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Section 1: 10-Q (10-Q)

Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
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 1-13792
Systemax Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
11-3262067
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
11 Harbor Park Drive
Port Washington, New York 11050
(Address of principal executive offices, including zip code)
Registrant’s telephone number, including area code: (516) 608-7000

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 whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,”  “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
 
Accelerated filer ☒
Non-accelerated filer ☐
 
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 Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)   Yes ☐   No ☒

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
 Symbol(s)
Name of each exchange on which registered
Common Stock ($.01 par value)
SYX
New York Stock Exchange
The number of shares outstanding of the registrant’s Common Stock as of July 30, 2019 was 37,485,837.


Table of Contents

TABLE OF CONTENTS

Available Information
 
 
 
Part I
Financial Information
 
Item 1.
Item 2.
Item 3.
Item 4.
 
 
 
Part II
Other Information
 
Item 1.
Item 6.
 
 
 
 

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Table of Contents

Available Information

We maintain an internet web site at www.systemax.com.  We file reports with the Securities and Exchange Commission (“SEC”) and make available free of charge on or through this website our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, including all amendments to those reports.  These are available as soon as is reasonably practicable after they are filed with the SEC.  All reports mentioned above are also available from the SEC’s website (www.sec.gov).  The information on our website is not part of this or any other report we file with, or furnish to, the SEC.

Our Board of Directors has adopted the following corporate governance documents with respect to the Company (the “Corporate Governance Documents”):

Corporate Ethics Policy for officers, directors and employees
Charter for the Audit Committee of the Board of Directors
Charter for the Compensation Committee of the Board of Directors
Charter for the Nominating/Corporate Governance Committee of the Board of Directors
Corporate Governance Guidelines and Principles

In accordance with the corporate governance rules of the New York Stock Exchange, each of the Corporate Governance Documents is available on our Company web site, www.systemax.com.

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Table of Contents

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Systemax Inc.
Condensed Consolidated Balance Sheets (Unaudited)
(In millions)

 
June 30,
2019
 
December 31,
2018
ASSETS:
 
 
 
Current assets:
 
 
 
Cash
$
90.8

 
$
295.4

Accounts receivable, net
96.2

 
84.1

Inventories
101.4

 
107.3

Prepaid expenses and other current assets
4.7

 
10.6

Total current assets
293.1

 
497.4

 
 
 
 
Property, plant and equipment, net
15.3

 
14.9

Operating lease right-of-use assets
63.4

 
0.0

Deferred income taxes
9.1

 
8.9

Goodwill and intangibles
7.3

 
7.7

Other assets
1.3

 
1.1

Total assets
$
389.5

 
$
530.0

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY:
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
116.8

 
$
101.1

Dividend payable
0.0

 
243.5

Accrued expenses and other current liabilities
39.7

 
35.0

Operating lease liabilities
11.4

 
0.0

Total current liabilities
167.9

 
379.6

Deferred income tax liability
0.1

 
0.1

Other liabilities
2.6

 
12.6

Operating lease liabilities
62.8

 
0.0

Total liabilities
233.4

 
392.3

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Shareholders’ equity:
 

 
 

Preferred stock
0.0

 
0.0

Common stock
0.4

 
0.4

Additional paid-in capital
188.1

 
187.0

Treasury stock
(23.2
)
 
(25.1
)
Retained earnings
(12.3
)
 
(27.6
)
Accumulated other comprehensive income
3.1

 
3.0

Total shareholders’ equity
156.1

 
137.7

Total liabilities and shareholders’ equity
$
389.5

 
$
530.0


See Notes to Condensed Consolidated Financial Statements.

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Systemax Inc.
Condensed Consolidated Statements of Operations (Unaudited)
(In millions, except per share amounts)
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Net sales
$
248.6

 
$
231.2

 
$
480.8

 
$
443.4

Cost of sales
162.6

 
151.2

 
314.5

 
290.9

Gross profit
86.0

 
80.0

 
166.3

 
152.5

Selling, distribution & administrative expenses
66.0

 
61.7

 
133.1

 
123.1

Operating income from continuing operations
20.0

 
18.3

 
33.2

 
29.4

Interest and other (income) expense, net
(0.1
)
 
0.0

 
(0.1
)
 
0.1

Income from continuing operations before income taxes
20.1

 
18.3

 
33.3

 
29.3

Provision for income taxes
5.2

 
4.9

 
8.4

 
7.2

Net income from continuing operations
14.9

 
13.4

 
24.9

 
22.1

Income (loss) from discontinued operations, net of tax
(0.3
)
 
4.8

 
(0.6
)
 
10.7

Net income
$
14.6


$
18.2


$
24.3


$
32.8

 
 
 
 
 
 
 
 
Net income per common share from continuing operations:
 

 
 

 
 
 
 
Basic
$
0.40

 
$
0.36

 
$
0.66

 
$
0.59

Diluted
$
0.39

 
$
0.35

 
$
0.66

 
$
0.58

Net income (loss) per common share from discontinued operations:
 
 
 
 
 
 
 
Basic
$
(0.01
)
 
$
0.13

 
$
(0.02
)
 
$
0.29

Diluted
$
(0.01
)
 
$
0.13

 
$
(0.02
)
 
$
0.28

Net income per common share:
 
 
 
 
 
 
 
Basic
$
0.39

 
$
0.49

 
$
0.64

 
$
0.88

Diluted
$
0.38

 
$
0.48

 
$
0.64

 
$
0.87

 
 
 
 
 
 
 
 
Weighted average common and common equivalent shares:
 

 
 

 
 

 
 
Basic
37.5

 
37.2

 
37.4

 
37.2

Diluted
37.9

 
37.9

 
37.9

 
37.9

 
 
 
 
 
 
 
 
Dividends declared
$
0.12

 
$
1.11

 
$
0.24

 
$
1.22

 
See Notes to Condensed Consolidated Financial Statements.

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Systemax Inc.
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
(In millions)

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Net income
$
14.6

 
$
18.2

 
$
24.3

 
$
32.8

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation
0.1

 
(3.7
)
 
0.1

 
(2.3
)
Total comprehensive income
$
14.7

 
$
14.5

 
$
24.4

 
$
30.5

 
See Notes to Condensed Consolidated Financial Statements.

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Systemax Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In millions)
 
Six Months Ended
June 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Income from continuing operations
$
24.9

 
$
22.1

Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities:
 

 
 

Depreciation and amortization
2.0

 
2.2

Provision for returns and doubtful accounts
0.3

 
0.0

Stock-based compensation
2.8

 
0.8

Provision for deferred taxes
(0.2
)
 
0.2

Gain on disposition and abandonment
0.1

 
0.0

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(12.8
)
 
(10.4
)
Inventories
6.0

 
(1.5
)
Prepaid expenses and other assets
(1.2
)
 
(2.2
)
Income taxes payable
5.9

 
5.5

Accounts payable
15.4

 
3.2

Accrued expenses, other current and non current liabilities
6.9

 
(1.9
)
Net cash provided by operating activities from continuing operations
50.1


18.0

Net cash provided by (used in) operating activities from discontinued operations
0.1


(1.7
)
Net cash provided by operating activities
50.2


16.3

 
 
 
 
Cash flows from investing activities:
 
 
 

Purchases of property, plant and equipment
(2.4
)
 
(1.1
)
Net cash used in investing activities from continuing operations
(2.4
)

(1.1
)
Net cash used in investing activities from discontinued operations
0.0


(0.3
)
Net cash used in investing activities
(2.4
)
 
(1.4
)
 
 
 
 
Cash flows from financing activities:
 
 
 

Dividends paid
(252.5
)
 
(101.1
)
Proceeds from issuance of common stock
0.6

 
0.9

Payment of payroll taxes on stock-based compensation through shares withheld
(0.8
)
 
(1.3
)
Proceeds from the issuance of common stock from employee stock purchase plan
0.4

 
0.0

Net cash used in financing activities
(252.3
)

(101.5
)
 
 
 
 
Effects of exchange rates on cash
(0.1
)

(1.0
)
 
 
 
 
Net decrease in cash
(204.6
)

(87.6
)
Cash – beginning of period
295.4

 
184.5

Cash – end of period
$
90.8

 
$
96.9

 
 
 
 
Supplemental disclosures of non-cash operating and investing activities:
 
 
 
Right-of-use assets obtained in exchange for lease obligations:
 
 
 
Operating leases
$
14.7

 
$
0.0


See Notes to Condensed Consolidated Financial Statements.

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Systemax Inc.
Condensed Consolidated Statement of Shareholders’ Equity (Unaudited)
(In millions)

 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
Number of
Shares
Outstanding
 
Amount
 
Additional
Paid-in
Capital
 
Treasury
Stock
 
Retained
Earnings
 
Accumulated Other
Comprehensive Income
 
Total
Equity
Balances, January 1, 2018
37,094

 
$
0.4

 
$
186.5

 
$
(21.8
)
 
$
44.8

 
$
1.9

 
$
211.8

Stock-based compensation expense
 
 
 

 
0.4

 
 
 
 
 
 
 
0.4

Issuance of restricted stock
38

 
 
 
(0.5
)
 
0.5

 
 
 
 
 
0.0

Stock withheld for employee taxes
(31
)
 
 
 
(0.5
)
 
(0.4
)
 
 
 
 
 
(0.9
)
Proceeds from issuance of common stock
72

 
 
 
(0.1
)
 
0.9

 
 
 
 
 
0.8

Dividends declared
 
 
 
 
 
 
 
 
(4.1
)
 
 
 
(4.1
)
Change in cumulative translation adjustment
 
 
 
 
 
 
 
 
 
 
1.4

 
1.4

Net income
 

 
 

 
 

 
 

 
14.6

 
 
 
14.6

Balances March 31, 2018
37,173

 
$
0.4

 
$
185.8

 
$
(20.8
)
 
$
55.3

 
$
3.3

 
$
224.0

Stock-based compensation expense
 
 
 
 
0.4

 
 
 
 
 
 
 
0.4

Issuance of restricted stock
19

 
 
 
(0.2
)
 
0.2

 
 
 
 
 
0.0

Stock withheld for employee taxes
(10
)
 
 
 
(0.3
)
 
$
(0.1
)
 
 
 
 
 
(0.4
)
Proceeds from issuance of common stock
10

 
 
 
 
 
$
0.1

 
 
 
 
 
0.1

Dividends declared
 
 
 
 
 
 
 
 
(41.3
)
 
 
 
(41.3
)
Change in cumulative translation adjustment
 
 
 
 
 
 
 
 
 
 
(3.7
)
 
(3.7
)
Net income
 
 
 
 
 
 
 
 
18.2

 
 
 
18.2

Balances, June 30, 2018
37,192

 
$
0.4

 
$
185.7

 
$
(20.6
)
 
$
32.2

 
$
(0.4
)
 
$
197.3




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Common Stock
 
 
 
 
 
 
 
 
 
 
 
Number of
Shares
Outstanding
 
Amount
 
Additional
Paid-in
Capital
 
Treasury
Stock
 
Retained
Earnings
 
Accumulated Other
Comprehensive Income
 
Total
Equity
Balances, January 1, 2019
37,335

 
$
0.4

 
$
187.0

 
$
(25.1
)
 
$
(27.6
)
 
$
3.0

 
$
137.7

Stock-based compensation expense
 

 
 

 
1.5

 
 
 
 
 
 

 
1.5

Issuance of restricted stock
103

 
 
 
(1.8
)
 
1.8

 
 
 
 

 
0.0

Stock withheld for employee taxes
(34
)
 
 
 


 
(0.8
)
 
 
 
 
 
(0.8
)
Proceeds from issuance of common stock
3

 
 
 


 


 
 
 
 
 
0.0

Issuance of shares under employee stock purchase plan
21

 
 
 
0.4

 
 
 
 
 
 
 
0.4

Dividends declared
 
 
 
 
 
 
 
 
(4.5
)
 
 
 
(4.5
)
Change in cumulative translation adjustment
 
 
 
 
 
 
 
 
 
 
0.0

 
0.0

Net income
 

 
 

 
 

 
 

 
9.7

 
 
 
9.7

Balances, March 31, 2019
37,428

 
$
0.4

 
$
187.1

 
$
(24.1
)
 
$
(22.4
)
 
$
3.0

 
$
144.0

Stock-based compensation expense
 
 
 
 
1.3

 
 
 
 
 
 
 
1.3

Issuance of restricted stock
6

 
 
 


 


 
 
 
 
 
0.0

Stock withheld for employee taxes
(1
)
 
 
 
 
 
 
 
 
 
 
 
0.0

Proceeds from issuance of common stock
53

 
 
 
(0.3
)
 
0.9

 
 
 
 
 
0.6

Dividends declared
 
 
 
 
 
 
 
 
(4.5
)
 
 
 
(4.5
)
Change in cumulative translation adjustment
 
 
 
 
 
 
 
 
 
 
0.1

 
0.1

Net income
 
 
 
 
 
 
 
 
14.6

 
 
 
14.6

Balances, June 30, 2019
37,486

 
$
0.4

 
$
188.1

 
$
(23.2
)
 
$
(12.3
)
 
$
3.1

 
$
156.1


See Notes to Condensed Consolidated Financial Statements.

