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Section 1: 10-K (10-K)

esnd-10k_20171231.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, 2017

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, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” 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

 

 

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Securities Act.   

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, 2017 was approximately $0.55 billion.

On February 16, 2018, Essendant Inc. had 37,706,376 shares of common stock outstanding.

Documents Incorporated by Reference:

Certain portions of Essendant Inc.’s definitive Proxy Statement relating to its 2018 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, 2017

TABLE OF CONTENTS

 

 

 

 

  

Page No.

 

 

Part I

  

 

 

 

 

Item 1.

 

Business

  

1

 

 

Executive Officers of the Registrant

  

4

Item 1A.

 

Risk Factors

  

6

Item 1B.

 

Unresolved Comment Letters

  

10

Item 2.

 

Properties

  

10

Item 3.

 

Legal Proceedings

  

10

Item 4.

 

Mine Safety Disclosure

  

10

 

 

Part II

  

 

 

 

 

Item 5.

 

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

  

11

Item 6.

 

Selected Financial Data

  

13

Item 7.

 

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

  

14

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

  

64

Item 9A.

 

Controls and Procedures

  

64

Item 9B.

 

Other Information

  

64

 

 

Part III

  

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

  

65

Item 11.

 

Executive Compensation

  

65

Item 12.

 

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

  

65

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

  

65

Item 14.

 

Principal Accounting Fees and Services

  

65

 

 

 

 

 

Part IV

  

 

Item 15.

 

Exhibits and Financial Statement Schedules

  

66

 

 

 

 

 

Signatures

  

71

 

 

Schedule II—Valuation and Qualifying Accounts

  

72

 

 

 


PART I

ITEM  1.

BUSINESS.

General

Essendant Inc. is a leading national 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. Essendant serves a diverse group of approximately 29,000 reseller customers. They include resellers in the independent reseller channel, including: office and workplace, facilities and maintenance, technology, military, automotive aftermarket, healthcare, other vertical suppliers and industrial resellers; the national reseller channel; and the e-commerce channel. 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, Dubai, United Arab Emirates (“UAE”) and Hong Kong.

Essendant powers the potential of the Company’s customers through smarter operations, business growth and category expansion, leveraging the Company’s product portfolio, fulfillment network and industry specific sales, marketing and digital expertise.

Essendant experienced significant sales declines in 2017, which were largely unanticipated and outpaced the Company’s ability to align its cost base. As a result, the Company is taking actions to create value and sharpen its focus on three strategic drivers:

1) Improve efficiency across the distribution network and reduce the cost base  

 

Reengineer inbound freight operations by opening freight consolidation centers in select locations that will reduce costs across the supply chain and improve distribution center efficiency

 

Align the distribution network footprint with sales volumes to streamline costs while maintaining high service levels

 

Implement targeted cost improvements

 

2) Accelerate sales performance in key channels

 

Partner with independent resellers who are well positioned to grow

 

Align resources around channels that provide growth opportunities, including customers in e-commerce, JanSan, vertical markets, industrial, and automotive

 

3) Advance supplier partnerships that leverage Essendant’s network and capabilities

 

Collaborate with suppliers to create more value utilizing Essendant’s nationwide distribution network, drop-ship capabilities, and next-day delivery proposition

 

Continue to refine the Company’s product assortment and ongoing rollout of the preferred supplier program

 

Broad and Diverse Product Portfolio

Essendant provides access to over 170,000 products and is a leading national distributor in the following product categories:

JanSan. This product category includes janitorial and sanitation supplies, breakroom items, foodservice consumables, safety and security items, and paper and packaging supplies. This product category provided 26.3% of net sales in 2017.

Technology Products. Included in this category are computer accessories and computer hardware items such as printers and other peripherals, imaging supplies and data storage. The technology product category generated 24.1% of the Company’s 2017 consolidated net sales.

Traditional Office Products. The traditional office products category includes products such as writing instruments, business machines, filing and record storage products, presentation products, shipping and mailing supplies, calendars and general office accessories. This product category contributed 14.8% of net sales during 2017.

Industrial Supplies. Included in this category are various industrial MRO (maintenance, repair and operations) items, hand and power tools, safety and security supplies, janitorial equipment, oilfield and welding supplies. In 2017, the industrial product category accounted for 11.7% of the Company’s net sales.

Cut Sheet Paper Products. Essendant provides access to a broad range of cut sheet paper products including copy paper with a wide assortment of styles and types. In 2017, the cut sheet paper product category accounted for 8.2% of the Company’s net sales.

1


Automotive Products. The Company has a broad portfolio of automotive aftermarket tools and equipment. In 2017, this product category accounted for 6.5% of the Company’s net sales.

Office Furniture. This product category includes desks, filing and storage solutions, seating and systems furniture, along with a variety of specialized products for niche markets such as education, government, healthcare and professional services. This product category represented 5.3% of net sales for the year.

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

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: Finish Pro, Painters Pride®, Quipall®, Nesco®, Performance 1®, Advanced Tool Design or “ATD”, and AIM. During 2017, Essendant brand products accounted for approximately 16.4% of Essendant’s net sales.

 

Extensive Fulfillment and Distribution 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-item order fill rate of approximately 97%.  

The Company has a network of 70 distribution centers in the U.S., Canada and Dubai. In the U.S., Essendant has 64 distribution centers spread across the nation to facilitate next-day delivery, including delivery via the Company’s dedicated fleet of approximately 480 trucks. This enables Essendant to make direct deliveries to resellers from regional distribution centers and local distribution points. In 2018, the Company plans to reengineer the inbound freight operations through the use of freight consolidation centers and align the network distribution footprint with sales volumes to streamline costs. This will result in a decrease in distribution centers in 2018 and future years compared to 2017.

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 “Wrap and Label” and “Drop-Ship” programs. “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. The “Drop-Ship” program allows resellers to have products delivered directly to their customers without stocking the products themselves. Resellers benefit from “Drop-Ship” as they are able to sell products to their customers without having to expend capital to maintain inventory and increase their market area.

Sales, Marketing, Digital and Strategic Services

Essendant’s sales, marketing and digital 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, 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.

Customers

Essendant serves a diverse group of approximately 29,000 reseller customers. They include resellers in the independent reseller channel, including: office and workplace, facilities and maintenance, technology, military, automotive aftermarket, healthcare, other vertical suppliers and industrial resellers; the national reseller channel; and the e-commerce channel. The Company also operates e-commerce businesses that sell tools, equipment and other items online to the consumer market. Essendant’s domestic operations generated approximately $4.9 billion of its $5.0 billion in 2017 consolidated net sales, with its international operations contributing an additional $0.1 billion to 2017 net sales.

The Company defines its sales channels as independent resellers, which accounted for 80% of consolidated net sales in 2017 compared to 77% in 2016, e-commerce, which accounted for 15% of consolidated net sales in 2017 compared to 14% in 2016, and national resellers, which accounted for 5% of consolidated net sales in 2017 compared to 9% in 2016. During 2017, the Company refined the channel definitions of its customers to more appropriately align with business changes. One independent reseller customer, W.B. Mason Co., Inc., accounted for approximately 12% of the Company’s 2017 consolidated net sales. No other single customer accounted for more than 10% of 2017 consolidated net sales.

2


Purchasing and Merchandising Strategy

As a leading distributor of workplace items, Essendant leverages its broad product selection as a key merchandising strategy. Based on purchasing volume, Essendant receives substantial supplier allowances and can realize significant economies of scale in its logistics and distribution activities. 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. In 2017, the Company’s largest supplier was Hewlett-Packard Company, which represented approximately 19% of the Company’s total purchases.

