1.54 compared to adjusted earnings per share of $3.08 in 2015. Refer to the Adjusted Gross Profit, Adjusted Operating Expenses, Adjusted Operating Income, Adjusted Net Income, Adjusted Diluted Earnings Per Share, Adjusted EBITDA and Free Cash Flow table (the “Non-GAAP table”) included later in this section for more detail on the Actions.

 

Sales decreased 0.3%, workday adjusted, to $5.4 billion, driven by reduced sales in JanSan, industrial supplies, office furniture and technology products, partly offset by growth in the cut-sheet paper product and automotive product categories.

 

Gross margin as a percent of sales for 2016 was 14.2% versus 15.6% in 2015, including impacts of the Actions discussed below. Gross margin was primarily impacted by customer mix and higher freight costs. Adjusted gross margin was $759.9 million or 14.2% of sales in 2016 as compared to $841.4 million or 15.7% of sales in 2015.

 

Operating expenses in 2016 totaled $642.3 million or 12.0% of sales compared with $806.7 or 15.0% of sales in 2015, including impacts of the Actions discussed below. Adjusted operating expenses in 2016 increased to $645.4 million or 12.0% of sales compared to $632.6 million or 11.8% of sales in 2015, principally driven by the recognition of an allowance totaling $13.3 million on prepaid rebates and receivables from one customer.

 

Operating income in 2016 was $117.5 million or 2.2% of sales, compared with $29.8 million or 0.6% of sales in the prior year, including impacts of the Actions discussed below. Adjusted operating income in 2016 was $114.4 million or 2.1% of sales, compared with $208.8 million or 3.9% of sales in 2015, resulting from reduced gross margin in the current year.

 

Operating cash flows for 2016 were $130.9 million versus $162.7 million in 2015. The 2016 reduction was primarily attributable to reduced gross margin generated from sales and reduced accounts payable balances, partially offset by reduced accounts receivable and inventory balances.

 

Cash flow used in investing activities was $3.8 million in 2016 as compared to $67.9 million in the prior year, due primarily to acquisitions consummated in 2015 and the proceeds from the sale of the City of Industry facility in 2016.

 

Cash outflows from financing activities increased $51.0 million due primarily to credit facility repayments during 2016, partially offset by reduced share repurchase activity as compared to 2015.

 

During 2016, the Company repurchased 0.2 million shares for $6.8 million and also paid $20.5 million in dividends.

 

In February 2017, the Company replaced two of its financing agreements with a new credit agreement to provide enhanced liquidity and increase debt availability.

15


 

Actions impacting comparability of results (the “Actions”)

 

 

In 2016, the Company entered into a two-year operating lease agreement in connection with the disposition of its City of Industry facility. The sale of the facility resulted in a $20.5 million gain. Refer to Item 8, Note 12 – “Leases, Contractual Obligations and Contingencies” for further details of this transaction.

 

A voluntary lump-sum pension offering was completed in the second quarter of 2016 and resulted in a significant reduction of interest rate, mortality and investment risk of the Essendant Pension Plan. Due to this offer, a settlement and remeasurement of the Essendant Pension Plan was required, resulting in a defined benefit plan settlement loss of $12.5 million, for the year ended December 31, 2016. Refer to Item 8, Note 13 - “Pension and Post-Retirement Benefit Plans”, for further information on the remeasurement and voluntary lump sum program.

 

In 2016, the Company recognized an accrual of $4.0 million related to ongoing Telephone Consumer Protection Act of 1991 (“TCPA”) litigation. Refer to Item 8, Note 18 – “Legal Matters” for further details.

 

In 2016, the Company recognized the tax impact of settlement of a dividend from a foreign subsidiary of $1.7 million.

 

In 2016, the Company incurred charges of $1.2 million related to severance costs for two members of the Company’s operating leadership team.

 

In 2016, the Company recognized a $0.6 million reserve related to discrete prior year uncertain tax positions. Refer to Item 8, Note 15 – “Income taxes” for further details of associated reserves.

 

Charges totaling $120.7 million relating to the Industrial business unit were incurred in the fourth quarter of 2015. These charges were comprised of an impairment of goodwill and intangibles totaling $115.8 million and an increase in reserves for obsolete inventory of $4.9 million. These impacts are the result of the macroeconomic environment in the oilfield and energy sectors.