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Table of Contents

Systemax Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)

1.
Basis of Presentation

The accompanying condensed consolidated financial statements of Systemax Inc., with its subsidiaries, (the "Company") are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America are not required in these interim financial statements and have been condensed or omitted.  All significant intercompany accounts and transactions have been eliminated in consolidation.

As previously disclosed, in August 2018 the Company sold its France-based IT business. With the completion of the sale, Systemax operates and is internally managed in one reportable business segment, its Industrial Products Group (“IPG”), which includes its former Corporate and other segment. IPG focuses on industrial supplies and MRO (maintenance, repair and operations) markets the Company has served since 1949.

The sale of the France based IT business, which had been included in the Company's former European Technology Products segment, met the “strategic shift with major impact” criteria as defined under Accounting Standards Update ("ASU") 2014-08, "Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity". Therefore, the prior year results of the France-based IT business are included in discontinued operations in the accompanying consolidated financial statements. For the three and six month periods ended June 30, 2019, there were no net sales or net income/loss of the France business included in discontinued operations. For the three and six month periods ended June 30, 2018, net sales of the France business included in discontinued operations totaled $131.9 million and $274.9 million, respectively, and net income of the France business included in discontinued operations totaled $4.4 million and $9.9 million, respectively.

As previously disclosed, in March 2017 the Company sold Systemax Europe SARL and its subsidiaries (the “SARL Businesses”) which had been included in the Company's former European Technology Products segment. The sale of the SARL Businesses met the “strategic shift with major impact” criteria as described above. For the three and six month periods ended June 30, 2019, there were no net sales or net income/loss of the SARL Businesses included in discontinued operations. For the three and six month periods ended June 30, 2018, there were no net sales of the SARL Businesses included in discontinued operations. For the three and six month periods ended June 30, 2018, net income of the SARL Businesses included in discontinued operations totaled $0.4 million and $0.2 million, respectively.

Also included in discontinued operations is the Company’s former North American Technology Group ("NATG") business, which was sold in December 2015 and is winding down its operations. The sale of the NATG business had a major impact on the Company and therefore certain components met the strategic shift criteria as defined under ASU 2014-08. Accordingly, these components and any related results of operations are reflected in discontinued operations. For the three and six month periods ended June 30, 2019 and 2018, there were no net sales of the NATG business included in discontinued operations. Net loss from the NATG business was $0.3 million and $0.6 million, respectively, for the three and six month periods ended June 30, 2019, and net income from the NATG business was zero for the three months ended June 30, 2018 and $0.6 million for the six months ended June 30, 2018.

In the opinion of management, the accompanying condensed consolidated financial statements contain all normal and recurring adjustments necessary to present fairly the financial position of the Company as of June 30, 2019 and the results of operations for the three and six month periods ended June 30, 2019 and 2018, statements of comprehensive income (loss) for the three and six month periods ended June 30, 2019 and 2018, cash flows for the six month periods ended June 30, 2019 and 2018 and changes in shareholders’ equity for the three and six month periods ended June 30, 2019 and 2018.  The December 31, 2018 Condensed Consolidated Balance Sheet has been derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements as of December 31, 2018 and for the year then ended included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018.  The results for the six month period ended June 30, 2019 are not necessarily indicative of the results for the entire year.


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Table of Contents

Systemax manages its business and reports using a 52-53 week fiscal year that ends at midnight on the Saturday closest to December 31.  For clarity of presentation herein, fiscal years and quarters are referred to as if they ended on the traditional calendar month.  The actual fiscal second quarter ended on June 29, 2019 and June 30, 2018. The second quarters of both 2019 and 2018 included 13 weeks and the first six months of both 2019 and 2018 included 26 weeks.

Recent Accounting Pronouncements

Public companies in the United States are subject to the accounting and reporting requirements of various authorities, including the Financial Accounting Standards Board (“FASB”) and the Securities and Exchange Commission (“SEC”).  These authorities issue numerous pronouncements, most of which are not applicable to the Company’s current or reasonably foreseeable operating structure.

In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year, with early adoption permitted after adoption of ASU 2014-09. The Company adopted this standard beginning January 1, 2019 and its adoption did not materially impact the Company's consolidated financial position or results of operations.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurements, which eliminates, adds or modifies certain disclosure requirements for fair value measurements. Entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year, with early adoption permitted to adopt either the entire standard or only the provisions that eliminate or modify the requirements. The Company is evaluating the effect of adopting this pronouncement.

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in Accounting Standards Codification 350-40 to determine which implementation costs to defer and recognize as an asset. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year, with early adoption permitted, including adoption in any interim period. The Company is evaluating the effect of adopting this pronouncement.

In June 2016, the FASB ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments as modified by subsequently issued ASU 2018-19. This ASU requires estimating credit losses for certain financial instruments, including trade receivables, held at the reporting date based on historical experience, current conditions and reasonable forecasts. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year. The Company is evaluating the effect of adopting this pronouncement.



2. Leases
    
On January 1, 2019, the Company adopted ASU 2016-02, "Leases" (Topic 842). This ASU requires all companies to record their operating and finance leases that meet certain criteria under the standard as Right of Use ("ROU") assets with the corresponding lease obligations recorded as short term and long term liabilities. The Company adopted this standard utilizing the modified retrospective transition method that allows for a cumulative-effect adjustment in the period of adoption of the new leasing standard without restating prior periods. There was no cumulative-effect adjustment made to opening retained earnings upon adoption of this ASU. Additionally, the Company elected to adopt the available package of practical expedients under the transition guidance.
    
The Company has operating and finance leases for office and warehouse facilities, headquarters and call centers and certain computer, communications equipment and machinery and equipment which provide the right to use the underlying assets in exchange for agreed upon lease payments, determined by the payment schedule contained in each lease. The Company determines if an arrangement is an operating or finance lease at the inception of the lease. Leases with a term of one year or less are not considered to be ROU assets. All other leases are recorded on the balance sheet, with ROU assets representing the right to use the underlying asset for the lease term and lease liabilities representing the obligation to make lease payments

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arising from the lease. The Company’s lease portfolio consists primarily of operating leases which expire at various dates through 2032.

The ROU assets and corresponding lease liabilities are recorded based upon the net present value of the remaining lease payments, discounted using interest rates determined by utilizing such factors as the Company's current credit facility terms, the length of the remaining term of the lease, the Company's expected debt credit rating and comparable company term loan yields. Adoption of the new standard resulted in the Company recording ROU assets and lease liabilities of approximately $54 million and $64 million, respectively, at January 1, 2019. Certain leases may include options to extend the lease, however the Company is not including any impact of such options in the valuation of its ROU assets or liabilities as they are not currently probable of being extended. The Company’s lease agreements do not contain residual value guarantees or restrictive covenants. The Company has sublease agreements for unused space we lease in the United States and Germany. For the three and six month periods ended June 30, 2019, the Company recorded $0.4 million and $1.0 million, respectively, of sublease income in continuing and discontinued operations.

In April 2019, the Company entered into a lease agreement for a portion of a distribution facility located in Texas for approximately 490,000 square feet and a lease term of 125 months. The total lease obligation is approximately $19.8 million. The Company is separately charged for real estate taxes, insurance and common area maintenance. The Company recorded an ROU asset and related lease liability of approximately $14.7 million during the second quarter of 2019.

The following table details the Company's ROU asset operating lease cost, included in continuing operations, for the three and six months ended June 30, 2019 (in millions):
 
Three Months Ended
June 30,
 
Six Months Ended June 30,
 
2019
 
2019
Operating lease cost
$
3.0

 
$
5.7


The following tables detail the Company's ROU asset activity for continuing and discontinued operations as of June 30, 2019.
 
 
Six Months Ended June 30,
 
 
2019
Weighted Average Remaining Lease Term
 
 
Operating leases
 
8.5 years

 
 
 
Weighted Average Discount Rate
 
 
Operating leases
 
5.7
%

Maturities of lease liabilities were as follows (in millions):

Year Ending December 31
 
Operating Leases
2019 (remaining six months)
 
$
5.4

2020
 
13.9

2021
 
10.9

2022
 
9.9

2023
 
9.8

Thereafter
 
45.0

Total lease payments
 
94.9

Less: interest
 
(20.7
)
Total present value of lease liabilities
 
$
74.2


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The Company currently leases its headquarters office facility from an entity owned by the Company’s principal shareholders.


3.
Revenue

The Company’s revenue generated by its operating subsidiaries is comprised of sales of MRO products as well as other industrial and business supplies that are sold by the IPG segment. IPG also has revenues from related activities, such as freight and, to a lesser extent, services.

The Company recognizes revenue when a sales arrangement with a customer exists through the Company’s invoicing or a contract, the performance obligations have been identified, the transaction price is fixed or determinable and the Company has satisfied its performance obligations. The Company’s standard terms, provided on its invoices as well as on its websites, are included in communications with the customer and have standard payment terms of 30 days. Certain customers may have extended payment terms that have been pre-approved by the Company’s credit department, but generally none extend longer than 120 days.

The Company’s performance obligation is primarily a single obligation to deliver products. The Company’s performance obligations are satisfied when products are transferred to a customer in accordance with agreed upon shipping terms. Certain sales may include product and/or services that are distinct and accounted for as separate performance obligations. The Company’s performance obligations for services are satisfied when the services are rendered. The Company’s total service revenue is immaterial as it accounted for less than 1% of total revenue for the second quarter and six months ended June 30, 2019 and 2018, respectively.

The Company’s revenue is shown as “Net sales” in the accompanying Condensed Consolidated Statements of Operations and is measured as the determined transaction price, net of any variable consideration consisting primarily of rights to return product. The Company has elected to treat shipping and handling revenues as activities to fulfill its performance obligation. Billings for freight and shipping and handling are recorded in net sales and costs of freight and shipping and handling are recorded in cost of sales in the accompanying Condensed Consolidated Statements of Operations.

The Company records a contract liability in cases where customers pay in advance of the Company satisfying its performance obligation. The Company did not have any material unsatisfied performance obligations or liabilities as of June 30, 2019 and December 31, 2018.