Competition

The markets in which the Company participates are highly competitive. The Company competes with other distributors, e-commerce businesses, manufacturers of the products the Company sells, buying groups, national resellers and warehouse clubs. These competitors also sell and provide the same, or similar products and services that Essendant provides. Essendant competes primarily on the basis of diversity of category and product lines, availability of products, nationwide next day delivery, product affordability, and the quality of industry specific sales, marketing and digital expertise.

 

Employees

As of January 31, 2018, Essendant employed approximately 6,400 associates worldwide, with 6,200 employees located in the United States.

Approximately 590 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 covering the associates in Baltimore, Los Angeles and New Jersey are scheduled to expire in April 2018, August 2018 and April 2020, respectively.

3


Executive Officers Of The Registrant

The executive officers of the Company are as follows:

 

Name, Age and Position with the Company

  

Business Experience

 

 

Richard Phillips

  47, President, Chief Executive Officer

 

Richard Phillips was elected to the Executive Committee of the Board of Directors and named President and Chief Executive Officer (“CEO”) in October 2017. This appointment followed being the Interim President and CEO since June 2017. Mr. Phillips joined the Company in January 2013 as President of Online and New Channels and was named President, ORS Nasco in November 2015. He was named Group President, Industrial in August 2016, where he added responsibility for the Company’s automotive and e-commerce businesses. Prior to joining Essendant, Mr. Phillips spent 14 years at McKinsey & Company, where he was elected Partner in 2005 and worked with global clients in a number of industries, with a functional emphasis in strategy, commercial performance and operations. He previously spent six years at Baxter Healthcare in various finance and sales roles. Mr. Phillips earned a B.S. degree in Finance from Indiana University and a Masters of Management degree, with distinction, from the Kellogg Business School at Northwestern University.

 

 

Kirk Armstrong

  53, 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.

 

 

Harry Dochelli

  58, President, Office and Facilities

 

Harry Dochelli was named as the Company’s President, Office and Facilities in August 2016. From 2013 to 2016, Mr. Dochelli served as Vice President, Independent Dealer Channels 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 Executive Vice President 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 Office Depot, Inc.), most recently serving as Executive Vice President of North America Contract Sales. In October 2016, Mr. Dochelli was elected to the International Sanitary Supply Association Board (“ISSA”), as a Distributor Director for a three-year term.

 

 

Keith Dougherty

  47, Senior Vice President, Merchandising, Inventory and Pricing

 

Keith 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 US Foods, a foodservice distributor, most recently as Senior Vice President, Category Management, Indirect Spend and National Accounts from 2013 to 2016. Prior to US Foods, Mr. Dougherty spent seven years with the investment banks Smith Barney and Salomon Brothers. 

 

 

 

Christopher Kempa

  48, Group President, Industrial

 

 

Christopher Kempa was named Group President, Industrial in June 2017. From 2015 to 2017, Mr. Kempa served as the Senior Vice President, Merchandising. Prior to joining Essendant, Mr. Kempa spent 21 years with Grainger, Inc., a supplier of maintainence, repair and operations supplies. Mr. Kempa held leadership roles within sales, distribution, enterprise systems, merchandising, global supply chain and operating several International businesses, including as Vice President, Global Sourcing and Export from 2014 to 2015 and as Vice President and General Manager, Global Exports and Central America from 2012 to 2013.

 

 

4


Name, Age and Position with the Company

  

Business Experience

 

 

Brendan McKeough

  51, Senior Vice President, General Counsel and Secretary

 

  

 

 

Brendan McKeough was named Senior Vice President, General Counsel and Secretary in March 2017. He was named the Company’s Deputy General Counsel in April 2013 after joining Essendant as Assistant General Counsel in 2003. Mr. McKeough was with Sears, Roebuck and Co., where he held the positions of Assistant General Counsel from 1999 to 2003 and Senior Counsel from 1997 to 1999.

 

 

 

Elizabeth Meloy

  40, Senior Vice President, Strategy and Corporate      Development

 

 

Elizabeth 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.

 

 

 

Carole Tomko
  63, 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 Essendant, Ms. Tomko was a partner in an executive search and human resources consulting firm from 2004 to 2014.  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

  59, Senior Vice President, Chief Financial Officer and Chief Information Officer

 

Janet Zelenka was named Senior Vice President and Chief Financial Officer (“CFO”) in May 2017. Ms. Zelenka also currently serves as the Company’s Chief Information Officer (“CIO”). 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.

 

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

 

 

 

5


ITEM  1A.  RISK FACTORS.

Any of the risks described below could have a material adverse effect on the Company’s results of operations and financial condition. 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.

Several market dynamics are impacting Essendant’s customers that have and may continue to adversely impact the Company’s sales.

The Company is operating in a challenging environment, with many market dynamics impacting the Company and its customers. Sales risks facing the Company include the following:

 

A significant percentage of the Company’s annual sales are to a relatively small number of customers. For example, in 2017, Essendant’s largest customer accounted for approximately 12% of net sales, while Essendant’s five and twenty largest customers accounted for approximately 25% and 36% of net sales, respectively. The loss of these customers, or a material reduction in sales to these customers, would have a material adverse effect on the Company’s results of operations and financial condition.

 

The Company’s sales to independent resellers account for a significant portion of the Company’s net sales.  In 2017, sales to the five largest independent reseller customers comprised 22% of total net sales, while the twenty largest independent reseller customers comprised 29% of total net sales.    

 

The challenging market dynamics in the industry have led to increased consolidation, conversion and acquisition of independent office products resellers and increased sales by the Company’s suppliers directly to the Company’s customers.  For example, in recent years, several of Essendant’s current and potential customers were involved in business combinations.  Following business combinations, the surviving companies often review their supply chain and sourcing options, which can result in the companies altering their sourcing relationships or seeking to modify terms with their vendors.  

 

Customers have an increasing ability to purchase goods direct from the manufacturers, and may choose to do so if they believe they can get a lower price or faster delivery, or to diversify their suppliers. A number of the Company’s suppliers have decreased their minimum order sizes, making it more economical for smaller resellers, such as independent dealers, to buy products directly. If customers continue to increase purchases from manufacturers and decrease their purchases from Essendant, the Company’s results of operations and financial condition will be adversely affected.

 

E-commerce businesses, as well as the online branches of brick-and-mortar warehouse clubs and big box stores, have increased their competitive presence both at the wholesale and retail levels. This increased competition from e-commerce businesses has put competitive pressure on Essendant. If customers continue to increase purchases from online retailers and decrease their purchases from Essendant, the Company’s results of operations and financial condition will be adversely affected.

 

Many of the Company’s independent resellers use third party technology vendors (“3PVs”) to automate the exchange of information between the Company and independent resellers, such as purchase orders, order confirmations, stock availability checks, invoices, and advanced shipping notices. 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 results of operations and financial condition could be adversely affected.

 

The Company’s customers may be able to reduce or terminate their purchases from the Company on little or no notice.  The loss of customers has and is expected to continue to adversely impact the Company’s sales, and reduced revenue results in the deleveraging of the Company’s cost base.  If these trends continue and the Company is not able to replace these sales declines, the Company’s results of operations and financial condition will be negatively impacted.  