 

Restructuring actions were taken in 2015 to improve our operational utilization, labor spend, inventory performance and functional alignment of the organization. This included workforce reductions and facility consolidations with an unfavorable impact of $18.6 million for the year ended December 31, 2015. For the year ended December 31, 2016, the impact of these actions was favorable, including a $1.2 million reversal of restructuring expenses due to the release of severance accruals, partially offset by a $0.3 million facility consolidation charge.

 

In 2015 we sold Azerty de Mexico, our operations in Mexico. The total charges in 2015 related to the disposition of this subsidiary were $17.0 million. In 2015, this subsidiary had net sales of $50.1 million and operating loss of $5.0 million, excluding the charges previously mentioned.

 

In 2015, we officially rebranded the Company to Essendant Inc. to communicate the Company’s strategy in a consistent manner. When we announced in the first quarter of 2015 our decision to rebrand the company, the ORS Nasco trademark and certain OKI brands were determined to be impaired. Pre-tax, non-cash, impairment charges and accelerated amortization totaling $12.0 million were recorded in the year ended December 31, 2015.

 

In 2014, the Company sold its subsidiary that provided software services in exchange for a combination of cash and convertible and non-convertible notes. In conjunction with this sale, in 2014 the Company recognized an $8.2 million loss on the disposition of the business. This consisted of a $9.0 million goodwill impairment and a $0.8 million gain on disposal as the carrying value of the entity was less than the total value of the consideration received. Based upon subsequent information, the Company determined it will not be able to collect the note amounts or other receivables due from the acquirer. As such, the Company fully impaired the receivables and recorded a loss of $10.7 million during 2015.

Critical Accounting Policies, Judgments and Estimates

As described in Item 8, Note 2 – “Summary of Significant Accounting Policies”, the preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results may differ from those estimates.

 

The Company’s critical accounting policies are those which are most significant to the Company’s financial condition and results of operations and require especially difficult, subjective or complex judgments or estimates by management. In most cases, critical accounting policies require management to make estimates on matters that are uncertain at the time the estimate is made. The basis for the estimates is historical experience, terms of existing contracts, observance of industry trends, information provided by customers or suppliers, and information available from other outside sources, as appropriate. These critical accounting policies include the following:

16


Supplier Allowances

Supplier allowances are common practice in the business products industry and have a significant impact on the Company’s overall gross margin. Receivables related to supplier allowances totaled $86.9 million and $111.0 million as of December 31, 2016 and 2015, respectively.

 

The majority of the Company’s annual supplier allowances and incentives are variable, based solely on the volume and mix of the Company’s product purchases from suppliers. These variable allowances are recorded based on the Company’s annual inventory purchase volumes and product mix and are included in the Company’s Consolidated Financial Statements as a reduction to cost of goods sold, thereby reflecting the net inventory purchase cost. The potential amount of variable supplier allowances often differs based on purchase volumes by supplier and product category. Changes in the Company’s sales volume (which can increase or reduce inventory purchase requirements), changes in product sales mix (especially because higher-margin products often benefit from higher supplier allowance rates), or changes in the amount of purchases Essendant makes to attain supplier allowances can create fluctuations in future results.

 

Customer Rebates

Customer rebates and discounts are common practice in the business products industry and have a significant impact on the Company’s overall sales and gross margin. Prepaid customer rebates were $47.9 million and $36.3 million, while accrued customer rebates were $65.3 million and $63.6 million as of December 31, 2016 and 2015, respectively.

 

Customer rebates include volume rebates, sales growth incentives, advertising allowances, participation in promotions and other miscellaneous discount programs. Estimates for volume rebates and growth incentives are based on estimated annual sales volume to the Company’s customers. The aggregate amount of customer rebates depends on product sales mix and customer mix changes. Reported results reflect management’s current estimate of such rebates. Changes in estimates of sales volumes, product mix, customer mix or sales patterns, or actual results that vary from such estimates may impact future results.

Allowance for doubtful accounts

Management estimates an allowance for doubtful accounts, which addresses the collectability of trade accounts receivable. This allowance adjusts gross trade accounts receivable downward to its estimated collectible or net realizable value. To determine the allowance for doubtful accounts, management reviews specific customer risks and the Company’s trade accounts receivable aging. Uncollectible trade receivable balances are written off against the allowance for doubtful accounts when it is determined that the trade receivable balance is uncollectible. Allowance for doubtful accounts totaled $18.2 million and $17.8 million as of December 31, 2016 and 2015, respectively.    