The Company offers customers rights to return product within a certain time, usually 30 days. The Company estimates its sales returns liability quarterly, based upon its historical returns rates, as a percentage of historical sales for the trailing twelve-month period. The total accrued sales returns liability was approximately $2.1 million and $1.8 million at June 30, 2019 and December 31, 2018, respectively, and was recorded as a refund liability in Accrued expenses and other current liabilities in the accompanying Condensed Consolidated Balance Sheets.


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Disaggregation of Revenues

IPG serves customers in diverse geographies, which are subject to different economic and industry factors. The Company's presentation of revenue by geography most reasonably depicts how the nature, amount, timing and uncertainty of Company revenue and cash flows are affected by economic and industry factors. Revenue is attributed to countries based on the location of the selling subsidiary.

The following table presents the Company's revenue by geography for the three and six months ended June 30, 2019 and 2018 (in millions):


 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Net sales:
 

 
 
 
 
 
 
MRO products and industrial supplies-United States
$
236.7

 
$
220.4

 
$
457.5

 
$
422.4

MRO products and industrial supplies-Canada
11.9

 
10.8

 
23.3

 
21.0

Consolidated
$
248.6

 
$
231.2

 
$
480.8

 
$
443.4



4.
Discontinued Operations and Special Charges (Gains)

The Company’s discontinued operations include the results of the France business sold in August 2018, the SARL Businesses sold in March 2017 and the NATG business sold in December 2015 (See Note 1). 

In the second quarter ended June 30, 2019, the Company's NATG discontinued operations received approximately $0.2 million in vendor settlements and for the six months ended June 30, 2019, the Company's received approximately $0.2 million in vendor settlements and recorded approximately $0.1 million of professional fees. The Company expects that total additional charges related to the NATG business after this quarter will approximately $1.0 million and that these charges will be presented in discontinued operations.

In the second quarter ended June 30, 2018, the Company recorded, within discontinued operations, net recoveries of $0.1 million related to the wind-down of the SARL Businesses. The Company received escrow funds of approximately $0.2 million and recorded approximately $0.1 million of accelerated depreciation on fixed assets. For the six months ended June 30, 2018, the Company recorded $0.2 million recoveries of escrow funds, $0.1 million of accelerated depreciation and $0.1 million for legal and professional fees.

In the second quarter ended June 30, 2018, the Company's NATG discontinued operations received $0.1 million in vendor settlements, recorded $0.1 million in lease reserve adjustments related to their exited leased facilities and recorded approximately $0.1 million of legal and professional fees. For the six months ended June 30, 2018, the Company received $0.7 million in restitution receipts, received $0.1 million in vendor settlements, recorded approximately $0.2 million of legal and professional fees and recorded $0.1 million in favorable lease reserve adjustments related to their leased facilities.


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Below is a summary of the impact on net sales, net income (loss) and net income (loss) per share from discontinued operations for the three and six months ended June 30, 2019 and 2018.

Pretax income (loss) of Discontinued operations to the Net Income (loss) of discontinued operations is as follows (in millions):

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Net sales
$
0.0

 
$
131.9

 
$
0.0

 
$
274.9

Cost of sales
0.0

 
110.8

 
0.0

 
229.6

Gross profit
0.0

 
21.1

 
0.0

 
45.3

Selling, distribution & administrative expenses
0.4

 
13.7

 
0.8

 
29.3

Special charges (gains)
(0.2
)
 
0.0

 
(0.1
)
 
(0.7
)
Operating (loss) income from discontinued operations
(0.2
)
 
7.4

 
(0.7
)
 
16.7

Interest and other (income) expenses, net
0.0

 
(0.1
)
 
0.0

 
(0.3
)
Income (loss) from discontinued operations before income taxes
(0.2
)
 
7.5

 
(0.7
)
 
17.0

Provision (benefit) for income taxes
0.1

 
2.7

 
(0.1
)
 
6.3

Net income (loss) from discontinued operations
$
(0.3
)
 
$
4.8

 
$
(0.6
)
 
$
10.7

Net income (loss) per share – basic
$
(0.01
)
 
$
0.13

 
$
(0.02
)
 
$
0.29

Net income (loss) per share – diluted
$
(0.01
)
 
$
0.13

 
$
(0.02
)
 
$
0.28


The following table details liabilities related to the sold NATG segment’s non-lease components that remain as of June 30, 2019 (in millions):
 
 
 
NATG – Non-lease components
Balance January 1, 2019
 
 
$
2.8

Charged to expense
 
 
0.7

Paid or otherwise settled
 
 
(0.3
)
Balance June 30, 2019
 
 
$
3.2


On January 1, 2019 the Company reclassified approximately $3.4 million of the opening balance of the NATG exit cost liability to ROU assets and operating lease obligations.

 
 
5.
Net Income per Common Share

Net income per common share - basic was calculated based upon the weighted average number of common shares outstanding during the respective periods presented using the two class method of computing earnings per share.  The two class method was used as the Company has outstanding restricted stock with rights to dividend participation for unvested shares.  Net income per common share - diluted was calculated based upon the weighted average number of common shares outstanding and included the equivalent shares for dilutive options outstanding during the respective periods, including unvested options.  The dilutive effect of outstanding options and restricted stock issued by the Company is reflected in net income per share - diluted using the treasury stock method.  Under the treasury stock method, options will only have a dilutive effect when the average market price of common stock during the period exceeds the exercise price of the options.


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The weighted average number of stock options outstanding included in the computation of diluted earnings per share was 0.3 million and $0.6 million shares for the three months ended June 30, 2019 and 2018, respectively, and 0.3 million shares and 0.6 million shares for the six months ended June 30, 2019 and 2018, respectively. The weighted average number of restricted stock awards included in the computation of diluted earnings per share was 0.1 million and 0.1 million shares for the three months ended June 30, 2019 and 2018, respectively, and 0.2 million shares and 0.2 million shares for the six months ended June 30, 2019 and 2018, respectively. The weighted average number of stock options outstanding excluded from the computation of diluted earnings per share due to their antidilutive effect was 0.2 million shares for the three and six months ended June 30, 2019 and none for the three and six months ended June 30, 2018.


6.
Credit Facilities

The Company maintains a $75 million secured revolving credit facility with one financial institution, which has a five year term, maturing on October 28, 2021 and provides for borrowings in the United States. The credit agreement contains certain operating, financial and other covenants, including limits on annual levels of capital expenditures, availability tests related to payments of dividends and stock repurchases and fixed charge coverage tests related to acquisitions.  The revolving credit agreement requires that a minimum level of availability be maintained. If such availability is not maintained, the Company will be required to maintain a fixed charge coverage ratio (as defined). The borrowings under the agreement are subject to borrowing base limitations of up to 85% of eligible accounts receivable and the inventory advance rate computed as the lesser of 60% or 85% of the net orderly liquidation value (“NOLV”). Borrowings are secured by substantially all of the Borrower’s assets, as defined, including all accounts, accounts receivable, inventory and certain other assets, subject to limited exceptions, including the exclusion of certain foreign assets from the collateral. The interest rate under the amended and restated facility is computed at applicable market rates based on the London interbank offered rate (“LIBOR”), the Federal Reserve Bank of New York (“NYFRB”) or the Prime Rate, plus an applicable margin. The applicable margin varies based on borrowing base availability. As of June 30, 2019, eligible collateral under the credit agreement was $75.0 million, total availability was $73.0 million, total outstanding letters of credit were $1.3 million, total excess availability was $71.7 million and there were no outstanding borrowings. The Company was in compliance with all of the covenants of the credit agreement in place as of June 30, 2019.


7. Fair Value Measurements

Financial instruments consist primarily of investments in cash, trade accounts receivable, debt and accounts payable. The Company estimates the fair value of financial instruments based on interest rates available to the Company. At June 30, 2019 and 2018, the carrying amounts of cash, accounts receivable and accounts payable are considered to be representative of their respective fair values due to their short-term nature. Cash is classified as Level 1 within the fair value hierarchy.   The Company’s debt is considered to be representative of its fair value because of its variable interest rate.

The fair value with respect to goodwill and non-amortizing intangibles assets is measured in connection with the Company’s annual impairment testing. The Company performs a qualitative assessment of goodwill and non-amortizing intangibles to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If the qualitative assessment shows that the fair value of the reporting unit exceeds its carrying amount, the Company is not required to complete the annual two step goodwill impairment test.  If a quantitative analysis is required to be performed for goodwill, the fair value of the reporting unit to which the goodwill has been assigned is determined using a discounted cash flow model.  A discounted cash flow model is also used to determine fair value of indefinite-lived intangibles using projected cash flows of the intangible. Unobservable inputs related to these discounted cash flow models include projected sales growth, gross margin percentages, new business opportunities, working capital requirements, capital expenditures and growth in selling, distribution and administrative expense. Any excess of a reporting unit's carrying amount over fair value would be charged to impairment expense.

Long-lived assets are assets used in the Company’s operations and include definite-lived intangible assets, leasehold improvements, warehouse and similar property used to generate sales and cash flows.  Long-lived assets are tested for impairment utilizing a recoverability test, whenever circumstances indicate that an impairment may have occurred. The recoverability test compares the carrying value of an asset group to the undiscounted cash flows directly attributable to the asset group over the life of the primary asset.  If the undiscounted cash flows of an asset group is less than the carrying value of the asset group, the fair value of the asset group is then measured.  If the fair value is also determined to be less than the carrying value of the asset group, the asset group is impaired.


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8.
Legal Proceedings

The Company and its subsidiaries are from time to time involved in various lawsuits, claims, investigations and proceedings which may include commercial, employment, tax, customs and trade, customer, vendor, personal injury, creditors rights and health and safety law matters, which are handled and defended in the ordinary course of business.  In addition, the Company is from time to time subjected to various assertions, claims, proceedings and requests for damages and/or indemnification concerning sales channel practices and intellectual property matters, including patent infringement suits involving technologies that are incorporated in a broad spectrum of products the Company sells or that are incorporated in the Company’s e-commerce sales channels, as well as trademark/copyright infringement claims.  The Company is also audited by (or has initiated voluntary disclosure agreements with) various U.S. Federal and state authorities, as well as Canadian authorities, concerning potential income tax, sales tax and/or "unclaimed property" liabilities.  These matters are in various stages of investigation, negotiation and/or litigation.   The Company is also being audited by an entity representing 28 states seeking recovery of “unclaimed property” and has received separate demands from 20 states requesting payments of their claimed amounts.  The Company is complying with the unclaimed property audit, is providing requested information and is corresponding with the states regarding possible further discussions. The Company intends to vigorously defend these matters and believes it has strong defenses. In September 2017 the Company and certain subsidiaries comprising its former NATG “Tiger” consumer electronics business were sued in United States District Court, Northern District of California by a software publisher alleging that the NATG subsidiaries violated certain contractual sales channel restrictions resulting in claims of breach of contract and trademark/copyright infringement. Although Systemax Inc. has been dismissed from the case, the Company is continuing to assess the remaining claims against and the defenses available to the remaining subsidiary defendants and related possible insurance coverage; the Company cannot predict the outcome of this matter and believes the potential damages, if any, cannot be estimated at this time.