 

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 sales mix from higher to lower margin channels;

 

Shift in product category sales 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 grow sales to existing and new customers, increase sales of higher margin products and reduce expenses, the Company’s results of operations and financial condition will continue to be adversely affected.

6


 

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

Supplier allowances and promotional incentives, which are based on Essendant’s product purchases, contribute significantly to the Company’s gross margin and profitability. If Essendant does not comply with suppliers’ terms and conditions, maintain a mix of purchases focused on products with higher allowances, achieve specified purchase volume hurdles, or if suppliers change allowance programs, the Company will experience a reduction in allowances and promotional incentives. For example, in 2017, the Company experienced sales declines and the Company lowered inventory purchases. As a result, the Company earned lower supplier allowances which contributed to a lower gross margin compared to 2016. The loss or diminution of supplier allowances and promotional support could have an adverse effect on the Company’s results of operations and financial condition.

 

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 to Essendant could have a material adverse effect on the Company’s results of operations and financial condition. 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. The Company continues to sell and extend trade credit to this customer. As of December 31, 2017, the Company had further exposure to this customer related to continuing activity totaling approximately $17.1 million.

 

Essendant is engaged in substantial cost reduction activities that may impair the Company’s results of operations and financial condition.

 

Essendant is engaged in substantial cost reduction activities. These activities include distribution facility consolidations and workforce reductions, moving to a consolidation center model for inbound freight, refining the product assortment and other steps aimed at aligning its cost base with the current sales volume. These activities could disrupt Essendant’s relationships with customers and suppliers which may result in declines in the Company’s results of operations and financial condition. At the same time, cost reduction activities may not sufficiently align the cost base with current or future sales.

 

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, buying groups and the business-to-business sales divisions of national business products resellers. The Company is also increasingly competing with e-commerce businesses that are selling both to resellers and directly to end customers, putting price and margin pressures on the Company. If the Company is unable to compete effectively with e-commerce businesses and others in a changing market, or if it is unable to offer competitive pricing to help customers compete with e-commerce businesses at the retail level, the Company’s results of operations and financial condition 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. The Company has several large suppliers, for example, the Hewlett Packard Company, which represented approximately 19% of the Company’s total purchases in 2017. 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 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 the Company’s results of operations and financial condition.

 

Some manufacturers refuse to sell their products to distributors 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.

 

7


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.

 

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 product categories. 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 results of operations and financial condition.

 

Essendant may not be successful in implementing strategic drivers.

The Company is undertaking three key drivers, including; improving efficiency across the distribution network and reducing the cost base, accelerating sales performance in key channels and advancing supplier partnerships that leverage the Company’s network and capabilities. If Essendant is unable to efficiently, effectively and timely implement these objectives, 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 initiatives the Company implements in connection with these objectives could disrupt Essendant’s relationships with customers and suppliers.  

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 170,000 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. In addition, Essendant sources some of its private 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.

 

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.

 

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. Historically, the Company’s incentive compensation plans have paid out substantially below target. Compensation arrangements, such as the Company’s management incentive plans, long-term incentive plans, and other compensatory arrangements, may not be successful in retaining and motivating 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 strategies.

8


 

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, storage and transportation of hazardous materials, privacy and data security, imports and exports, tax, antitrust 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 results of operations and financial condition.

 

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 of those 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 and financial condition. 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 results of operations and financial condition 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 Company’s 2017 Credit Agreement 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 Company’s 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. In addition, there is no assurance that the Company could obtain additional capital or refinance its financing agreements on acceptable terms, or at all. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” included in Part II, Item 7.

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 results of operations and financial condition. 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 results of operations and financial condition.

9


 

 

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, 2017, 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, comprised of 64 distribution centers in the United States, 5 distribution centers in Canada and 1 distribution center in Dubai, UAE, totaling approximately 13.5 million square feet of warehouse space, of which 1.8 million square feet are owned and 11.7 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.

 

 


10


 

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:

 

 

2017

 

 

2016

 

 

High

 

 

Low

 

 

High

 

 

Low

 

January 1 - March 31

$

22.09

 

 

$

14.05

 

 

$

32.18

 

 

$

25.60

 

April 1 - June 30

 

17.85

 

 

 

14.30

 

 

34.56

 

 

 

29.01

 

July 1 - September 30

14.77

 

 

11.31

 

 

32.49

 

 

18.84

 

October 1 - December 31

13.68

 

 

8.34

 

 

21.67

 

 

15.05

 

On February 16, 2018, the closing stock price of the Company’s common stock as reported by Nasdaq was $8.48 per share. For the period from January 1, 2018 to February 16, 2018, the high closing stock price was $10.23 and the low closing stock price was $8.29. On February 16, 2018, there were approximately 416 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, 2012 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.

 

11


Common Stock Repurchases

During 2017, the Company did not repurchase any shares of its common stock. During 2016, the Company repurchased 0.2 million shares of common stock at an aggregate cost of $6.8 million. As of February 16, 2018, 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.

 

Stock and Cash Dividends

The Company declares and pays dividends on a quarterly basis. During 2017 and 2016, the Company declared and paid a dividend of $0.14 per share per quarter. In the aggregate, the Company declared dividends of $20.8 million and $20.6 million in 2017 and 2016, respectively. On February 15, 2018, the Board of Directors approved a dividend of $0.14 per share to be paid on April 13, 2018 to shareholders of record as of March 15, 2018. See Part II, Item 8, Note 11 – “Debt” for limitations 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.

 

12


ITEM 6.

SELECTED FINANCIAL DATA.

The selected consolidated financial data of the Company for the years ended December 31, 2013 through 2017 has 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,

 

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

$

5,037,327

 

 

$

5,369,022

 

 

$

5,363,046

 

 

$

5,327,205

 

 

$

5,085,293

 

Cost of goods sold

 

4,331,273

 

 

 

4,609,161

 

 

 

4,526,551

 

 

 

4,524,676

 

 

 

4,297,952

 

     Gross profit(1)

 

706,054

 

 

 

759,861

 

 

 

836,495

 

 

 

802,529

 

 

 

787,341

 

Operating expenses(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Warehousing, marketing and administrative expenses

 

664,280

 

 

 

629,825

 

 

 

675,913

 

 

 

595,673

 

 

 

578,958

 

Impairments of goodwill and intangible assets

 

285,166

 

 

 

-

 

 

 

129,338

 

 

 

9,034

 

 

 

1,183

 

Defined benefit plan settlement loss

 

-

 

 

 

12,510

 

 

 

-

 

 

 

-

 

 

 

-

 

Loss (gain) on disposition of business

 

-

 

 

 

-

 

 

 

1,461

 

 

 

(800

)

 

 

-

 

Operating (loss) income

 

(243,392

)

 

 

117,526

 

 

 

29,783

 

 

 

198,622

 

 

 

207,200

 

Interest expense

 

26,696

 

 

 

24,143

 

 

 

20,580

 

 

 

16,234

 

 

 

12,233

 

Interest income

 

(1,078

)

 

 

(1,272

)

 

 

(996

)

 

 

(500

)

 

 

(593

)

(Loss) income before income taxes

 

(269,010

)

 

 

94,655

 

 

 

10,199

 

 

 

182,888

 

 

 

195,560

 

Income tax (benefit) expense(3)

 

(2,029

)

 

 

30,803

 

 

 

54,541

 

 

 

70,773

 

 

 

73,507

 

Net (loss) income

$

(266,981

)

 

$

63,852

 

 

$

(44,342

)

 

$

112,115

 

 

$

122,053

 