Goodwill and Intangible Assets

The Company tests goodwill for impairment annually as of October 1 and whenever events or circumstances indicate that an impairment may have occurred, such as a significant adverse change in the business climate, loss of key personnel or a decision to sell or dispose of a reporting unit. Determining whether an impairment has occurred requires a comparison of the carrying value of the net assets of the reporting unit to the fair value of the respective reporting unit. The Company estimates fair value of the reporting unit using discounted cash flows of forecasted future results, comparable public company multiples and merger and acquisition (M&A) valuations involving comparable companies.  

 

Assumptions used in the discounted cash flow methodology include a discount rate, which is based upon the Company’s current weighted average cost of capital, and a projection of sales, gross margin, EBIT margin, capital expenditures and working capital for three future years and a terminal growth rate. The assumptions used for future projections are determined based upon the Company’s long-range strategic plan. These assumptions are inherently uncertain as they relate to future events and circumstances. Loss of customers due to customer consolidation or other factors, decline in demand for the products the Company sells, a shift in customer buying trends to lower margin products, a decline in supplier allowances and promotional incentives due to reductions in inventory purchases, or other events or circumstances could have a material, negative impact on future results.  

 

The Company determined public company multiples based on a group of comparable public companies and determined M&A valuations based on M&A transactions involving comparable companies. While the companies used in both the public company analysis and the M&A analysis are comparable, they are not identical to the Company’s reporting units and they may have exposure to customer or supplier trends or other business factors that are materially different than what the Company may experience.  

Acquired intangible assets are initially recorded at their fair market values determined on quoted market prices in active markets, if available, or recognized valuation models. Intangible assets that have finite useful lives are amortized on a straight-line basis over their useful lives. Intangible assets that have indefinite useful lives are not amortized but are tested at least annually for impairment or

17


whenever events or circumstances indicate impairment may have occurred. The Company makes an annual impairment assessment of its intangibles.

 

As of December 31, 2016 and 2015, the Company’s Consolidated Balance Sheets reflected $297.9 million and $299.4 million of goodwill, and $83.7 million and $96.4 million in net intangible assets, respectively. As of October 1, 2016 and 2015, the percentage by which the fair value of each reporting unit exceeded its carrying value is shown in the following table. As discussed above, the assumptions that were used to calculate these fair values include a degree of uncertainty.

 

Reporting Unit

 

2016

 

 

2015

 

Office & Facilities (formerly Business & Facility Essentials)

 

 

8

%

 

 

129

%

Industrial (formerly ORS Industrial)

 

 

17

%

 

N/A

 

Automotive

 

 

9

%

 

 

10

%

CPO

 

 

11

%

 

 

77

%

Inventory Reserves

The Company also records adjustments to inventory that is obsolete, damaged, defective or slow moving. Inventory is recorded at the lower of cost or market. These adjustments are determined using historical trends such as age of inventory, market demands, customer commitments, and new products introduced to the market. The reserves are further adjusted, if necessary, as new information becomes available; however, based on historical experience, the Company does not believe the estimates and assumptions will have a material impact on the financial statements.

 

Income Taxes

The Company accounts for income taxes using the liability method in accordance with the accounting guidance for income taxes. The Company estimates actual current tax expense and assesses temporary differences that exist due to differing treatments of items for tax and financial statement purposes. These temporary differences result in the recognition of deferred tax assets and liabilities. A provision has not been made for deferred U.S. income taxes on the undistributed earnings of the Company’s foreign subsidiaries as these earnings have historically been permanently invested. It is not practicable to determine the amount of unrecognized deferred tax liability for such unremitted foreign earnings. The Company accounts for interest and penalties related to uncertain tax positions as a component of income tax expense.

Pension Benefits

To select the appropriate actuarial assumptions when determining pension benefit obligations, the Company relied on current market conditions, historical information and consultation with and input from the Company’s outside actuaries. These actuarial assumptions include discount rates, expected long-term rates of return on plan assets, and life expectancy of plan participants. The expected long-term rate of return on plan assets assumption is based on historical returns and the future expectation of returns for each asset category, as well as the target asset allocation of the asset portfolio.

 

Pension expense for 2016 was $17.6 million, compared to $5.4 million in 2015 and $3.6 million in 2014. 2016 pension expense includes a settlement charge of $12.5 million related to a lump-sum offering. Refer to Item 8, Note 13 – “Pension Plans and Defined Contribution Plan” for further information. To better understand the impact of changes in pension expense based on certain circumstances the company performed a sensitivity analysis, noting that a one percentage point decrease or increase in the assumed discount rate would have resulted in an increase or decrease in pension expense for 2016 of approximately $2.9 million and increase or decrease in the year-end projected benefit obligation by $27.4 million. Additionally, a one percentage point decrease or increase in the expected rate of return assumption would have resulted in an increase or decrease, respectively in the net periodic benefit cost for 2016 of approximately $1.7 million. See Item 8, Note 13 - “Pension Plans and Defined Contribution Plan” for more information.