Although the Company does not expect, based on currently available information, that the outcome in any of these matters, individually or collectively, will have a material adverse effect on its financial position or results of operations, the ultimate outcome is inherently unpredictable.  Therefore, judgments could be rendered or settlements entered, that could adversely affect the Company’s operating results or cash flows in a particular period.  The Company regularly assesses all of its litigation and threatened litigation as to the probability of ultimately incurring a liability and records its best estimate of the ultimate loss in situations where it assesses the likelihood of loss as probable and estimable.  In this regard, the Company establishes accrual estimates for its various lawsuits, claims, investigations and proceedings when it is probable that an asset has been impaired or a liability incurred at the date of the financial statements and the loss can be reasonably estimated. At June 30, 2019 the Company has established accruals for certain of its various lawsuits, claims, investigations and proceedings based upon estimates of the most likely outcome in a range of loss or the minimum amounts in a range of loss if no amount within a range is a more likely estimate.  The Company does not believe that at June 30, 2019 any reasonably possible losses in excess of the amounts accrued would be material to the financial statements.



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

This report contains forward looking statements within the meaning of that term in the Private Securities Litigation Reform Act of 1995 (Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934).  Additional written or oral forward looking statements may be made by the Company from time to time, in filings with the Securities and Exchange Commission or otherwise.  Statements contained in this report that are not historical facts are forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and are based on management’s estimates, assumptions and projections and are not guarantees of future performance.  Forward looking statements may include, but are not limited to, projections or estimates of revenue, income or loss, exit costs, cash flow needs and capital expenditures, fluctuations in general economic conditions, future operations, plans relating to new distribution facilities, plans for utilizing alternative sources of supply in response to government tariff and trade actions, and plans for new products or services, plans for acquisition or sale of businesses, including expansion or restructuring plans, such as our exit from and winding down of our sold North American Technology Group ("NATG") operations and European operations, financing needs, compliance with financial covenants in loan agreements, assessments of materiality, predictions of future events and the effects of pending and possible litigation and assumptions relating to the foregoing. In addition, when used in this discussion, the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans” and variations thereof and similar expressions are intended to identify forward looking statements.


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Other factors that may affect our future results of operations and financial condition include, but are not limited to, unanticipated developments in any one or more of the following areas, as well as other factors which may be detailed from time to time in our Securities and Exchange Commission filings: general economic conditions, such as customer inventory levels, interest rates, borrowing ability and economic conditions in the manufacturing industry generally, will continue to impact our business; the imposition of tariffs and other trade barriers, as well as retaliatory trade measures, have caused us to raise the prices on certain of our products and seek alternate sources of supply, which could negatively impact our sales or disrupt our operations in the future; increases in freight and shipping costs have from time to time impacted our margins to the extent the increases could not be passed along to customers in a timely manner and may impact our margins again in the future, and factors affecting the shipping and distribution of products imported to the United States by us or our domestic vendors, such as global availability of shipping containers and fuel costs; our reliance on common carrier delivery services for shipping inventoried merchandise to customers; our reliance on drop ship deliveries directly to customers by our product vendors for products we do not hold in inventory; delays in the timely availability of products from our suppliers could delay receipt of needed product and result in lost sales; our ability to maintain available capacity in our distribution operations for stocked inventory and to enable on time shipment and deliveries, such as by timely implementing additional temporary or permanent distribution resources, whether in the form of additional facilities we operate or by outsourcing certain functions to third party distribution and logistics partners; we compete with other companies for recruiting, training, integrating and retaining talented and experienced employees, particularly in markets where we and they have central distribution facilities; this aspect of competition is aggravated by the current tight labor market in the U.S.; risks involved with e-commerce, including possible loss of business and customer dissatisfaction if outages or other computer-related problems should preclude customer access to our products and services; our information systems and other technology platforms supporting our sales, procurement and other operations are critical to our operations and disruptions or delays have occurred and could occur in the future, and if not timely addressed could have a material adverse effect on us; a data security breach due to our e-commerce, data storage or other information systems being hacked by those seeking to steal Company, vendor, employee or customer information, or due to employee error, resulting in disruption to our operations, litigation and/or loss of reputation or business; managing various inventory risks, such as being unable to profitably resell excess or obsolete inventory and/or the loss of product return rights from our vendors; meeting credit card industry compliance standards in order to maintain our ability to accept credit cards; rising interest rates, increased borrowing costs or limited credit availability, including our own ability to maintain satisfactory credit agreements and to renew credit facilities, could impact both our and our customers’ ability to fund purchases and conduct operations in the ordinary course; pending or threatened litigation and investigations, as well as anti-dumping and other government trade and customs proceedings, could adversely affect our business and results of operations; sales tax laws or government enforcement priorities may be changed which could result in e-commerce and direct mail retailers having to collect sales taxes in states where the current laws and/or prior interpretations do not require us to do so; and extreme weather conditions could disrupt our product supply chain and our ability to ship or receive products, which would adversely impact sales.

Forward-looking statements in this report are based on the Company’s beliefs and expectations as of the date of this report and are subject to risks and uncertainties which may have a significant impact on the Company’s business, operating results or financial condition.  Investors are cautioned that these forward-looking statements are inherently uncertain.  Should one or more of the risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein.  Statements in this report, particularly in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Notes to Condensed Consolidated Financial Statements, as well as information under the heading “Risk Factors” in our Annual Report on Form 10-K for fiscal year 2018, describe certain factors, among others, that could contribute to or cause such differences.

Readers are cautioned not to place undue reliance on any forward looking statements contained in this report, which speak only as of the date of this report.  We undertake no obligation to publicly release the result of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unexpected events.

Overview

Systemax Inc., through its operating subsidiaries, is primarily a direct marketer of brand name and private label industrial and business equipment and supplies in North America going to market through a system of branded e-commerce websites and relationship marketers. As a result of the sale of its France-based IT value added reseller business, the Company operates and is internally managed in one reportable business segment, Industrial Products Group (“IPG”), which includes its former Corporate and other segment. IPG focuses on industrial supplies and MRO (maintenance, repair and operations) markets the Company has served since 1949.

On August 31, 2018, the Company closed on the sale of its France-based IT value added reseller business. The sale was denominated on a cash-free, debt-free basis and included normalized working capital adjustments. The France business had been included in

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the Company's former European Technology Products segment. Initially, the Company was providing limited transition services to the France business for a period of up to six months, following the closing, under a transition services agreement. This transition services agreement was extended in the first quarter of 2019 for an additional six month period.

On March 24, 2017 the Company sold Systemax Europe SARL and its subsidiaries (the “SARL Businesses”), which had been included in the Company's former European Technology Products segment.

The sale of the France business and SARL Businesses met the “strategic shift with major impact” criteria as defined under Accounting Standards Update (“ASU”) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which allows for dispositions with major impact to be presented in the financial statements as discontinued operations. Therefore, the prior year results of the France business and SARL Businesses are included in discontinued operations in the accompanying condensed consolidated financial statements.  For the three months ended June 30, 2019 and 2018, net sales of the France business included in discontinued operations totaled $0 and $131.9 million, respectively, and for the six months ended June 30, 2019 and 2018, net sales totaled $0 and $274.9 million, respectively. For the three months ended June 30, 2019 and 2018, net income of the France business included in discontinued operations totaled $0 and $4.4 million, respectively, and for the six months ended June 30, 2019 and 2018, net income totaled $0 and $9.9 million. For the three and six months ended June 30, 2019, there was no activity related to the SARL Businesses in net sales or net income (loss) in discontinued operations and for the three and six month periods ended June 30, 2018, net income of the SARL Businesses included in discontinued operations totaled $0.4 million and $0.2 million, respectively.

On December 1, 2015, the Company sold its NATG operating businesses and began the wind-down of its remaining NATG operations.  The sale of the NATG business had a major impact on the Company and therefore certain components met the strategic shift criteria as defined under ASU 2014-08. In the second quarter and six months ended June 30, 2019 and 2018, there were no net sales recorded for discontinued NATG operations within discontinued operations. In the second quarter and six months ended June 30, 2019, net loss totaled $0.3 million and $0.6 million, respectively, primarily related to operating expenses and legal and professional fees. For the three months ended June 30, 2018, there was no net income recorded for the discontinued NATG operations and for the six months ended June 30, 2018, net income of $0.6 million was recorded primarily related to restitution payments and vendor settlements received offset by legal and professional fees and operating expenses.

In order to provide more meaningful information to investors, the Company is presenting its operating income and operating margin on a non-GAAP basis in the “Reconciliation of Consolidated GAAP Operating Income from Continuing Operations to Consolidated Non-GAAP Operating Income from Continuing Operations" table. This non-GAAP presentation reflects the Misco Germany operations as discontinued operations for all periods presented. Additional non-GAAP adjustments for executive separation and transition costs, intangible amortization and equity compensation are made to continuing operations.  Management’s Discussion and Analysis that follows will include our current and discontinued operations.

Continuing Operations

The Company sells a wide array of industrial and general business hard goods and supplies and to a lesser extent products that would fall into the generally recognizable category of maintenance, repair and operational ("MRO") products, which are marketed in North America.  Many of these products are manufactured by other companies.  Some products are manufactured for us and sold under our brand as a white label product, and some are manufactured to our own design and marketed under the trademarks: GlobalTM, GlobalIndustrial.comTM, NexelTM, ParamountTM and InterionTM..  

See Note 3 to the condensed consolidated financial statements for additional financial information about our business' geographic operations.

Discontinued Operations

As disclosed above, the operating results of discontinued operations in the accompanying financial statements are primarily from the France business sold in August 2018 and the NATG business sold in 2015.

Operating Conditions

The North American industrial products market is highly fragmented and we compete against multiple distribution channels.  Industrial products distribution is working capital intensive, requiring us to incur significant costs associated with the warehousing of many products, including the costs of maintaining inventory, leasing warehouse space, inventory management systems and employing personnel to perform the associated tasks.  We supplement our on-hand product availability by maintaining relationships with major distributors and manufacturers, utilizing a combination of stock and drop-shipment fulfillment.

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The primary component of our operating expenses historically has been employee-related costs, which includes items such as wages, commissions, bonuses, employee benefits and equity based compensation, as well as marketing expenses, primarily comprised of digital marketing spend, and occupancy related charges associated with our distribution and call center facilities. We continually assess our operations to ensure that they are efficient, aligned with market conditions and responsive to customer needs.

In the discussion of our results of operations, constant currency refers to the adjustment of the results of our foreign operations to exclude the effects of period to period fluctuations in currency exchange rates.

The discussion of our results of operations and financial condition that follows will provide information that will assist in understanding our financial statements, the factors that we believe may affect our future results and financial condition as well as information about how certain accounting principles and estimates affect the consolidated financial statements.  This discussion should be read in conjunction with the condensed consolidated financial statements included herein and in conjunction with the audited financial statements as of December 31, 2018 and the other information provided in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and revenues and expenses during the period.  Significant accounting policies employed by the Company, including the use of estimates, were presented in the Notes to Consolidated Financial Statements of the Company’s 2018 Annual Report on Form 10-K.

Critical accounting policies are those that are most important to the presentation of our financial condition and results of operations, require management’s most difficult, subjective and complex judgments, and involve uncertainties.  The accounting policies that have been identified as critical to our business operations and understanding the results of operations pertain to revenue recognition; accounts receivable and allowance for doubtful accounts; inventory valuation; right of use assets; goodwill and intangible assets; long-lived assets; income taxes; and special charges.  The application of each of these critical accounting policies and estimates was discussed in Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.  There have been no significant changes in the application of critical accounting policies or estimates during 2019.  Management believes that full consideration has been given to all relevant circumstances that we may be subject to, and the condensed consolidated financial statements of the Company accurately reflect management’s best estimate of the consolidated results of operations, financial position and cash flows of the Company for the periods presented.  Because of the uncertainty in these estimates, actual results could differ from estimates used in applying the critical accounting policies.  We are not aware of any reasonably likely events or circumstances which would result in different amounts being reported that would materially affect the Company’s financial condition or results of operations.