Net (loss) income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income per common share—basic

$

(7.27

)

 

$

1.75

 

 

$

(1.18

)

 

$

2.90

 

 

$

3.08

 

Net (loss) income per common share—diluted

$

(7.27

)

 

$

1.73

 

 

$

(1.18

)

 

$

2.87

 

 

$

3.03

 

Cash dividends declared per share

$

0.56

 

 

$

0.56

 

 

$

0.56

 

 

$

0.56

 

 

$

0.56

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Working capital

$

793,128

 

 

$

904,715

 

 

$

956,588

 

 

$

968,894

 

 

$

829,917

 

Total assets

 

1,774,250

 

 

 

2,163,506

 

 

 

2,262,859

 

 

 

2,347,368

 

 

 

2,104,019

 

Total debt(4)

 

498,123

 

 

 

608,969

 

 

 

716,315

 

 

 

710,768

 

 

 

530,306

 

Total stockholders’ equity

 

494,914

 

 

 

781,106

 

 

 

723,734

 

 

 

843,667

 

 

 

820,146

 

Statement of Cash Flows Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

$

185,543

 

 

$

130,942

 

 

$

162,734

 

 

$

77,133

 

 

$

74,737

 

Net cash used in investing activities

 

(38,455

)

 

 

(3,769

)

 

 

(67,929

)

 

 

(183,633

)

 

 

(30,273

)

Net cash (used in) provided by financing activities

 

(140,001

)

 

 

(135,964

)

 

 

(84,990

)

 

 

105,968

 

 

 

(53,060

)

 

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

(2) 2017 — Includes $285.2 million of charges related to goodwill impairment, $19.7 million of transformational expenses, $9.0 million of charges related to litigation reserves, partially offset by a $0.3 million gain reflecting recovery of notes receivable reserved in 2015.

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 a 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.

     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 the Company’s 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.

(3) Includes $2.6 million related to the one-time impact of the passage of the Tax Cuts and Jobs Act (“Tax reform”, “2017 Tax act” or the “Act”) in 2017; $1.7 million related to tax effect of a dividend from a foreign subsidiary and a $0.4 million change in reserve related to uncertain tax positions taken in the prior year in 2016; and the tax effects for items noted above for each respective year.

(4) Total debt includes current maturities where applicable.

13


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 to”, “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 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”) for information concerning the reconciliation of GAAP to Non-GAAP financial measures.

 

Key Trends and Recent Results

Results for 2017 were negatively impacted by lower sales volume that resulted in reduced gross profit, supplier allowances and inventory balances as the Company reduced purchases to more closely align with sales. The decline in operating results and softening within the industries that the Company operates, led to charges for goodwill impairment. The Company incurred transformational expenses in the year as part of the Company’s strategic driver to advance supplier partnerships and, in addition to higher costs for employee compensation, was unable to deleverage fixed costs at a pace commensurate with the sales decline. We are implementing strategies to address market trends, but we expect these trends will continue to impact results of operations and financial condition in subsequent periods.

 

Recent Results

 

 

Net loss per share for 2017 was $(7.27) compared to diluted earnings per share of $1.73 in 2016, including impacts of the Actions discussed below. Non-GAAP adjusted diluted earnings per share in 2017 were $0.67 compared to adjusted earnings per share of $1.54 in 2016. Refer to the Non-GAAP table included later in this section for more detail on the Actions.

 

Sales decreased 5.8%, workday adjusted, to $5.0 billion, driven by reduced sales in JanSan, traditional office products, office furniture and technology products, partly offset by growth in industrial supplies, cut-sheet paper and automotive product categories.

 

Gross profit was down $53.8 million, primarily due to decreased sales volume, and gross profit as a percentage of sales for 2017 decreased slightly to 14.0% in 2017 compared to 14.2% in 2016.

 

Operating expenses in 2017 totaled $949.4 million or 18.8% of sales compared with $642.3 million or 12.0% of sales in 2016, including impacts of the Actions discussed below. Adjusted operating expenses in 2017 decreased to $635.8 million compared to $646.1 million in 2016, principally driven by cost saving initiatives, partially offset by increased variable incentive compensation. Adjusted operating expenses as a percentage of sales increased to 12.6% in 2017 from 12.0% in 2016 due to lower sales volume.

 

Operating loss in 2017 was $(243.4) million or (4.8%) of sales, compared with operating income of $117.5 million or 2.2% of sales in the prior year, including impacts of the Actions discussed below. Adjusted operating income in 2017 was $70.2 million or 1.4% of sales, compared with $113.8 million or 2.1% of sales in 2016, primarily resulting from reduced gross margin in the current year, partially offset by reduced adjusted operating expenses.

 

Operating cash flows for 2017 were $185.5 million versus $130.9 million in 2016. The 2017 increase was primarily attributable to increased accounts payable balances, and reduced accounts receivable and inventory balances.

 

Cash flow used in investing activities was $38.5 million in 2017 compared to $3.8 million in the prior year, due primarily to the sale of the City of Industry, California facility in 2016.

 

Cash outflows from financing activities were $140.0 million in 2017 compared to $136.0 million in 2016.

 

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

 

14


Actions impacting comparability of results (the “Actions”)

 

2017 Actions

 

Goodwill impairment charges of $285.2 million were recognized (refer to Note 6 – “Goodwill and Intangible Assets”).

 

Transformational expenses associated with the implementation of strategic drivers to improve the value of the business totaled $19.7 million. These expenses, which result from the changing strategies of the Company, included consulting fees and other activities for which the Company has had significant expense.

 

Litigation matters resulted in accruals of $9.0 million (refer to Note 18 – “Legal Matters”).

 

One-time tax expenses of $2.6 million related to the December 2017 changes in tax laws (refer to Note 15 – “Income Taxes”).

 

Recovery related to notes receivable, which were impaired in 2015, resulted in $0.3 million of gain in 2017.

 

2016 Actions

 

Sale of a facility resulted in a $20.5 million gain.

 

A voluntary lump-sum pension offering 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.

 

An accrual related to ongoing Telephone Consumer Protection Act of 1991 (“TCPA”) litigation of $4.0 million.

 

The tax impact of settlement of a dividend from a foreign subsidiary of $1.7 million.

 

Severance costs of $1.2 million related to two members of the Company’s operating leadership team.

 

A $1.2 million reversal of restructuring expenses accrued in 2015 due to severance, partially offset by a $0.3 million facility consolidation charge.

 

A reserve recognized related to discrete prior year uncertain tax positions of $0.4 million.

 

2015 Actions

 

Charges totaling $120.7 million relating to the Industrial business unit were incurred in the fourth quarter. 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 were the result of the macroeconomic environment in the oilfield and energy sectors.

 

Restructuring actions were taken to improve the Company’s 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.

 

Sale of Azerty de Mexico, the Company’s operations in Mexico, resulted in total charges of $17.0 million. In the year, the subsidiary had net sales of $50.1 million and operating loss of $5.0 million, excluding the charges previously mentioned.

 

The Company officially rebranded to Essendant Inc. to communicate the Company’s strategy in a consistent manner. The rebranding resulted in reevaluation of the Company’s trademarks and it was determined that the ORS Nasco trademark and certain OKI brands were impaired. Pre-tax, non-cash, impairment charges and accelerated amortization totaling $12.0 million were recorded in the year.

 

In 2014, the Company sold its subsidiary that provided software services in exchange for a combination of cash and convertible and non-convertible notes. Based upon subsequent information, the Company determined it was not able to collect the note amounts or other receivables due from the acquirer and, as such, fully impaired the receivables and recorded a loss of $10.7 million during 2015.