18


Results for the Years Ended December 31, 2016, 2015 and 2014

The following table presents the Consolidated Statements of Operations results (in thousands):

 

Year Ended December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

 

 

Amount

 

 

% of Revenue

 

 

 

Amount

 

 

% of Revenue

 

 

 

Amount

 

 

% of Revenue

 

Net sales: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Janitorial, foodservice and breakroom supplies (JanSan)

$

 

1,435,476

 

 

 

26.7

%

 

$

 

1,457,993

 

 

 

27.2

%

 

$

 

1,443,242

 

 

 

27.1

%

Technology products

 

 

1,347,652

 

 

 

25.1

%

 

 

 

1,363,146

 

 

 

25.4

%

 

 

 

1,447,661

 

 

 

27.2

%

Traditional office products

 

 

860,324

 

 

 

16.0

%

 

 

 

860,024

 

 

 

16.0

%

 

 

 

861,649

 

 

 

16.2

%

Industrial supplies

 

 

560,682

 

 

 

10.4

%

 

 

 

586,580

 

 

 

10.9

%

 

 

 

601,937

 

 

 

11.3

%

Cut sheet paper

 

 

394,650

 

 

 

7.4

%

 

 

 

343,604

 

 

 

6.4

%

 

 

 

465,400

 

 

 

8.7

%

Automotive

 

 

316,546

 

 

 

5.9

%

 

 

 

279,966

 

 

 

5.2

%

 

 

 

33,709

 

 

 

0.6

%

Office furniture

 

 

298,655

 

 

 

5.6

%

 

 

 

318,870

 

 

 

5.9

%

 

 

 

312,203

 

 

 

5.9

%

Freight and other

 

 

155,037

 

 

 

2.9

%

 

 

 

152,863

 

 

 

3.0

%

 

 

 

161,404

 

 

 

3.0

%

Total net sales

 

 

5,369,022

 

 

 

100.0

%

 

 

 

5,363,046

 

 

 

100.0

%

 

 

 

5,327,205

 

 

 

100.0

%

Cost of goods sold

 

 

4,609,161

 

 

 

85.8

%

 

 

 

4,526,551

 

 

 

84.4

%

 

 

 

4,524,676

 

 

 

84.9

%

Total gross profit

$

 

759,861

 

 

 

14.2

%

 

$

 

836,495

 

 

 

15.6

%

 

$

 

802,529

 

 

 

15.1

%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Warehousing, marketing and administrative expenses

 

 

629,825

 

 

 

11.7

%

 

 

 

675,913

 

 

 

12.6

%

 

 

 

595,673

 

 

 

11.2

%

Defined benefit plan settlement

 

 

12,510

 

 

 

0.2

%

 

 

 

-

 

 

 

0.0

%

 

 

 

-

 

 

 

0.0

%

Impairments of goodwill and intangible assets

 

 

-

 

 

 

0.0

%

 

 

 

129,338

 

 

 

2.4

%

 

 

 

9,034

 

 

 

0.2

%

Loss (gain) on disposition of business

 

 

-

 

 

 

0.0

%

 

 

 

1,461

 

 

 

0.0

%

 

 

 

(800

)

 

 

0.0

%

Total operating expenses

 

 

642,335

 

 

 

12.0

%

 

 

 

806,712

 

 

 

15.0

%

 

 

 

603,907

 

 

 

11.3

%

Total operating income

$

 

117,526

 

 

 

2.2

%

 

$

 

29,783

 

 

 

0.6

%

 

$

 

198,622

 

 

 

3.7

%

Interest expense

 

 

24,143

 

 

 

0.4

%

 

 

 

20,580

 

 

 

0.4

%

 

 

 

16,234

 

 

 

0.3

%

Interest income

 

 

(1,272

)

 

 

0.0

%

 

 

 

(996

)

 

 

0.0

%

 

 

 

(500

)

 

 

0.0

%

Interest expense, net

 

 

22,871

 

 

 

0.4

%

 

 

 

19,584

 

 

 

0.4

%

 

 

 

15,734

 

 

 

0.3

%

Income before income taxes

 

 

94,655

 

 

 

1.8

%

 

 

 

10,199

 

 

 

0.2

%

 

 

 

182,888

 

 

 

3.4

%

Income tax expense

 

 

30,803

 

 

 

0.6

%

 

 

 

54,541

 

 

 

1.0

%

 

 

 

70,773

 

 

 

1.3

%

Net income (loss)

$

 

63,852

 

 

 

1.2

%

 

$

 

(44,342

)

 

 

-0.8

%

 

$

 

112,115

 

 

 

2.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Certain prior period amounts have been reclassified to conform to the current presentation. Such changes include reclassification of specific products to different product categories and did not impact the Consolidated Statements of Operations. All presentations described below are based on the reclassified amounts.