Public companies in the United States are subject to the accounting and reporting requirements of various authorities, including the Financial Accounting Standards Board (“FASB”) and the Securities and Exchange Commission (“SEC”).  These authorities issue numerous pronouncements, most of which are not applicable to the Company’s current or reasonably foreseeable operating structure. See Note 1 of the condensed consolidated financial statements, Recent Accounting Pronouncements.

Highlights from Q2 2019 and Year to Date Q2 2019

The discussion of our results of operations and financial conditions that follows will provide information that will assist in understanding our financial statements and information about how certain accounting principles and estimates affect the condensed consolidated financial statements included herein.

Consolidated sales increased 7.5% to $248.6 million for the second quarter ended June 30, 2019 compared to $231.2 million in 2018 and increased 8.4% to $480.8 million for the six months ended June 30, 2019 compared to $443.4 million in 2018.
On a constant currency basis, average daily sales increased 7.8% for the second quarter ended June 30, 2019 compared to 2018 and increased 8.7% for the six months ended June 30, 2019 compared to 2018.
Consolidated operating income grew 9.3% to $20.0 million for the second quarter ended June 30, 2019 compared to $18.3 million in 2018 and grew 12.9% to $33.2 million for the six months ended June 30, 2019 compared to $29.4 million in 2018.
Net income per diluted share from continuing operations grew 11.4% to $0.39 for the second quarter ended June 30, 2019 compared to $.35 in 2018 and grew 13.8% to $0.66 for the six months ended June 30, 2019 compared to $0.58 in 2018.

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GAAP Results of Operations

Three and Six Months Ended June 30, 2019 compared to the Three and Six Months Ended June 30, 2018

Key Performance Indicators* (in millions):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
%
Change
 
2019
 
2018
 
%
Change
Net sales of continuing operations:
 
 
 
 
 
 
 
 
 
 
 
Consolidated net sales
$
248.6

 
$
231.2

 
7.5
 %
 
$
480.8

 
$
443.4

 
8.4
 %
Consolidated gross profit
$
86.0

 
$
80.0

 
7.5
 %
 
$
166.3

 
$
152.5

 
9.0
 %
Consolidated gross margin
34.6
%
 
34.6
%
 
0.0
 %
 
34.6
%
 
34.4
%
 
0.2
 %
Consolidated SD&A costs
$
66.0

 
$
61.7

 
7.0
 %
 
$
133.1

 
$
123.1

 
8.1
 %
Consolidated SD&A costs as a % of net sales
26.5
%
 
26.7
%
 
(0.2
)%
 
27.7
%
 
27.8
%
 
(0.1
)%
Consolidated operating income
$
20.0

 
$
18.3

 
9.3
 %
 
$
33.2

 
$
29.4

 
12.9
 %
Consolidated operating margin from continuing operations
8.0
%
 
7.9
%
 
0.1
 %
 
6.9
%
 
6.6
%
 
0.3
 %
Effective income tax rate
25.9
%
 
26.8
%
 
(0.9
)%
 
25.2
%
 
24.6
%
 
0.6
 %
Net income from continuing operations
$
14.9

 
$
13.4

 
11.2
 %
 
$
24.9

 
$
22.1

 
12.7
 %
Net margin from continuing operations
6.0
%
 
5.8
%
 
0.2
 %
 
5.2
%
 
5.0
%
 
0.2
 %
Net income (loss) from discontinued operations
$
(0.3
)
 
$
4.8

 
(106.3
)%
 
$
(0.6
)
 
$
10.7

 
(105.6
)%

*excludes discontinued operations (See Note 4 of Notes to Condensed Consolidated Financial Statements).




21

Table of Contents

SYSTEMAX INC.
Reconciliation of Consolidated GAAP Operating Income from Continuing Operations to Consolidated Non-GAAP Operating Income from Continuing Operations – Unaudited
(in millions)

 
Three Months Ended June 30,
 
Change
 
Six Months Ended
June 30,
 
Change
GAAP:
2019
 
2018
 
2019 vs. 2018
 
2019
 
2018
 
2019 vs. 2018
Net sales
$
248.6

 
$
231.2

 
7.5
%
 
480.8

 
443.4

 
8.4
%
Average daily sales*
3.9

 
3.6

 
7.8
%
 
3.8

 
3.5

 
8.7
%
Operating income
20.0

 
18.3

 
9.3
%
 
33.2

 
29.4

 
12.9
%
  Operating margin%
8.0
%
 
7.9
%
 
 
 
6.9
%
 
6.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-GAAP adjustments:
 
 
 
 
 
 
 
 
 
 
 
  Executive separation & transition costs
0.4

 
0.0

 
 
 
1.0

 
0.0

 
 
Stock based compensation
1.3

 
0.2

 
 
 
2.4

 
0.5

 
 
Intangible amortization
0.1

 
0.2

 
 
 
0.1

 
0.5

 
 
Reverse results of Germany included in GAAP continuing operations
0.1

 
0.0

 
 
 
0.1

 
0.0

 
 
Total Non-GAAP Adjustments:
1.9

 
0.4

 
 
 
3.6

 
1.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-GAAP operating income
$
21.9

 
$
18.7

 
17.1
%
 
$
36.8

 
$
30.4

 
21.1
%
Non-GAAP Operating Margin %
8.8
%
 
8.1
%
 
 
 
7.6
%
 
6.9
%
 
 
 
*
Average daily sales is calculated based upon the number of selling days in each period, converted to US Dollars on a constant currency basis. In Q2 2019 and 2018 there were 64 selling days in the U.S and for the first six months of 2019 and 2018 there were 128 selling days. In Canada there were 63 selling days in Q2 2019 and 64 selling days in Q2 2018 and for the first six months of 2019 and 2018 there were 126 selling days.
 
1

On August 31, 2018, the Company closed on the sale of the France operations. Results of this divested business have been classified as discontinued operations for all periods presented. On March 24, 2017, the Company closed on the sale of its European Technology Group businesses, other than its operations in France.  Prior year results of these divested businesses have been classified as discontinued operations. On December 1, 2015 the Company closed on the sale of certain assets of its North American Technology Group (“NATG”). Pursuant to this transaction, the Company continues to wind down the remaining operations of NATG during 2019. Costs of the wind down in the second quarter and six months ended June 30, 2019 and 2018 are included within discontinued operations. 
 
2

In order to provide more meaningful information to investors, the Company is presenting its operating income and operating margin on a non-GAAP basis in the “Reconciliation of Consolidated GAAP Operating Income from Continuing Operations to Consolidated Non-GAAP Operating Income from Continuing Operations" table. This non-GAAP presentation reflects the Misco Germany operations as discontinued operations for all periods presented. Additional non-GAAP adjustments for executive separation and transition costs, intangible amortization and equity compensation are made to continuing operations.  
 
3

Systemax manages its business and reports using a 52-53 week fiscal year that ends at midnight on the Saturday closest to December 31.  For clarity of presentation, fiscal years and quarters are described as if they ended on the last day of the respective calendar month.  The actual fiscal quarter ended on June 29, 2019 and June 30, 2018. The second quarters of both 2019 and 2018 included 13 weeks and the first six months of 2019 and 2018 included 26 weeks.


22

Table of Contents

Management’s discussion and analysis that follows will include current operations and discontinued operations.  The discussion is based upon the GAAP Results of Operations table.

NET SALES

The Company's net sales benefited during the quarter ended June 30, 2019 from continued strong demand across the business with solid performance across sales channels, specifically managed sales, where we continue to invest in sales productivity and training initiatives. Revenue performance was broad based across product categories, with growth continuing to be led by newer product lines where we are investing in subject matter expertise, sales training and an expanding product offering. Net sales also benefited from above market growth in our Canada business which delivered its tenth consecutive quarter of double digit growth. Canada sales were up approximately 16% in local currency on an average daily sales basis for the quarter and six months ended June 30, 2019 compared to the same period in 2018.  U.S. revenue was up 7.5% in the quarter ended June 30, 2019 compared to the same period in 2018 and up 8.4% for the six months ended June 30, 2019. On a constant currency basis, average daily sales increased 7.8% for the second quarter of 2019 compared to the same period in 2018 and increased 8.7% for the six months ended June 30, 2019. In the U.S., there were 64 selling days in the second quarter of 2019 and 2018 and 128 selling days for the six months ended June 30, 2019 and 2018. In Canada there were 63 selling days in the second quarter of 2019 and 64 selling days in the second quarter of 2018 and 126 selling days for the six months ended June 30, 2019 and 2018.

GROSS MARGIN

Gross margin is dependent on variables such as product mix including sourcing and category, competition, pricing strategy, cooperative advertising funds classified as a reduction to cost of sales, free freight and freight discounting arrangements, inventory valuation and obsolescence and other variables, any or all of which may result in fluctuations in gross margin. 

Gross margin was unchanged in the second quarter of 2019 compared to the second quarter of 2018 reflecting proactive management of our inventory, purchasing and sell prices as the Company addressed the 10% tariffs, enacted in September 2018, which were levied by the U.S. on products imported from China. Gross margin increased 20 basis points for the six months ended June 30, 2019 compared to 2018. The Company is managing the latest round of tariffs which increased to 25% in June 2019 in a similar fashion to how it managed the initial tariffs. The Company continues to believe that any impact will be gradual as it monitors sell prices in the market, continues to work with suppliers to mitigate costs, and actively reviews its supply chain.

SELLING, DISTRIBUTION AND ADMINISTRATIVE EXPENSES (“SD&A”)

SD&A costs as a percentage of sales was 26.5% in the second quarter of 2019 compared to 26.7% for the same period in 2018. Included in the second quarter of 2019 was approximately $0.4 million of executive separation and transition expense. Excluding these expenses, SD&A improved 30 basis points as a percentage of sales compared to the prior year. This improvement was primarily the result of improved efficiencies across our operations, including marketing spend. In the second quarter of 2019, the significant cost increases were increased salary and related costs of approximately $3.0 million, of which $0.4 million related to executive separation and transition costs previously mentioned and increased net internet advertising spend of approximately $1.0 million and increased contract services costs of approximately $0.2 million and approximately $0.4 million of costs associated with our new distribution center offset by savings in telephony and consulting fees of approximately $0.2 million. For the six months ended June 30, 2019 SD&A costs as a percentage of sales was 27.7% compared to 27.8% for the same period in 2018. Included in the first six months of 2019 was approximately $1.0 million of executive separation and transition costs and $0.6 million of equity compensation expense related to the repricing of stock options. Excluding these expenses, SD&A for the first six months of 2019 improved 40 basis points as a percentage of sales compared to the same period in 2018. The significant cost increases for the six months ended June 30, 2019 were increased salary and related costs of approximately $6.8 million, of which $1.6 million related to executive separation and transition costs previously mentioned, increased net internet advertising spend of approximately $1.5 million, increased contract services costs of approximately $0.7 million and approximately $0.4 million of costs associated with our new distribution center.

DISCONTINUED OPERATIONS AND SPECIAL CHARGES (GAINS)

The Company’s discontinued operations include the results of the France business sold in August 2018, the SARL Businesses sold in March 2017 and the NATG business sold in December 2015 (See Note 1). 

Total special charges and gains included in discontinued operations totaled $0.2 million gain for the second quarter of 2019, $0.1 million gain for the six months ended June 30, 2019 and a $0.7 million gain for the six months ended June 30, 2018.