 

Actions and events expected to affect future results

 

Restructuring Program. Essendant has launched a restructuring program to advance the Company’s strategic drivers by reducing the cost base, aligning organizational infrastructure and leadership with the Company’s growth channels to drive sales, and providing capacity to invest in products with preferred suppliers and in growth categories.  The Company expects to the restructuring program and other initiatives to reduce costs beginning in 2018 and reach run-rate annual savings of more than $50 million by 2020, with more than half achieved in 2018.

The program includes facility consolidations and workforce reductions with an estimated cash cost of $30 million to $40 million over the restructuring period, which began in the first quarter of 2018.  

Product assortment refinements are also planned to eliminate items that have limited availability and lower sales. This is expected to improve service levels and have minimal impact on sales.  It will also increase capacity to support expansion into new categories to support customer growth, and is necessary to execute the planned facility consolidations. A non-cash charge related to these refinements is expected in the first quarter of 2018 and estimated in the range of $42 million to $48 million. Refer to Note 7 – “Severance and Restructuring Charges” for further details.

 

Tax Reform. In 2018, the Company anticipates the effective tax rate, excluding Actions, will be between 35% and 37%, reflecting the reduction in income tax rate promulgated by Tax reform, partly offset by increased state income taxes, the loss of deductions for entertainment expenses and reductions in share price subsequent to the grant date on equity compensation vesting during the year. Refer to Note 2 – “Summary of Significant Accounting Policies” for further details.

15


Critical Accounting Policies, Judgments and Estimates

As described in 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 results of operations and financial condition 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:

Supplier Allowances

 

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 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 based on judgments as to the collectability of trade accounts receivable balances driven by historic results and future expectations. 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.    

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 the age of the 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 as of and for the year ended December 31, 2017. Product assortment refinements are planned in 2018 to address items with limited availability and lower sales. An estimated non-cash charge of $42 million to $48 million is expected in the first quarter of 2018 and will be reflected as additional cost of goods sold.

 

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.

16


Pension Obligations

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.

At December 31, 2017, the Company refined the method used to determine the service and interest cost components of the Company’s net periodic benefit cost. Previously, the cost was determined using a single weighted-average discount rate derived from the yield curve. Under the refined method, known as the spot rate approach, individual spot rates along the yield curve that correspond with the timing of each benefit payment are used. The Company believes this change provides a more precise measurement of service and interest costs by improving the correlation between projected cash outflows and corresponding spot rates on the yield curve. Compared to the previous method, the spot rate approach will decrease the service and interest components of the Company’s benefit costs by an immaterial amount in 2018. There is no impact on the total benefit obligation. The Company will account for this change prospectively as a change in accounting estimate.

 

Pension expense for 2017 was $4.2 million, compared to $17.6 million in 2016 and $5.4 million in 2015. 2016 pension expense includes a settlement charge of $12.5 million related to a lump-sum offering. Refer to 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 2017 of approximately $2.0 million and increase or decrease in the year-end projected benefit obligation by $37.7 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 2017 of approximately $1.4 million.

Results for the Years Ended December 31, 2017, 2016 and 2015

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

 

 

Year Ended December 31,

 

 

 

2017

 

 

2016

 

 

2015

 

 

 

Amount

 

 

% of Revenue

 

 

 

Amount

 

 

% of Revenue

 

 

 

Amount

 

 

% of Revenue

 

Net sales: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Janitorial, foodservice and breakroom supplies (JanSan)

$

 

1,324,051

 

 

 

26.3

%

 

$

 

1,453,425

 

 

 

27.1

%

 

$

 

1,475,379

 

 

 

27.4

%

Technology products

 

 

1,216,103

 

 

 

24.1

%

 

 

 

1,348,404

 

 

 

25.1

%

 

 

 

1,356,342

 

 

 

25.3

%

Traditional office products

 

 

745,719

 

 

 

14.8

%

 

 

 

830,856

 

 

 

15.5

%

 

 

 

841,654

 

 

 

15.7

%

Industrial supplies

 

 

589,857

 

 

 

11.7

%

 

 

 

562,485

 

 

 

10.5

%

 

 

 

588,578

 

 

 

11.0

%

Cut sheet paper

 

 

414,989

 

 

 

8.2

%

 

 

 

403,090

 

 

 

7.4

%

 

 

 

346,969

 

 

 

6.5

%

Automotive

 

 

324,060

 

 

 

6.5

%

 

 

 

316,546

 

 

 

5.9

%

 

 

 

279,966

 

 

 

5.2

%

Office furniture

 

 

268,484

 

 

 

5.3

%

 

 

 

299,180

 

 

 

5.6

%

 

 

 

321,295

 

 

 

6.0

%

Freight and other

 

 

154,064

 

 

 

3.1

%

 

 

 

155,036

 

 

 

2.9

%

 

 

 

152,863

 

 

 

2.9

%

Total net sales

 

 

5,037,327

 

 

 

100.0

%

 

 

 

5,369,022

 

 

 

100.0

%

 

 

 

5,363,046

 

 

 

100.0

%

Cost of goods sold

 

 

4,331,273

 

 

 

86.0

%

 

 

 

4,609,161

 

 

 

85.8

%

 

 

 

4,526,551

 

 

 

84.4

%

Total gross profit

$

 

706,054

 

 

 

14.0

%

 

$

 

759,861

 

 

 

14.2

%

 

$

 

836,495

 

 

 

15.6

%

Total operating expenses

 

 

949,446

 

 

 

18.8

%

 

 

 

642,335

 

 

 

12.0

%

 

 

 

806,712

 

 

 

15.0

%

Total operating (loss) income

$

 

(243,392

)

 

 

-4.8

%

 

$

 

117,526

 

 

 

2.2

%

 

$

 

29,783

 

 

 

0.6

%

Interest expense, net

 

 

25,618

 

 

 

0.5

%

 

 

 

22,871

 

 

 

0.4

%

 

 

 

19,584

 

 

 

0.4

%

(Loss) income before income taxes

$

 

(269,010

)

 

 

-5.3

%

 

$

 

94,655

 

 

 

1.8

%

 

$

 

10,199

 

 

 

0.2

%

Income tax (benefit) expense

 

 

(2,029

)

 

 

0.0

%

 

 

 

30,803

 

 

 

0.6

%

 

 

 

54,541

 

 

 

1.0

%

Net (loss) income

$

 

(266,981

)

 

 

-5.3

%

 

$

 

63,852

 

 

 

1.2

%

 

$

 

(44,342

)

 

 

-0.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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.

 

17


 

Comparison of Results for the Years Ended December 31, 2017 and 2016

Net Sales. Net sales for the year ended December 31, 2017 were $5.0 billion, a workday adjusted decrease of 5.8% from $5.4 billion in sales during 2016. 2018 net sales are expected to be down 3% to 6% compared to 2017. Net sales by key product category for 2017 and 2016 included the following (in thousands):

 

JanSan sales decreased $129.4 million or 8.9% in 2017 compared to 2016. Sales decreased due to declines in the national reseller channel of $118.1 million and the independent reseller channel of $13.4 million. As a percentage of total sales, JanSan represented 26.3% in 2017, a decrease from the 2016 percentage of total sales of 27.1%. This decrease was principally the result of reduced demand due to specific customer losses and continued competitive actions from other JanSan product providers.