 

 

Comparison of Results for the Years Ended December 31, 2016 and 2015

Net Sales. Net sales for the year ended December 31, 2016 were $5.4 billion, a workday adjusted 0.3% decrease from $5.4 billion in sales during 2015. Net sales by key product category for 2016 and 2015 included the following (in thousands):

 

JanSan sales decreased $22.5 million or 1.5% in 2016 compared to 2015. Sales decreased due to a decline in sales in the independent distributor channel of $14.7 million and declines in national big-box retailer of $12.1 million, partially offset by online growth of $12.4 million. As a percentage of total sales, JanSan represented 26.7% in 2016, a decrease from the 2015 percentage of total sales of 27.2%. This decrease was the result of reduced demand principally due to declines in customer experience and competitive actions from other wholesalers.

 

Technology products (primarily ink and toner) sales decreased $15.5 million or 1.1% in 2016 versus 2015. Excluding our 2015 Mexican subsidiary sales of $50.1 million, which was sold in the prior year, net sales in this category increased 2.6% compared to the prior year, which was primarily driven by increases in sales in the independent dealer channel of $70.4 million partially offset by declines in sales to national big-box retailer of $38.6 million. As a percentage of total sales, technology products represented 25.1% in 2016, a decrease from the 2015 percentage of total sales of 25.4% due to the sale of our Mexican subsidiary.

 

19


Traditional office product sales increased $0.3 million in 2016 versus 2015. This minor increase in the category was primarily driven by the buying patterns of national big-box retailers. As a percentage of total sales, traditional office products represented 16.0% in both 2016 and 2015.

 

Industrial supplies sales decreased $25.9 million or 4.4%. The decline was driven by weakness in the general industrial channel and consolidation in the welding channel. Sales in the general industrial and welding channels declined by $22.9 million and $21.9 million, respectively. This was partially offset by growth in the retail channel of $17.8 million. As a percentage of total sales, industrial supplies represented 10.4% in 2016, a decrease from the 2015 percentage of total sales of 10.9%.

Cut sheet paper product sales increased $51.0 million or 14.9% in 2016 versus 2015. The increase in this category was primarily driven by increased sales to independent dealers of $50.0 million. As a percentage of total sales, cut sheet paper represented 7.4% in 2016, which increased from the 2015 percentage of total sales of 6.4%.

Automotive product sales increased $36.6 million or 13.1% in 2016 versus 2015. The increase in this category was primarily due to the acquisition of Nestor in the prior year which contributed an additional $64.9 million in net sales in the current year as compared to $27.1 million in the prior year. As a percentage of total sales, automotive products represented 5.9% in 2016, which increased from the 2015 percentage of total sales of 5.2% due to the impact of the acquisition.

Office furniture sales decreased $20.2 million or 6.3% in 2016 compared to 2015. The decreased revenue was primarily the result of declines in sales to national big-box retailers of $13.9 million and independent dealers of $7.8 million. As a percentage of total sales, office furniture represented 5.6% in 2016, a decrease from the 2015 percentage of total sales of 5.9%.

The remainder of the Company’s consolidated 2016 net sales was composed of freight and other revenues.

Gross Profit and Gross Margin Rate. Gross profit for 2016 was $759.9 million, compared to $836.5 million in 2015. Gross profit as a percentage of net sales (the gross margin rate) of 14.2% for 2016 was down 140 basis points (bps) from the prior-year period gross margin rate of 15.6%. This decrease was due to an unfavorable product margin (133 bps), primarily driven by an unfavorable change in category and channel mix (107 bps), and higher freight costs (21 bps). Our sales to larger resellers are generally lower margins than sales to our smaller resellers. Sales to new customers tend to be lower margin but improve over time. Lower margin category sales include cut-sheet paper products and technology products, while JanSan, traditional office products, furniture and industrial supplies are higher margin categories.