23

Table of Contents

OPERATING MARGIN

Operating margin for the three and six months ended June 30, 2019 increased by 10 basis points and 30 basis points, respectively, compared to the same period in 2018. The increase was driven by increased sales and freight margin, improved leverage within our fixed cost structure and good spend discipline in regards to marketing and general operating expenses.

INTEREST AND OTHER (INCOME) EXPENSE, NET

Interest and other (income) expense, net from continuing operations was $0.1 million income in the second quarter and six months ended June 30, 2019 compared to $0.0 and $0.1 million expense in the second quarter and six months ended June 30, 2018.

INCOME TAXES

For the quarter ended June 30, 2019 the Company recorded income taxes in continuing operations of approximately $5.2 million, for an effective tax rate of 25.9%. For the first six months of 2019 the Company reported income taxes in continuing operations of approximately $8.4 million, for an effective tax rate of 25.2%. Tax expense is related to the Company's U.S. and India operations and certain U.S. states. The Company's tax expense for the first six months of 2019 was favorably impacted by tax benefits of approximately $0.3 million related to stock-based compensation.

For Canadian tax purposes, the Company continues to carry a full valuation allowance against its deferred tax assets in Canada in 2019, including its net operating losses, and no tax expense has been recorded.

Financial Condition, Liquidity and Capital Resources

The following tables present selected liquidity data and historical cash flows (in millions):
 
Selected liquidity data
 
June 30,
2019
 
December 31,
2018
 
$ Change
Cash
$
90.8

 
$
295.4

 
$
(204.6
)
Accounts receivable, net
$
96.2

 
$
84.1

 
$
12.1

Inventories
$
101.4

 
$
107.3

 
$
(5.9
)
Prepaid expenses and other current assets
$
4.7

 
$
10.6

 
$
(5.9
)
Accounts payable
$
116.8

 
$
101.1

 
$
15.7

Dividend payable
$
0.0

 
$
243.5

 
$
(243.5
)
Accrued expenses and other current liabilities
$
39.7

 
$
35.0

 
$
4.7

Operating lease liabilities
$
11.4

 
$
0.0

 
$
11.4

Working capital
$
125.2

 
$
117.8

 
$
7.4


Historical Cash Flows
 
Six Months Ended
 June 30,
 
2019
 
2018
Net cash provided by (used in) operating activities from continuing operations
$
50.1

 
$
18.0

Net cash provided by (used in) provided by operating activities from discontinued operations
$
0.1

 
$
(1.7
)
Net cash used in investing activities from continuing operations
$
(2.4
)
 
$
(1.1
)
Net cash used in investing activities from discontinued operations
$
0.0

 
$
(0.3
)
Net cash used in financing activities from continuing operations
$
(252.3
)
 
$
(101.5
)
Effects of exchange rates on cash
$
(0.1
)
 
$
(1.0
)
Net decrease in cash and cash equivalents
$
(204.6
)
 
$
(87.6
)



24

Table of Contents

Our primary liquidity needs are to support working capital requirements in our business, including the start up costs for our new Texas distribution center anticipated to commence operations in the third quarter of 2019, funding recently declared and any future dividends, funding capital expenditures, continued investment in upgrading and expanding our technological capabilities and information technology infrastructure and funding acquisitions.  We rely principally upon operating cash flow to meet these needs.  We believe that cash flow available from these sources and our availability under our credit facility will be sufficient to fund our working capital and other cash requirements for at least the next twelve months. We believe our current capital structure and cash resources are adequate for our internal growth initiatives.  To the extent our growth initiatives expand, including major acquisitions, we may seek to raise additional capital.  We believe that, if needed, we can access public or private funding alternatives to raise additional capital.

Our working capital increased $7.4 million primarily related to net income in the first six months of 2019, increased accounts receivable balances offset by decreasing balances in inventory, prepaid and other current assets compared to increased balances in accounts payable and dividends paid in 2019. accrued expenses and the recording of $11.4 million of current operating lease liabilities. Accounts receivable days outstanding were 35.2 in 2019 compared to 34.0 in 2018. Inventory turns were 6.0 in 2019 and 6.3 in 2018 and accounts payable days outstanding were 64.6 in 2019 compared to 72.8 in 2018.  We expect that future accounts receivable, inventory and accounts payable balances will fluctuate with net sales and the product mix of our net sales.

Net cash provided by continuing operations was $50.1 million resulting from changes in our working capital accounts, which provided $20.2 million in cash compared to $7.3 million used in 2018, primarily the result of the changes in accounts payable balances and additional changes in inventory balances, accrued expenses and other current and non-current liabilities. Cash generated from net income adjusted by other non-cash items provided $29.9 million compared to $25.3 million provided by these items in 2018, primarily related to the net income from continuing operations and increased stock-based compensation expense in 2019. In the first quarter of 2019, the Company repriced approximately 0.6 million shares of outstanding stock options and recorded approximately $0.6 million of related compensation expense. Net cash provided by operating activities from discontinued operations was $0.1 million for the six months ended June 30, 2019 and $1.7 million used for the six months ended June 30, 2018.

Net cash used in investing activities from continuing operations totaled $2.4 million, primarily related to the Company's new distribution center in Texas and other warehouse projects including wire decking, in-rack sprinkler systems and warehouse lighting.  Net cash used in investing activities in 2018 totaled $1.1 million primarily for warehouse and information technology equipment and leasehold improvements. Net cash used in investing activities from discontinued operations was zero and $0.3 million for the six months ended June 30, 2019 and 2018, respectively.

Net cash used in financing activities totaled $252.3 million primarily related to the payment of the special dividend declared in December 2018 of $243.5 million and the regular quarterly dividends of $4.5 million each. Proceeds from the issuance of common stock from employee stock purchase plan was $0.4 million and proceeds from stock option exercises was $0.6 million, offset by payments of payroll taxes on stock based compensation through shares withheld of $0.8 million. In 2018, cash used in financing activities totaled $101.5 million and included approximately $101.1 million for dividends paid, $0.9 million in stock option exercises offset by payments of payroll taxes on stock based compensation through shares withheld of $1.3 million.

The Company maintains a $75.0 million secured revolving credit facility with one financial institution, which has a five year term, maturing on October 28, 2021 and provides for borrowings in the United States. The credit agreement contains certain operating, financial and other covenants, including limits on annual levels of capital expenditures, availability tests related to payments of dividends and stock repurchases and fixed charge coverage tests related to acquisitions.  The revolving credit agreement requires that a minimum level of availability be maintained. If such availability is not maintained, the Company will be required to maintain a fixed charge coverage ratio (as defined).  The borrowings under the agreement are subject to borrowing base limitations of up to 85% of eligible accounts receivable and the inventory advance rate computed as the lesser of 60% or 85% of the net orderly liquidation value (“NOLV”).   Borrowings are secured by substantially all of the Borrower’s assets, including all accounts receivable, inventory and certain other assets, subject to limited exceptions, including the exclusion of certain foreign assets from the collateral.  The interest rate under the amended and restated facility is computed at applicable market rates based on the London interbank offered rate (“LIBOR”), the Federal Reserve Bank of New York (“NYFRB”) or the Prime Rate, plus an applicable margin. The applicable margin varies based on borrowing base availability.  As of June 30, 2019, eligible collateral under the credit agreement was $75.0 million, total availability was $73.0 million, total outstanding letters of credit were $1.3 million, excess availability was $71.7 million and there were no outstanding borrowings.  The Company was in compliance with all of the covenants of credit agreement in place as of June 30, 2019.

We also have certain obligations with various parties that include commitments to make future payments.  Our principal commitments at June 30, 2019 consisted of payments under operating leases for certain of our real property and equipment and payments under employment, product and other service agreements.


25

Table of Contents

Levels of earnings and cash flows are dependent on factors such as consolidated gross margin and selling, distribution and administrative costs as a percentage of sales, product mix and relative levels of domestic and foreign sales.  Unusual gains or expense items, such as special (gains) charges and settlements, may impact earnings and are separately disclosed.  We expect that past performance may not be indicative of future performance due to the competitive nature of our business where the need to adjust prices to gain or hold market share is prevalent.

Macroeconomic conditions, such as business and consumer sentiment, may affect our revenues, cash flows or financial condition.  However, we do not believe that there is a direct correlation between any specific macroeconomic indicator and our revenues, cash flows or financial condition.  We are not currently interest rate sensitive, as we have minimal debt.
 
The expenses and capital expenditures described above will require significant levels of liquidity, which we believe can be adequately funded from our currently available cash resources.  In 2019 we anticipate capital expenditures in the range of $5.0 to $7.0 million, of which we are contractually committed to incur approximately $1.5 to $2.0 million of these expenditures. 

Over the past several years we have engaged in opportunistic acquisitions, choosing to pay the purchase price in cash, and may do so in the future as favorable situations arise.  However, a deep and prolonged period of reduced business spending could adversely impact our cash resources and force us to either forego future acquisition opportunities or to pay the purchase price in shares of our common stock, which could have a dilutive effect on our earnings per share. We believe that cash flows from operations and our availability under credit facilities will be sufficient to fund our working capital and other cash requirements for the next twelve months.

We maintain our cash and cash equivalents in money market funds or their equivalent that have maturities of less than three months and in non-interest bearing accounts that partially offset banking fees. As of June 30, 2019, we had no investments with maturities of greater than three months. Accordingly, we do not believe that our investments have significant exposure to interest rate risk.  At June 30, 2019 cash balances held in foreign subsidiaries totaled approximately $4.2 million. These balances are held in local country banks. The Company intends to repatriate excess foreign cash balances when available and when it is tax efficient.  The Company had in excess of $158 million of liquidity (cash and undrawn line of credit) in the U.S. as of June 30, 2019, which is sufficient to fund its U.S. operations and capital needs, including dividend payments, for the foreseeable future.

Off-balance Sheet Arrangements.

The Company has not created, and is not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating the Company’s business.  The Company does not have any arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect the Company’s liquidity or the availability of capital resources.
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risks, which include changes in U.S. and international interest rates as well as changes in currency exchange rates (principally Canadian dollars) as measured against the U.S. dollar and each other.

The translation of the financial statements of our operations outside of the United States is impacted by movements in foreign currency exchange rates.  Changes in currency exchange rates as measured against the U.S. dollar may positively or negatively affect income statement, balance sheet and cash flows as expressed in U.S. dollars.  We have limited involvement with derivative financial instruments and do not use them for trading purposes.  We may enter into foreign currency options or forward exchange contracts aimed at limiting in part the impact of certain currency fluctuations, but as of June 30, 2019 we had no outstanding option or forward exchange contracts.

Our exposure to market risk for changes in interest rates relates primarily to our variable rate debt.  Our variable rate debt consists of short-term borrowings under our credit facilities.  As of June 30, 2019, there were no outstanding balances under our variable rate credit facility.  A hypothetical change in average interest rates of one percentage point is not expected to have a material effect on our financial position, results of operations or cash flows.


26

Table of Contents

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of June 30, 2019.  Based upon this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective.

The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Company’s receipts and expenditures are being made only in accordance with authorizations of the Company’s management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the Company’s financial statements.