 

Technology product sales decreased $132.3 million or 9.8% in 2017 versus 2016. Sales in this product category decreased primarily due to declines in the national reseller channel of $68.6 million, independent reseller channel of $53.7 million as well as declines in e-commerce sales of $9.9 million. As a percentage of total sales, technology products represented 24.1% in 2017, a decrease from the 2016 percentage of total sales of 25.1% due to specific customer losses and reduced supplier promotion activity throughout 2017.

 

Traditional office product sales decreased $85.1 million or 10.2% in 2017 versus 2016. Sales in this category decreased due to reductions in the national reseller channel of $42.7 million, declines in the independent reseller channel of $36.9 million and e-commerce sales declines of $5.5 million. As a percentage of total sales, traditional office products represented 14.8% in 2017, a decrease from the 2016 percentage of total sales of 15.5%.

 

Industrial supplies sales increased $27.4 million or 4.9%. The increase was primarily driven by growth in general industrial sales of $14.6 million, international sales of $6.6 million and energy sales of $6.1 million. As a percentage of total sales, industrial supplies represented 11.7% in 2017, an increase from the 2016 percentage of total sales of 10.5% due to product category growth.

Cut sheet paper product sales increased $11.9 million or 3.0% in 2017 compared to 2016. The increase in this category was primarily driven by increased sales to independent resellers of $10.5 million and e-commerce sales increases of $3.4 million, partially offset by declines in sales to national resellers of $2.0 million. As a percentage of total sales, cut sheet paper represented 8.2% in 2017, which increased from the 2016 percentage of total sales of 7.4%.

Automotive product sales increased $7.5 million or 2.4% in 2017 versus 2016. The increase in this category was primarily due to increases in recreational vehicle and marine sales of $4.6 million and mobile sales of $2.6 million, partially offset by declines in collision sales of $3.6 million. As a percentage of total sales, automotive products represented 6.5% in 2017, which increased from the 2016 percentage of total sales of 5.9%.

Office furniture sales decreased $30.7 million or 10.3% in 2017 compared to 2016. The decrease was primarily the result of declines in sales to independent resellers of $16.4 million with additional declines in the national reseller channel of $7.2 million and e-commerce channel sales declines of $7.1 million. As a percentage of total sales, office furniture represented 5.3% in 2017, a decrease from the 2016 percentage of total sales of 5.6%.

The remainder of the Company’s consolidated 2017 net sales was composed of freight and other revenues.

Gross Profit and Gross Margin Rate. Gross profit for 2017 was $706.1 million, compared to $759.9 million in 2016. Gross profit as a percentage of net sales (the gross margin rate) of 14.0% for 2017 was down 20 basis points (“bps”) from the prior-year period gross margin rate of 14.2%. This decrease was due to deleveraging of the distribution network and transportation costs (41 bps) and inventory-related valuation (29 bps), partially offset by favorable product margin (43 bps) driven by inflation and benefits from merchandising and pricing actions related to the implementation of the Company’s strategic drivers which were offset by lower supplier allowances due to decreased sales volume. Sales to larger resellers are generally lower margin than sales to smaller resellers. Sales to new customers tend to be lower margin but typically improve over time. Lower margin categories include cut-sheet paper products and technology products, while JanSan, traditional office products, furniture and industrial supplies are higher margin categories.

18


Operating Expenses. Operating expenses for 2017 were $949.4 million or 18.8% of sales, compared with $642.3 million or 12.0% of sales in the same period last year. Excluding the Actions in 2017 and 2016, adjusted operating expenses were $635.8 million or 12.6% of sales in 2017 compared to $646.1 million or 12.0% of sales in 2016. The increase in adjusted operating expenses as a percentage of sales in 2017 was principally driven by a reset of incentive compensation. Through the Company’s strategic actions of reengineering the inbound freight operations by opening freight consolidation centers, aligning the distribution network footprint with sales volume and targeted cost improvements through a zero-based budgeting approach, the Company has targeted annualized cost savings in excess of $50 million by 2020.

Interest Expense, net. Net interest expense for 2017 was $25.6 million or 0.5% of total sales, compared with $22.9 million or 0.4% of total sales in 2016. This increase was primarily driven by higher interest rates in 2017, partially offset by reductions in outstanding debt.

Income Taxes. Income tax benefit was $(2.0) million in 2017, compared to expense of $30.8 million in 2016. The Company’s effective tax rate was 0.8% and 32.5% in 2017 and 2016, respectively. This change was primarily driven by the permanent impacts of the cumulative goodwill impairments that occurred in 2017. The Company’s effective tax rate excluding these Actions would have been 44.4% and 37.7% in 2017 and 2016, respectively. The increase reflects the change in accounting for equity compensation (ASU 2016-09) adopted in 2017 resulting in $2.0 million of additional tax expense during the year or $1.3 million effected for Tax reform. Further, income tax expense was impacted by the passage of tax reform in December 2017, including through the remeasurement of deferred tax assets and liabilities, recording of the one-time transition tax and other necessary reassessments of the Company’s historical tax positions totaling $2.6 million.

Net (Loss) Income. Net loss for 2017 was $(267.0) million compared to a net income of $63.9 million in 2016. Basic loss per share was $(7.27) in 2017, compared to diluted earnings per share of $1.73 in 2016. Excluding the Actions in 2017 and 2016, adjusted net income for 2017 and 2016 was $24.8 million and $57.0 million, respectively. Adjusted diluted earnings per share were $0.67 and $1.54 for 2017 and 2016, respectively. Adjusted diluted earnings per share in the first quarter of 2018 is expected to be lower than the fourth quarter of 2017, reflecting impacts from the national reseller sales decline, the annual first quarter reset of employee time off expense and lower supplier allowances resulting from opportunistic inventory purchases.

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 product category for 2016 and 2015 included the following:  

 

JanSan sales decreased $22.0 million or 1.5% in 2016 compared to 2015. Sales decreased due to a decline in sales in the independent reseller channel of $19.4 million and the national reseller channel of $13.5 million, partially offset by online growth of $12.7 million. As a percentage of total sales, JanSan represented 27.1% in 2016, a decrease from the 2015 percentage of total sales of 27.4%. This decrease was the result of reduced demand principally due to declines in customer experience and competitive actions from other wholesalers.

 

Technology product sales decreased $7.9 million or 0.6% in 2016 versus 2015. Excluding $50.1 million in sales from the Company’s subsidiary in Mexico in 2015, which was sold in 2016, net sales in this category increased 3.2% compared to the prior year, primarily driven by increases in sales in the independent reseller channel of $83.3 million, partially offset by declines in sales to national resellers of $37.8 million and declines in e-commerce sales of $3.3 million. As a percentage of total sales, technology products represented 25.1% in 2016, a decrease from the 2015 percentage of total sales of 25.3% due to the sale of the Company’s Mexican subsidiary.

 

Traditional office product sales decreased $10.8 million or 1.3% in 2016 versus 2015. This decrease in the product category was primarily driven by the buying patterns of national resellers totaling $7.7 million in the year, a decline of $1.8 million in the independent reseller channel and a decrease in e-commerce sales of $1.3 million. As a percentage of total sales, traditional office products represented 15.5% in 2016 a decrease from 15.7% in 2015.

Industrial supplies sales decreased $26.1 million or 4.4% in 2016 compared to 2015. 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 10.5% in 2016, a decrease from the 2015 percentage of total sales of 11.0%.