Operating Expenses. Operating expenses for 2016 were $642.3 million or 12.0% of sales, compared with $806.7 million or 15.0% of sales in the same period last year. Excluding the Actions in 2016 and 2015, adjusted operating expenses were $645.4 million or 12.0% of sales in 2016 compared to $632.6 million or 11.8% of sales in 2015. The increase in adjusted operating expenses in 2016 was principally driven by the recognition of an allowance on prepaid rebates and receivables from one customer totaling $13.3 million. As of February 21, 2017, the Company has further exposure to this customer related to 2017 activity totaling approximately $18.0 million. In 2017 the Company also expects to incur incentive compensation expense, approximately $15 million greater than in 2016.

Interest Expense, net. Net interest expense for 2016 was $22.9 million or 0.4% of total sales, compared with $19.6 million or 0.4% of total sales in 2015. This increase was primarily driven by higher interest rates in 2016.

Income Taxes. Income tax expense was $30.8 million in 2016, compared with $54.5 million in 2015. The Company’s effective tax rate was 32.5% and 534.8% in 2016 and 2015, respectively. This decrease was primarily driven by the prior year Actions, particularly the 2015 noncash impairment charges for goodwill which were nondeductible for tax purposes and the 2015 capital loss resulting from the sale of Azerty de Mexico which could not be recognized at that time and carried a full valuation allowance. Additional favorability in 2016 is attributed to the reduction of valuation allowances related to the gain on the sale of the City of Industry facility. The Company’s effective tax rate excluding these Actions would have been 37.7% and 39.1% in 2016 and 2015, respectively.  

Net Income (Loss). Net income for 2016 was $63.9 million as compared to a net loss of $44.3 million in 2015. Diluted earnings per share were $1.73 in 2016, compared to a loss per share of $1.18 in 2015. Excluding the Actions in 2016 and 2015, adjusted net income for 2016 and 2015 was $57.0 million and $116.4 million, respectively. Adjusted diluted earnings per share were $1.54 and $3.08 for 2016 and 2015, respectively.

20


Comparison of Results for the Years Ended December 31, 2015 and 2014

Net Sales. Net sales for the year ended December 31, 2015 were $5.4 billion, a workday adjusted 0.7% increase from $5.3 billion in sales during 2014. Net sales by product category for 2015 and 2014 included the following:  

 

Janitorial, foodservice and breakroom supplies sales increased $14.8 million or 1.0% in 2015 compared to 2014. Sales growth in this category was driven by increases in national big-box retailer sales of $24.0 million, including being named the primary supplier for a large national big-box retailer’s janitorial business, and growth in internet retailers sales, totaling $7.7 million, partially offset by lower sales of $9.2 million in the independent distributor channel. JanSan products represented 27.2% of total sales in 2015, which increased from the 2014 percentage of total sales of 27.1%.

 

Technology products (primarily ink and toner) sales decreased $84.5 million or 5.8% in 2015 versus 2014. Sales declined $44.7 million due to the loss of business with national big-box retailers and $53.8 million due to the divestiture of the Mexican subsidiary. The sales decline was partially offset by growth in internet retailers, totaling $9.4 million. Technology products represented 25.4% of total sales in 2015, which decreased from the 2014 percentage of total sales of 27.2%.

 

Traditional office products sales decreased $1.6 million or 0.2% in 2015 versus 2014. The reduction in this category was driven by a $19.0 million decrease in national big-box retailers, including loss of first call supplier status with a large national big-box retailer, partially offset by growth in internet retailers, totaling $7.0 million. As a percentage of total sales, traditional office products represented 16.0% in 2015, which decreased from the 2014 percentage of total sales of 16.2%.

Industrial supplies sales decreased $15.4 million or 2.6% in 2015 compared to 2014. The decline was driven by weakness in general industrial and in the energy channel. The general industrial channel was down $30.0 million and the energy channel declined $25.0 million. This was partially offset by growth in the retail channel due to the prior year acquisition of CPO of $59.2 million. Industrial supplies represented 10.9% of total sales in 2015, which decreased from the 2014 percentage of total sales of 11.3%.

Cut sheet paper products sales decreased $121.8 million or 26.2% in 2015 versus 2014. The decrease in this category was due to declines totaling $119.2 million with independent dealers. As a percentage of total sales, cut sheet paper represented 6.4% in 2015, which decreased from the 2014 percentage of total sales of 8.7%.

Automotive products sales increased $246.3 million or 730.5% in 2015 versus 2014. The increase in this category was solely driven by the acquisitions consummated in the prior year. As a percentage of total sales, automotive represented 5.2% in 2015, which increased from the 2014 percentage of total sales of 0.6%.