Management, including the Company’s Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s internal controls will prevent or detect all errors and all fraud.  A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.  Also, any evaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal controls over financial reporting during the quarterly period ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


27

Table of Contents

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

The Company and its subsidiaries are from time to time involved in various lawsuits, claims, investigations and proceedings which may include commercial, employment, tax, customs and trade, customer, vendor, personal injury, creditors rights and health and safety law matters, which are handled and defended in the ordinary course of business.  In addition, the Company is from time to time subjected to various assertions, claims, proceedings and requests for damages and/or indemnification concerning sales channel practices and intellectual property matters, including patent infringement suits involving technologies that are incorporated in a broad spectrum of products the Company sells or that are incorporated in the Company’s e-commerce sales channels as well as trademark/copyright infringement claims.  The Company is also audited by (or has initiated voluntary disclosure agreements with) various U.S. Federal and state authorities, as well as Canadian authorities, concerning potential income tax, sales tax and/or "unclaimed property" liabilities.  These matters are in various stages of investigation, negotiation and/or litigation.   The Company is also being audited by an entity representing 28 states seeking recovery of “unclaimed property” and has received separate demands from 20 states requesting payments of their claimed amounts.  The Company is complying with the unclaimed property audit, is providing requested information and is corresponding with the states regarding possible further discussions. The Company intends to vigorously defend these matters and believes it has strong defenses. In September 2017 the Company and certain subsidiaries comprising its former NATG “Tiger” consumer electronics business were sued in United States District Court, Northern District of California by a software publisher alleging that the NATG subsidiaries violated certain contractual sales channel restrictions resulting in claims of breach of contract and trademark/copyright infringement. Although Systemax Inc. has been dismissed from the case, the Company is continuing to assess the remaining claims against and the defenses available to the remaining subsidiary defendants and related possible insurance coverage; the Company cannot predict the outcome of this matter and believes the potential damages, if any, cannot be estimated at this time.

Although the Company does not expect, based on currently available information, that the outcome in any of these matters, individually or collectively, will have a material adverse effect on its financial position or results of operations, the ultimate outcome is inherently unpredictable.  Therefore, judgments could be rendered or settlements entered, that could adversely affect the Company’s operating results or cash flows in a particular period.  The Company regularly assesses all of its litigation and threatened litigation as to the probability of ultimately incurring a liability and records its best estimate of the ultimate loss in situations where it assesses the likelihood of loss as probable and estimable.  In this regard, the Company establishes accrual estimates for its various lawsuits, claims, investigations and proceedings when it is probable that an asset has been impaired or a liability incurred at the date of the financial statements and the loss can be reasonably estimated. At June 30, 2019 the Company has established accruals for certain of its various lawsuits, claims, investigations and proceedings based upon estimates of the most likely outcome in a range of loss or the minimum amounts in a range of loss if no amount within a range is a more likely estimate.  The Company does not believe that at June 30, 2019 any reasonably possible losses in excess of the amounts accrued would be material to the financial statements.


28

Table of Contents

Item 6. Exhibits
Lease Agreement, dated April 18, 2019, by and between Global Industrial Distribution Inc. (tenant) and HLIT II CTC 3, L.P. (landlord) (DeSoto, TX facility) (exhibits have been omitted pursuant to Item 601(a)(5) of Regulation S-K).
 
 
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101.INS
XBRL Instance Document
 
 
101.SCH
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document


29

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
SYSTEMAX INC.
 
 
Date: August 6, 2019
By:
/s/ Barry Litwin
 
 
Barry Litwin
 
 
President and Chief Executive Officer

30

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
SYSTEMAX INC.
 
 
Date: August 6, 2019
By:
/s/ Thomas Clark
 
 
Thomas Clark
 
 
Vice President and Chief Financial Officer






31
(Back To Top)

Section 2: EX-10.1 (EXHIBIT 10.1)

Exhibit
Exhibit 10.1

LEASE AGREEMENT BETWEEN

HLIT II CTC 3, L.P.,

AS LANDLORD, AND

GLOBAL INDUSTRIAL DISTRIBUTION INC.,

AS TENANT


DATED APRIL 18, 2019


CROSSROADS TRADE CENTER
DESOTO, TEXAS



        



LEASE AGREEMENT
THIS LEASE AGREEMENT (“Lease”) is dated this 18th day of April, 2019, between HLIT II CTC 3, L.P., a Texas limited partnership (“Landlord”) and GLOBAL INDUSTRIAL DISTRIBUTION INC., a Delaware corporation (“Tenant”). The following capitalized and bold faced terms, which have been placed at the beginning of this Lease for convenience, shall have the meaning set forth below.
Premises:
That portion of the Building, containing approximately 489,804 square feet, as determined by Landlord and as shown on Exhibit A situated on a portion of that certain real property legally described in Exhibit A-1 attached hereto (the “Land”).
Building:
The building located at 2119 North I-35 E, DeSoto, Texas 75115, containing approximately 948,380 square feet and commonly known as Building 3. Landlord and Tenant stipulate that the number of square feet in the Premises and in the Building set forth above is conclusive and shall be binding upon them.
Project:
The Building, the Land and other buildings, improvements, driveways, parking facilities, loading dock areas, roadways, any rail tracks associated with the Building and similar improvements situated on the Land and easements associated with the foregoing or the operation thereof.
Permitted Use
General industrial/warehouse use for the purpose of receiving, storing, shipping and selling products, materials and merchandise made and/or distributed by Tenant or its affiliates, together with an approximately 5,000 square foot “will call” area for customer pick up, and for such other lawful purposes as may be incidental thereto.
Tenant’s Proportionate
Share :
51.65%
Lease Term:
Beginning on the Commencement Date and ending on the last day of the one hundred twenty-fifth (125th) full calendar month thereafter, unless sooner terminated or extended pursuant to the terms and provisions of this Lease.
Commencement Date:
The earliest of (a) the date Tenant occupies any portion of the Premises and begins conducting business therein; provided that Tenant’s Early Entry into the Premises pursuant to Section 9 of the construction Addendum shall not constitute conduct of business for purposes of this subpart (a); (b) the date on which Landlord achieves Substantial Completion (as defined in the Construction Addendum) of the Tenant Improvements, or (c) the date Landlord would have achieved Substantial Completion but for a Tenant Delay (as defined in the Construction Addendum); provided that the Commencement Date will not occur prior to July 15, 2019.
Base Rent:
For each month of the Lease Term, the amounts for the periods set forth in the following table:
 
Lease Months
Annual Rate Per Sq. Ft.
Monthly Base Rent
 
1 – 5
$0.00
$0.00
 
6 – 17
$3.61
$147,349.37
 
18 – 29
$3.70
$151,022.90
 
30 – 41
$3.79
$154,696.43
 
42 – 53
$3.89
$158,778.13
 
54 – 65
$3.98
$162,451.66
 
66 – 77
$4.08
$166,533.36
 
78 – 89
$4.19
$171,023.23
 
90 – 101
$4.29
$175,104.93

i


 
102 – 113
$4.40
$179,594.80
 
114 – 125
$4.51
$184,084.67
 
As used herein, the term “Lease Month” means each calendar month during the Lease Term. If the Commencement Date does not occur on the first day of a calendar month, the period from the Commencement Date to the first day of the next calendar month (the “Partial Month”) shall be included in the first Lease Month for purposes of determining the duration of the Lease Term; provided that, for purposes of payment of Base Rent, the Partial Month shall not be included with the first (1st) Lease Month and Tenant shall pay Base Rent and Operating Expenses for the Partial Month at the rate payable for the sixth (6th) Lease Month, prorated appropriately.
Initial Estimated Monthly Operating Expense Payments (estimates only and subject to adjustment to actual costs and expenses according to the provisions of this Lease):
Expense
Annual Estimate Per Sq. Ft.
Monthly Estimate
Utilities:
To be paid separately in accordance with Section 7 below.
Common Area Maintenance:

$0.20

$
8,163.40
 
Insurance:

$0.07

$
2,857.19
 
Taxes:

$0.95

$
38,776.15
 
 
 
 
 
Estimated Total:

$1.22

$
49,796.74
 
Initial Monthly Base Rent and Operating Expense Payments:
$197,146.11
Security Deposit:
$233,881.41
Guarantor:
Global Industrial Holdings LLC, a Delaware limited liability company. Concurrent with Tenant’s execution and delivery of this Lease, Tenant shall cause Guarantor to execute and deliver a guaranty in favor of Landlord in the form attached hereto as Exhibit G (the “Guaranty”).
Brokers:
Cushman & Wakefield of Texas, Inc., representing Tenant, and
Jones Lang LaSalle, representing Landlord
Tenant’s Notice Address:
Global Industrial Distribution Inc.
11 Harbor Park Drive
Port Washington, NY 11050
Attention: General Counsel
Telephone: 516-608-7606
Landlord’s Notice Address:
HLIT II CTC 3, L.P.
c/o Clarion Partners
1717 McKinney Ave., Suite 1900
Dallas, Texas 75202-1236
Attention: Courtney Phelps
Addenda:
Rules and Regulations; Exhibit A (Premises); Exhibit A-1 (Legal Description of Real Property); Exhibit B (Construction Addendum); Exhibit C (Space Plan); Exhibit D (Commencement Date Agreement); Exhibit E (Renewal Option); Exhibit F (Tenant’s Parking Spaces and Tenant’s Trailer Spaces); and Exhibit G (Guaranty)
        

    
    


ii


TABLE OF CONTENTS
 
 
 
Page

1.
 
Granting Clause
1

2.
 
Acceptance of Premises
1

3.
 
Use
1

4.
 
Base Rent
2

5.
 
Security Deposit
2

6.
 
Operating Expense Payments
3

7.
 
Utilities
4

8.
 
Taxes
5

9.
 
Insurance
5

10.
 
Landlord's Repairs
8

11.
 
Tenant's Repairs
8

12.
 
Tenant-Made Alterations and Trade Fixtures
9

13.
 
Signs
10

14.
 
Parking
11

15.
 
Restoration
11

16.
 
Condemnation
12

17.
 
Assignment and Subletting
12

18.
 
Indemnification
13

19.
 
Inspection and Access
14

20.
 
Quiet Enjoyment
14

21.
 
Surrender
14

22.
 
Holding Over
14

23.
 
Events of Default
15

24.
 
Landlord's Remedies
15

25.
 
Tenant's Remedies /Limitation of Liability
17

26.
 
Waiver of Jury Trial
18

27.
 
Subordination
18

28.
 
Mechanic's Liens
19

29.
 
Estoppel Certificates
19

30.
 
Environmental Compliance
19

31.
 
Rules and Regulations
21

32.
 
Security Service
21

33.
 
Force Majeure
21

34.
 
Entire Agreement
21

35.
 
Severability
21

36.
 
Brokers
21

37.
 
Landlord's Lien/Security Interest
21

38.
 
Relocation
21

39.
 
Miscellaneous
21

40.
 
Waiver of Consumer Rights
24

41.
 