Cut sheet paper product sales increased $56.1 million or 16.2% in 2016 versus 2015. The increase in this category was solely driven by increased sales to independent resellers of $56.0 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 6.5%.

19


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 third quarter of 2015, which contributed an additional $64.9 million in net sales in 2016 compared to $27.1 million in 2015. 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 $22.1 million or 6.9% in 2016 compared to 2015. The decreased revenue was primarily the result of declines in sales to national resellers of $14.4 million and independent resellers of $7.7 million. As a percentage of total sales, office furniture represented 5.6% in 2016, a decrease from the 2015 percentage of total sales of 6.0%.

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. The gross margin rate of 14.2% for 2016 was down 140 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).

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 $646.1 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.

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 effective tax rate decline was primarily driven by the prior year Actions, particularly the 2015 noncash impairment charges for goodwill that were nondeductible for tax purposes and the 2015 loss on the sale of the Mexican subsidiary that 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 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


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 flow from operations and collections of receivables, coupled with the Company’s sources of borrowings and available cash on hand, are sufficient to fund currently anticipated requirements. These requirements include payments of interest and dividends, scheduled debt repayments, capital expenditures, working capital needs, the funding of pension plans, additional share repurchases and acquisitions, if applicable. The Company believes that its sources of borrowings are sound and that the strength of its balance sheet affords the Company 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,

 

 

2017

 

 

2016

 

2017 Credit Agreement

 

 

 

 

 

 

 

Term Loan

$

73.1

 

 

$

-

 

Revolving Credit Facility

 

181.3

 

 

 

-

 

FILO Facility

 

100.0

 

 

 

-

 

2013 Credit Agreement

 

-

 

 

 

260.4

 

2013 Note Purchase Agreement

 

150.0

 

 

 

150.0

 

Receivables Securitization Program

 

-

 

 

 

200.0

 

Debt

 

504.4

 

 

 

610.4

 

Stockholders’ equity

 

494.9

 

 

 

781.1

 

Total capitalization

$

999.3

 

 

$

1,391.5

 

 

 

 

 

 

 

 

 

Debt-to-total capitalization ratio

 

50.5

%

 

 

43.9

%

 

The increase in the debt-to-capitalization ratio at December 31, 2017, compared to December 31, 2016 is due primarily to the net loss during the year which more than offset reductions in outstanding debt.

 

As discussed further in Item 8, Note 11 – “Debt,” in February 2017, the Company entered into the 2017 Credit Agreement and terminated the Receivables Securitization Program. 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.

 

21


Availability of financing as of December 31, 2017, is summarized below (in millions):

 

 

Aggregated Committed Principal

 

 

Gross Borrowing Base Availability

 

 

Total Utilization

 

 

Net Availability

 

2017 Credit Agreement

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Term Loan

$

73.1

 

 

$

73.1

 

 

$

73.1

 

 

$

-

 

Revolving Credit Facility (1)

 

1,000.0

 

 

 

837.0

 

 

 

358.4

 

 

 

478.6

 

First-in-Last-Out ("FILO") (2)

 

100.0

 

 

 

99.0

 

 

 

100.0

 

 

 

(1.0

)

Total all Funding Sources

$

1,173.1

 

 

$

1,009.1

 

 

$

531.5

 

 

$

477.6

 

 

 

1)

The 2017 Credit Agreement provides for the issuance of letters of credit up to $50.0 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 $177.1 million were utilized as of December 31, 2017.

 

2)

The FILO loan was remeasured effective for the year ended December 31, 2017. The under-collateralized amount of $1.0 million was then funded via the Revolving Credit Facility.

 

Disclosures About Contractual Obligations

The following table aggregates all contractual obligations that affect financial condition and liquidity as of December 31, 2017 (in millions):

 

 

 

Payment due by period

 

 

 

 

 

Contractual obligations

 

2018

 

 

2019 & 2020

 

 

2021 & 2022

 

 

Thereafter

 

 

Total

 

Debt

 

$

6

 

 

$

12

 

 

$

486

 

 

$

-

 

 

$

504

 

Fixed interest payments on long term debt (1)

 

 

8

 

 

 

16

 

 

 

7

 

 

 

-

 

 

 

31

 

Operating leases

 

 

58

 

 

 

102

 

 

 

59

 

 

 

90

 

 

 

309

 

Purchase obligations

 

 

6

 

 

 

3

 

 

 

-

 

 

 

-

 

 

 

9

 

Tax payment pursuant to the Tax Reform

 

 

-

 

 

 

1

 

 

 

-

 

 

 

2

 

 

 

3

 

Acquisition related future payments

 

 

2

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

2

 

Total contractual cash obligations

 

$

80

 

 

$

134

 

 

$

552

 

 

$

92

 

 

$

858

 

 

 

1)

The Company has entered into an interest rate swap transaction on a portion of its long-term debt. The fixed interest payments noted in the table are based on the notional amounts and fixed rate inherent in the swap transactions and related debt instruments.

  

In December 2017, the Company’s Board of Directors approved a cash contribution to the Essendant Pension Plan, which was made in 2018, totaling $10.0 million. Additional contributions, if any, for 2018 have not yet been determined.

 

At December 31, 2017, the Company had a liability for unrecognized tax benefits of $3.9 million as discussed in Item 8, Note 15 - “Income Taxes”, and an accrual for the related interest, that is 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.

 

22


Cash Flows

Cash flows for the Company for the years ended December 31, 2017, 2016 and 2015 are summarized below (in thousands):

 

 

Years Ended December 31,

 

 

2017

 

 

2016

 

 

2015

 

Net cash provided by operating activities

$

185,543

 

 

$

130,942

 

 

$

162,734

 

Net cash used in investing activities

 

(38,455

)

 

 

(3,769

)

 

 

(67,929

)

Net cash used in financing activities

 

(140,001

)

 

 

(135,964

)

 

 

(84,990

)

 

Cash Flows From Operations

The 2017 increase in net cash provided by operating activities was principally the result of increased accounts payable and reductions in accounts receivable and inventory, partly offset by diminished operating results. The 2016 decline in net cash provided by operating activities compared to 2015 was principally the result of diminished operating results and decreased accounts payable, partially offset by reductions in accounts receivable and inventory. Free cash flow for 2018 is expected to be in excess of $40 million.

 

Cash Flows From Investing Activities

Gross capital spending for 2017, 2016 and 2015, was $38.6 million, $37.7 million and $28.3 million, respectively, which was used for various investments in fleet equipment, information technology systems, technology hardware, and distribution center equipment and facility projects. During 2016, the Company received $33.9 million from the disposition of the City of Industry facility. Additionally, cash used in 2015 included $40.5 million related to an acquisition.

  

Cash Flows From Financing Activities

The Company’s cash flow from financing activities is largely dependent on levels of borrowing under the Company’s credit agreements, the acquisition or issuance of treasury stock, and quarterly dividend payments. Cash outflows from financing activities in 2017 included the repayment of the asset securitization program and payment of debt issuance costs incurred in connection with the 2017 Credit Agreement, partially offset by incremental borrowings under the 2017 Credit Agreement. Cash outflows from financing activities in 2016 included the partial debt repayment of $108.1 million compared to 2015 net borrowings of $4.6 million, partly offset by 2016 share repurchase activity of $6.8 million compared to 2015 share repurchases of $68.1 million.