Office furniture sales increased $6.7 million or 2.1% in 2015 compared to 2014. The increase reflects growth in internet retailers and independent dealers of $4.3 million and $2.0 million, respectively. As a percentage of total sales, office furniture products remained flat at 5.9% in 2015 and 2014.

The remainder of the Company’s consolidated 2015 net sales was composed of freight and other revenues.

Gross Profit and Gross Margin Rate. Gross profit for 2015 was $836.5 million, compared to $802.5 million in 2014. Gross profit as a percentage of net sales of 15.6% for 2015 was up 50 bps from the prior-year period gross margin rate of 15.1%. This increase was due to a favorable product margin (41 bps) driven by favorable product mix (14 bps) and purchase driven inventory allowances (34 bps). Acquisitions added 28 bps of gross margin during 2015. Excluding the impact of acquisitions, product margin increased 18 bps driven by favorable purchase driven inventory allowances (42 bps), partly offset by unfavorable impacts of product mix (24 bps).

Operating Expenses. Operating expenses for 2015 were $806.7 million or 15.0% of sales, compared with $603.9 million or 11.3% of sales in the same period last year. Excluding the Actions in 2015 and an $8.2 million loss on disposition of business in 2014, adjusted operating expenses were $632.6 million or 11.8% of sales in 2015 compared to $595.7 million or 11.2% of sales in 2014. The 2015 operating expenses were affected by acquisitions which added an incremental 23 bps, partly offset by reduced expenses including a variable management compensation reduction of 21 bps. We also incurred approximately $12.0 million of operating expense related to the common platform initiative to combine the Company’s office product and janitorial platforms.

Interest Expense, net. Net interest expense for 2015 was $19.6 million, compared with $15.7 million in 2014. This increase was driven by the increase in outstanding debt over the prior year related to our acquisitions.

21


Income Taxes. Income tax expense was $54.5 million in 2015, compared with $70.8 million in 2014. The Company’s effective tax rate was 534.8% and 38.7% in 2015 and 2014, respectively. The increase was driven by the Actions, particularly the noncash impairment charges for goodwill which is nondeductible for tax purposes and the capital loss resulting from the sale of Azerty de Mexico which cannot be recognized at this time and carries a full valuation allowance. The Company’s 2015 effective tax rate excluding these Actions would have been 39.1%.  

Net Income (Loss). Net loss for 2015 was $44.3 million and diluted earnings per share were $(1.18), compared to 2014 net income of $112.1 million and diluted earnings per share of $2.87. Excluding the Actions in 2015 and $8.2 million on disposition of business in 2014, adjusted net income for 2015 and 2014 were $116.4 million and $120.3 million, respectively. Adjusted diluted earnings per share were $3.08 for 2015 and 2014.

Liquidity and Capital Resources

 

Essendant’s growth has historically been funded by a combination of cash provided by operating activities and debt financing. The Company believes that its cash from operations and collections of receivables, coupled with its sources of borrowings and available cash on hand, are sufficient to fund its currently anticipated requirements. These requirements include payments of interest and dividends, scheduled debt repayments, capital expenditures, working capital needs, the funding of pension plans, and funding for additional share repurchases and acquisitions, if any. The Company believes that its sources of borrowings are sound and that the strength of its balance sheet affords the financial flexibility to respond to both internal growth opportunities and those available through acquisitions.

 

The Company’s outstanding debt consisted of the following amounts (in millions):

 

As of

 

 

As of

 

 

December 31,

 

 

December 31,

 

 

2016

 

 

2015

 

2013 Credit Agreement

$

260.4

 

 

$

368.4

 

2013 Note Purchase Agreement

 

150.0

 

 

 

150.0

 

Receivables Securitization Program

 

200.0

 

 

 

200.0

 

Debt

 

610.4

 

 

 

718.4

 

Stockholders’ equity

 

781.1

 

 

 

723.7

 

Total capitalization

$

1,391.5

 

 

$

1,442.1

 

 

 

 

 

 

 

 

 

Debt-to-total capitalization ratio

 

43.9

%

 

 

49.8

%

 

This decrease in the debt-to-capitalization ratio at December 31, 2016, as compared to December 31, 2015 is due to the reduction in outstanding debt resulting from partial debt repayments in the year and the effect on equity related to the increase in retained earnings during the year.