City Incentives
24


iii


LIST OF DEFINED TERMS
 
 
 
Page

 
 
Addenda
iii

 
 
Arbitration Notice
E-1

 
 
Base Rent
i

 
 
Brokers
ii

 
 
Building
i

 
 
Building Sign
10

 
 
Commencement Date
i

 
 
Commencement Date of the Renewal Term
E-1

 
 
Controllable Operating Expenses
4

 
 
Environmental Requirements
20

 
 
Estimates
E-2

 
 
Event of Default
15

 
 
Force Majeure
21

 
 
GAAP
12

 
 
Guarantor
ii

 
 
Guaranty
ii

 
 
Hazardous Substance
20

 
 
holder
18

 
 
include
1

 
 
including
1

 
 
Initial Estimated Monthly Operating Expense Payments
ii

 
 
Initial Monthly Base Rent and Operating Expense Payments
ii

 
 
Land
i

 
 
Landlord
i

 
 
Landlord’s Notice Address
iii

 
 
Lease
i

 
 
Lease Month
ii

 
 
Lease Term
i

 
 
Legal Requirements
1

 
 
mortgage
18

 
 
OFAC
2

 
 
Operating Expenses
3

 
 
Partial Month
ii

 
 
PCBs
20

 
 
Permitted Use
i

 
 
Plans
B-1

 
 
Premises
i

 
 
Proceeding for Relief
15

 
 
Project
i

 
 
Renewal Amendment
E-1

 
 
Renewal Notice
E-1

 
 
Renewal Term
E-1

 
 
Replacement Cost
9

 
 
Security Deposit
ii

 
 
Substantial Completion
B-1

 
 
Substantially Completed
B-1

 
 
Taken
12

 
 
Taking
12

 
 
Tangible Net Worth
12

 
 
Taxes
5

 
 
Telecommunications Services
24

 
 
Tenant
i

 
 
Tenant Affiliate
12


iv



 
 
Tenant Delay
B-1

 
 
Tenant Energy Use Disclosure
5

 
 
Tenant Improvements
B-1

 
 
Tenant's Notice Address
ii

 
 
Tenant's Portion
9

 
 
Tenant's Proportionate Share
i

 
 
Tenant-Made Alterations
9

 
 
Tenant-Related Parties
8

 
 
Trade Fixtures
10

 
 
Transfer
12



v


LEASE
1.Granting Clause. In consideration of the obligation of Tenant to pay rent as herein provided and in consideration of the other terms, covenants, and conditions hereof, Landlord leases to Tenant, and Tenant leases from Landlord, the Premises, to have and to hold for the Lease Term, subject to the terms, covenants and conditions of this Lease.
2.Acceptance of Premises. Except as may otherwise be expressly provided in a Construction Addendum attached hereto as Exhibit B, Tenant shall accept the Premises on the Commencement Date in its “AS‑IS, WHERE‑IS” condition, subject to all applicable laws, ordinances, regulations, covenants and restrictions, and Landlord shall have no obligation to perform or pay for any repair or other work therein. Landlord has made no representation or warranty as to the suitability of the Premises for the conduct of Tenant’s business, and Tenant waives any implied warranty that the Premises are suitable for Tenant’s intended purposes. TENANT ACKNOWLEDGES THAT (a) IT HAS INSPECTED AND ACCEPTS THE PREMISES IN AN “AS‑IS, WHERE‑IS” CONDITION (EXCEPT AS EXPRESSLY PROVIDED IN THE CONSTRUCTION ADDENDUM ATTACHED HERETO AS EXHIBIT B), (b) THE BUILDINGS AND IMPROVEMENTS COMPRISING THE PREMISES ARE SUITABLE FOR THE PURPOSE FOR WHICH THE PREMISES ARE LEASED AND LANDLORD HAS MADE NO WARRANTY, REPRESENTATION, COVENANT, OR AGREEMENT WITH RESPECT TO THE SUITABILITY, HABITABILITY, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF THE PREMISES, (c) THE PREMISES ARE IN GOOD AND SATISFACTORY CONDITION, (d) NO REPRESENTATIONS AS TO THE REPAIR OF THE PREMISES, NOR PROMISES TO ALTER, REMODEL OR IMPROVE THE PREMISES HAVE BEEN MADE BY LANDLORD (EXCEPT AS EXPRESSLY PROVIDED IN THE CONSTRUCTION ADDENDUM ATTACHED HERETO AS EXHIBIT B), AND (e) THERE ARE NO REPRESENTATIONS OR WARRANTIES, EXPRESSED, IMPLIED OR STATUTORY, THAT EXTEND BEYOND THE DESCRIPTION OF THE PREMISES. TENANT HEREBY WAIVES ANY WARRANTY OF CONDITION OR HABITABILITY, SUITABILITY FOR OCCUPANCY, USE OR HABITATION, FITNESS FOR A PARTICULAR PURPOSE OR MERCHANTABILITY, EXPRESS OR IMPLIED, RELATING TO THE PREMISES. Tenant has not relied on any representations or warranties not expressly set forth in this Lease. Except as provided in Section 10 and Exhibit B, in no event shall Landlord have any obligation for any defects in the Premises or any limitation on its use. The taking of possession of the Premises shall be conclusive evidence that Tenant accepts the Premises and that the Premises were in good condition at the time possession was taken except for items that are Landlord’s responsibility under Section 10 and Exhibit B.

3.Use.

(a)    Subject to Tenant’s compliance with all zoning ordinances and Legal Requirements (as hereinafter defined), the Premises shall be used only for the Permitted Use and for such other lawful purposes as may be incidental thereto. Tenant shall not conduct or give notice of any auction, liquidation, or going out of business sale on the Premises. Tenant will use the Premises in a careful, safe and proper manner and will not commit waste, overload the floor or structure of the Premises or subject the Premises to use that would damage the Premises. Tenant shall not permit any objectionable or unpleasant odors, smoke, dust, gas, noise, or vibrations to emanate from the Premises, or take any other action that would constitute a nuisance or would disturb, unreasonably interfere with, or endanger Landlord or any tenants of the Project. Outside storage, including storage of trucks and other vehicles, is prohibited without Landlord’s prior written consent, with the exception of the trailer parking as noted herein. As used in this Lease, “including” and “include” shall always mean “without limitation.”

(b)    Tenant, at its sole expense, shall use and occupy the Premises in compliance with all laws, including the Americans With Disabilities Act, orders, judgments, ordinances, regulations, codes, directives, permits, licenses, covenants and restrictions now or hereafter applicable to Tenant’s use and occupancy of the Premises (collectively, “Legal Requirements”). The Premises shall not be used as a place of public accommodation under the Americans With Disabilities Act or similar state statutes or local ordinances or any regulations promulgated thereunder, all as may be amended from time to time. Tenant shall, at its expense, make any alterations or modifications, within or without the Premises, that are required by Legal Requirements related to Tenant’s specific use or occupation of the Premises. Tenant will not use or permit the Premises to be used for any purpose or in any manner that would void Tenant’s or Landlord’s insurance, increase the insurance risk, or cause the disallowance of any sprinkler credits. If any

1


increase in the cost of any insurance on the Premises or the Project is caused by Tenant’s use or occupation of the Premises, or because Tenant vacates the Premises, then Tenant shall pay the amount of such increase to Landlord. Any entrance into or occupation of the Premises by Tenant prior to the Commencement Date shall be subject to all obligations of Tenant under this Lease, subject to Tenant’s early access rights as set forth in Section 9 of Exhibit B. Tenant represents and warrants to Landlord that Tenant is currently in compliance with and shall at all times during the Lease Term (including any extension thereof) remain in compliance with the regulations of the Office of Foreign Assets Control (“OFAC”) of the Department of the Treasury (including those named on OFAC’s Specially Designated and Blocked Persons List) and any statute, executive order (including the September 24, 2001, Executive Order Blocking Property and Prohibiting Transactions with Persons Who Commit, Threaten to Commit, or Support Terrorism), or other governmental action relating thereto.

(c)    Tenant and its employees and invitees shall have the non-exclusive right to use, in common with others, any areas designated by Landlord from time to time as common areas for the use and enjoyment of all tenants and occupants of the Project, subject to such reasonable rules and regulations as Landlord may promulgate from time to time. Under no circumstances shall the right therein granted to use the common areas be deemed to include the right to store any property, temporarily or permanently, in the common areas. Landlord or such other person(s) as Landlord may appoint shall have the exclusive control and management of the common areas.
4.    Base Rent. Tenant shall pay Base Rent in the amounts in the table of Base Rent set forth on the first page of this Lease. The Base Rent payable for the sixth (6th) Lease Month, the Security Deposit, and the first monthly installment of estimated Operating Expenses (as hereafter defined) shall be due and payable on the date hereof, and Tenant promises to pay to Landlord in advance, without demand, deduction or set-off, monthly installments of Base Rent on or before the first day of each calendar month succeeding the sixth (6th) Lease Month in accordance with the table of Base Rent set forth on the first page of this Lease. Payments of Base Rent for any fractional calendar month shall be prorated. All payments required to be made by Tenant to Landlord hereunder shall be payable at such address as Landlord may specify from time to time by written notice delivered in accordance herewith. The obligation of Tenant to pay Base Rent and other sums to Landlord and the obligations of Landlord under this Lease are independent obligations. Tenant shall have no right at any time to abate, reduce, or set-off any rent due hereunder except where expressly provided in this Lease. Tenant acknowledges that late payment by Tenant to Landlord of any rent due hereunder will cause Landlord to incur costs not contemplated by this Lease, the exact amount of such costs being extremely difficult and impractical to determine. Therefore, if Tenant is delinquent in any monthly installment of Base Rent, estimated Operating Expenses or other sums due and payable hereunder for more than seven (7) days, Tenant shall pay to Landlord on demand a late charge equal to five percent (5%) of such delinquent sum; provided, however, Tenant shall not incur such late charge with respect to the first late payment during any calendar year so long as Tenant pays the amount due within ten (10) days after receipt of written notice that such payment was not made when due. In addition, all payments required of Tenant hereunder which are more than 30 days past due shall bear interest from the date due until paid at the lesser of fifteen percent or the maximum lawful rate of interest. The parties agree that such late charge and interest represent a fair and reasonable estimate of the costs that Landlord will incur by reason of such late payment by Tenant. The provision for such late charge shall be in addition to all of Landlord’s other rights and remedies hereunder or at law and shall not be construed as a penalty. Additionally, Tenant shall pay to Landlord all sales, use, transaction privilege, or other excise tax that may at any time be levied or imposed upon, or measured by, any amount payable by Tenant under this Lease.
5.Security Deposit. The Security Deposit shall be held by Landlord as security for the performance of Tenant’s obligations under this Lease. The Security Deposit is not an advance rental deposit or a measure of Landlord’s damages in case of Tenant’s default. Upon each occurrence of an Event of Default (hereinafter defined), Landlord may use all or part of the Security Deposit to pay delinquent payments due under this Lease, and the cost of any damage, injury, expense or liability caused by such Event of Default, without prejudice to any other remedy provided herein or provided by law. Tenant shall pay Landlord on demand the amount that will restore the Security Deposit to its original amount. Any such restoration payment which is not paid within ten days after Landlord’s written demand therefor shall bear interest from the date of such written demand until paid at the lesser of fifteen percent or the maximum lawful rate of interest. The parties agree that such interest represents a fair and reasonable estimate of the costs that Landlord will incur by reason of such late payment by Tenant. The provision for such interest shall be in addition to all of Landlord’s other rights and remedies hereunder or at law and shall not be construed as a penalty. Landlord’s obligation

2


respecting the Security Deposit is that of a debtor, not a trustee; no interest shall accrue thereon. If Tenant shall perform all of its obligations under this Lease and return the Premises to Landlord at the end of the Lease Term in the condition required upon surrender pursuant to the terms of this Lease, Landlord shall return all of the Security Deposit remaining after deducting all damages, charges and other amounts permitted by law to Tenant within thirty (30) days after the end of the Lease Term. Landlord and Tenant agree that such deductions shall include all damages and losses that Landlord has suffered or that Landlord reasonably estimates that it will suffer as a result of any breach of this Lease by Tenant. If Landlord transfers its interest in the Premises Landlord shall assign the Security Deposit to the transferee and, upon such transfer and the delivery to Tenant of an acknowledgement of the transferee’s responsibility for the Security Deposit as provided by law, Landlord thereafter shall have no further liability for the return of the Security Deposit.
6.    Operating Expense Payments.
(a)    During each month of the Lease Term (including during the initial four (4) Lease Months), on the same date that Base Rent is due, Tenant shall pay Landlord an amount equal to 1/12 of the annual cost, as estimated by Landlord from time to time, of Tenant’s Proportionate Share (hereinafter defined) of Operating Expenses for the Project. Payments thereof for any fractional calendar month shall be prorated.
(b)    The term “