 

The Company paid a $0.14 per share dividend on January 12, 2018, totaling $5.2 million. In February 2018, the Board of Directors approved a dividend of $0.14 to be paid on April 13, 2018 to shareholders of record as of March 15, 2018. In the aggregate, the Company paid dividends of $20.7 million, $20.5 million and $21.2 million in 2017, 2016 and 2015, respectively.

 

Inflation/Deflation and Changing Prices

The Company maintains substantial inventories to accommodate the prompt service and delivery requirements of its customers. Accordingly, the Company purchases products on a regular basis in an effort to maintain inventory at levels that it believes are sufficient to satisfy the anticipated needs of customers, based upon historical buying practices and market conditions. Although the Company historically has been able to pass through manufacturers’ price increases to customers on a timely basis, competitive conditions will influence how much of future price increases can be passed on. Conversely, when manufacturers’ prices decline, lower sales prices could result in lower margins as the Company sells through existing inventory. As a result, changes in the prices paid by the Company for products could have a material effect on the Company’s net sales, gross margins and net income.  

New Accounting Pronouncements

For information about recently issued accounting pronouncements, see Item 8, Note 2 - “Summary of Significant Accounting Policies.”

 

23


Adjusted Gross Profit, Adjusted Operating Expenses, Adjusted Operating Income, Adjusted Net Income, Adjusted Diluted Earnings Per Share, Adjusted EBITDA and Free Cash Flow (the “Non-GAAP table”)

The Non-GAAP table below presents Adjusted Gross Profit, Adjusted Operating Expenses, Adjusted Operating Income, Adjusted Net Income, Adjusted Diluted Earnings per Share, Adjusted EBITDA and Free Cash Flow for the twelve months ended December 31, 2017, 2016 and 2015. These non-GAAP measures exclude certain non-recurring items and exclude other items that do not reflect the Company’s ongoing operations, and are included to provide investors with useful information about the financial performance of the business. The presented non-GAAP financial measures should not be considered in isolation or as substitutes for the comparable GAAP financial measures. The non-GAAP financial measures do not reflect all of the amounts associated with the results of operations as determined in accordance with GAAP, and these non-GAAP financial measures should only be used to evaluate the results of operations in conjunction with the corresponding GAAP financial measures.

 

In order to calculate the non-GAAP measures, management excludes the following items to the extent they occur in the reporting period, to facilitate the comparison of current and prior year results and ongoing operations, as management believes these items do not reflect the underlying cost structure of the business. These items can vary significantly in amount and frequency.

 

 

Restructuring charges. Workforce reduction and facility closure charges such as employee termination costs, facility closure and consolidation costs, and other costs directly associated with shifting business strategies or business conditions that are part of a restructuring program. 

 

Restructuring actions were taken in 2015 and had impacts during both 2016 and 2015 (refer to Item 8, Note 7 – “Severance and Restructuring Charges”).

 

 

Gain or loss on sale of assets or businesses. Sales of assets, such as buildings or equipment, and businesses can cause gains or losses. These transactions occur as the Company is repositioning its business and reviewing its cost structure.

 

The Company recognized a gain on the sale of its City of Industry facility in 2016 (refer to Item 8, Note 12 – “Leases, Contractual Obligations and Contingencies”), a loss on the sale and related impairment of intangible assets of the operations in Mexico in 2015 and an impairment of the seller notes related to the sale of the software services provider in 2015.

 

 

Severance costs for operating leadership.  Employee termination costs related to members of the Company’s operating leadership team are excluded as they are based upon individual agreements.

 

In 2016, the Company recorded a charge related to the severance of two operating leaders which were not part of a restructuring program.

 

 

Asset impairments.  Changes in strategy or macroeconomic events may cause asset impairments.

 

During 2017, the Company recorded goodwill impairments which resulted from declines in sales, earnings and market capitalization (refer to Note 6 – “Goodwill and Intangible Assets”). In 2015, the Company recorded impairment and accelerated amortization of its trademarks upon the announcement of its rebranding effort. The Company recorded impairment of goodwill and intangible assets, as well as an increase in reserves for obsolete inventory, based on a strategic review of the Industrial business unit in 2015.

 

 

Other actions.  Actions, which may be non-recurring events, that result from the changing strategies and needs of the Company and do not reflect the underlying expense of the on-going business.

 

In 2017, other actions include transformational expenses, a litigation charge (refer to Note 18 – “Legal Matters”), the one-time impact due to the December 2017 passage of tax reform and a gain reflecting receipt of payment on notes receivable impaired in 2015. In 2016, other actions included settlement charges related to a defined benefit plan settlement, litigation charges, the tax impact of dividends from a foreign subsidiary and reserves related to prior year uncertain tax positions.

 

24


Adjusted gross profit, adjusted operating expenses and adjusted operating income. Adjusted gross profit, adjusted operating expenses and adjusted operating income provide management and investors with an understanding of the results from the primary operations of the business by excluding the effects of items described above that do not reflect the ordinary expenses and earnings of operations. Adjusted operating expenses and adjusted operating income are used to evaluate the period-over-period operating performance as they are more comparable measures of the continuing business. These measures may be useful to an investor in evaluating the underlying operating performance of the business.

 

Adjusted net income and adjusted diluted earnings per share. Adjusted net income and adjusted diluted earnings per share provide a more comparable view of the Company’s underlying performance and trends than the comparable GAAP measures. Net income and diluted earnings per share are adjusted for the effect of items described above that do not reflect the ordinary earnings of operations.

 

Adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”). Adjusted EBITDA is helpful in evaluating the Company’s operating performance and is used by management for various purposes, including as a measure of performance and as a basis for strategic planning and forecasting. Net income is adjusted for the effect of interest, taxes, depreciation and amortization and stock-based compensation expense. Management believes that adjusted EBITDA is commonly used by investors to evaluate operating performance between competitors because it helps reduce variability caused by differences in capital structures, income taxes, stock-based compensation accounting policies, and depreciation and amortization policies.  

 

Free cash flow. Free cash flow is useful to management and investors as it is a measure of the Company’s liquidity. It provides a more complete understanding of factors and trends affecting cash flows than the comparable GAAP measure. Net cash provided by (used in) operating activities and net cash provided by (used in) investing activities are aggregated and adjusted to exclude acquisitions, net of cash acquired and divestitures.

25


 

For the Years Ended December 31,

 

 

2017

 

 

2016

 

 

2015

 

Gross profit

$

706,054

 

 

$

759,861

 

 

$

836,495

 

Industrial inventory obsolescence reserve

 

-

 

 

 

-

 

 

 

4,887

 

Adjusted gross profit

$

706,054

 

 

$

759,861

 

 

$

841,382

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

$

949,446

 

 

$

642,335

 

 

$

806,712

 

Impairment of goodwill (Note 6)

 

(285,166

)

 

 

-

 

 

 

-

 

Transformational expenses

 

(19,745

)

 

 

-

 

 

 

-

 

Litigation reserve (Note 18)

 

(9,000

)

 

 

(4,000

)

 

 

-

 

Recovery of notes receivable

 

300

 

 

 

-

 

 

 

-

 

Gain on sale of City of Industry facility (Note 12)

 

-

 

 

 

20,541

 

 

 

-

 

Defined benefit plan settlement charge

 

-

 

 

 

(12,510

)

 

 

-

 

Severance costs for operating leadership

 

-

 

 

 

(1,245

)

 

 

-

 

Impairment of Industrial goodwill and intangible assets

 

-

 

 

 

-

 

 

 

(115,825

)

Restructuring charges (Note 7)

 

-

 

 

 

956

 

 

 

(18,575

)