 

As discussed further in Item 8, Note 11 – “Debt” in February 2017 the Company entered into the 2017 Credit Agreement. The maximum amount the Company is able to borrow under the 2017 Credit Agreement is determined based on the value of the Company’s accounts receivable, inventory, owned real estate and certain equipment.

 

The 2017 Credit Agreement increased the Company’s borrowing capacity by increasing the aggregate lender commitments and eliminating debt-to-earnings before interest, taxes, depreciation and amortization (“EBITDA”) covenants in the 2013 Credit Agreement and the 2013 Note Purchase Agreement. In addition, in February 2017 the Company terminated the Receivable Securitization Program (see Item 8, Note 11 – “Debt” for definitions of “2013 Credit Agreement”, “2013 Note Purchase Agreement” and “Receivables Securitization Program”).

 

22


Availability of financing as of the closing of the 2017 Credit Agreement in February 2017, is summarized below (in millions):

 

 

Aggregated Committed Principal

 

 

Borrowing Base Limitation

 

 

Total Utilization

 

 

Net Availability

 

2017 Credit Agreement

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Term Loan (1)

$

77.6

 

 

$

-

 

 

$

-

 

 

$

-

 

Revolving Credit Facility (2)

 

1,000.0

 

 

 

900.4

 

 

 

572.5

 

 

 

327.9

 

First-in-Last-Out ("FILO")

 

100.0

 

 

 

100.0

 

 

 

100.0

 

 

 

-

 

Total all Funding Sources

$

1,177.6

 

 

$

1,000.4

 

 

$

672.5

 

 

$

327.9

 

 

(1)

The term loan may be funded in a single funding on or prior to April 21, 2017. The proceeds from the funding are expected to be used to pay down borrowings and increase availability under the Revolving Credit Facility.

 

(1)

The 2017 Credit Agreement provides for the issuance of letters of credit up to $25.0 million, plus up to $165.0 million to be used as collateral for obligations under the 2013 Note Purchase Agreement. Letters of credit totaling approximately $177.5 million were outstanding after the February 2017 close on the 2017 Credit Agreement.

 

Disclosures About Contractual Obligations

The following table aggregates all contractual obligations that affect financial condition and liquidity as of December 31, 2016 (in millions):

 

 

 

Payment due by period

 

 

 

 

 

Contractual obligations

 

2017

 

 

2018 & 2019

 

 

 

 

2020 & 2021

 

 

 

 

Thereafter

 

 

Total

 

Debt(1)

 

$

-

 

 

$

460

 

 

 

 

$

150

 

 

 

 

$

-

 

 

$

610

 

Fixed interest payments on long term debt

 

 

7

 

 

 

11

 

 

 

 

 

6

 

 

 

 

 

-

 

 

 

24

 

Operating leases

 

 

51

 

 

 

92

 

 

 

 

 

59

 

 

 

 

 

72

 

 

 

274

 

Purchase obligations

 

 

10

 

 

 

4

 

 

 

 

 

-

 

 

 

 

 

-

 

 

 

14

 

Acquisition related future payments

 

 

12

 

 

 

2

 

 

 

 

 

-

 

 

 

 

 

-

 

 

 

14

 

Total contractual cash obligations

 

$

80

 

 

$

569

 

 

 

 

$

215

 

 

 

 

$

72

 

 

$

936

 

 

 

(1)

The debt that was scheduled to mature in 2018 was effectively repaid in February 2017 with borrowings under the 2017 Credit Agreement totaling $522.5 million due 2022.

  

In February 2017, the Company’s Board of Directors approved cash contributions to the Company’s pension plans. In 2017, the Company expects to make cash contributions totaling $5.0 million to the Essendant Union Employees’ Pension Plan and $5.0 million to the Essendant Pension Plan. Additional contributions, if any, for 2017 have not yet been determined.

 

In 2016, the Company offered lump sum distributions to eligible terminated, vested participants in the Essendant Pension Plan. As a result, the Company recognized a settlement loss of $12.5 million in 2016. Refer to Item 8, Note 13 - “Pension and Post-Retirement Benefit Plans”, for further information on the remeasurement and voluntary lump sum program.

 

At December 31, 2016, the Company had a liability for unrecognized tax benefits of $3.8 million as discussed in Item 8, Note 15 - “Income Taxes”, and an accrual for the related interest, that are excluded from the Contractual Obligations table. Due to the uncertainties related to these tax matters, the Company is unable to make a reasonably reliable estimate when cash settlement with a taxing authority may occur.

 

Cash Flows

Cash flows for the Company for the years ended December 31, 2016, 2015 and 2014 are summarized below (in thousands):