WESCO AIRCRAFT HOLDINGS, INC. The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, liquidity and capital resources. You should read this discussion in conjunction with our consolidated financial statements and the related notes contained elsewhere in this Annual Report on Form 10-K. The statements in this discussion regarding industry trends, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in Part I, Item 1A. "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements." Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Agreement and Plan of Merger
OnAugust 8, 2019 , the Company entered into an Agreement and Plan of Merger (the Merger Agreement) withWolverine Intermediate Holding II Corporation , aDelaware corporation (Parent), andWolverine Merger Corporation , aDelaware corporation and a direct wholly owned subsidiary of Parent (Merger Sub), pursuant to which Parent will acquire the Company for$11.05 per share through the merger of Merger Sub with and into the Company, with the Company surviving as a wholly owned subsidiary of Parent (the "Merger"). Parent and Merger Sub are affiliates ofPlatinum Equity Advisors, LLC , aU.S. -based private equity firm. The closing of the Merger is subject to customary closing conditions, including the receipt of requisite competition and merger control approvals in theUnited Kingdom . See Note 1 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion about the Merger.
Industry Trends Affecting Our Business
We rely on demand for new commercial and military aircraft for a significant portion of our sales. Commercial aircraft demand is driven by many factors, including the global economy, industry passenger volumes and capacity utilization, airline profitability, introduction of new models and the lifecycle of current fleets. Demand for business jets is closely correlated to regional economic conditions and corporate profits, but also influenced by new models and changes in ownership dynamics. Military aircraft demand is primarily driven by government spending, the timing of orders and evolvingU.S. Department of Defense strategies and policies. Aftermarket demand is affected by many of the same trends as those in OEM channels, as well as requirements to maintain aging aircraft and the cost of fuel, which can lead to greater utilization of existing planes. Demand in the military aftermarket is further driven by changes in overall fleet size and the level ofU.S. military operational activity domestically and overseas. Supply chain service providers and distributors have been aided by these trends along with an increase in outsourcing activities, as OEMs and their suppliers focus on reducing their capital commitments and operating costs.
Commercial Aerospace Market
Over the past three years, major airlines have ordered new aircraft at a robust pace, aided by strong profits and increasing passenger volumes. At the same time, volatile fuel prices have led to greater demand for fuel-efficient models and new engine options for existing aircraft designs. The rise of emerging markets has added to the growth in overall demand at a stronger pace than seen historically. Large commercial OEMs have indicated that they expect a high level of deliveries, with the exception of the Boeing Company's 737 MAX aircraft impact, primarily due to continued demand and their unprecedented level of backlogs. The pause in deliveries and reduced production rate of the 737 MAX aircraft by the Boeing company has negatively affected total large commercial aircraft deliveries. The impact is dependent upon when the aircraft returns to service, which will be determined by factors such as certification by theFAA and other regulatory authorities, when the OEM resumes deliveries and returns to its previous production schedule and whether or not the delay creates disruptions to the related supply chain. Business aviation has lagged the larger commercial market, reflecting a deeper downturn in the last recession, changes in corporate spending patterns and an uncertain economic outlook. However, production has increased for new models, and the market for certain pre-owned aircraft remains tight. Whether these conditions lead to increased deliveries in the future remains uncertain. 31 --------------------------------------------------------------------------------
Military Aerospace Market
Military production has fluctuated for many aircraft programs in the past few years. Increases in theU.S. Department of Defense budget for fiscal years 2018 and 2019 have supported greater production of certain military programs. In particular, we believe the services we provide the Joint Strike Fighter program will benefit our business as production for that program increases. We believe increased sales from other established programs that directly benefit from these changes also will benefit our business.U.S. Department of Defense spending continues to be uncertain for fiscal years 2020 through 2023, given that the limits imposed uponU.S. government discretionary spending by the Budget Control Act and the Bipartisan Budget Act of 2013 remain in effect for these fiscal years, unlessCongress acts to raise the spending limits or repeal or suspend the provisions of these laws. Future budget cuts or changes in spending priorities could result in existing program delays, changes or cancellations.
We apply the equity method of accounting for investments in which we have significant influence but not a controlling interest. Our APAC reporting unit has an equity investment in a joint venture inChina , the carrying value of which was$7.1 million and$10.4 million as ofSeptember 30, 2019 and 2018, respectively, and was included in "Other assets" in the unaudited Consolidated Balance Sheets. During the three months endedJune 30, 2019 , we recorded an impairment charge of$3.0 million resulting from a decline in value below the carrying amount of our equity method investment, which we determined was other than temporary in nature. The remaining$0.3 million decrease was due to foreign currency translation loss. As ofSeptember 30, 2019 , we did not identify any events or circumstances which would indicate a further decline in the fair value of our equity method investment that is other than temporary.
Other Factors Affecting Our Financial Results
Fluctuations in Revenue
There are many factors, such as changes in customer aircraft build rates,
customer plant shut downs, variation in customer working days, changes in
selling prices, the amount of new customers' consigned inventory and increases
or decreases in customer inventory levels, that can cause fluctuations in our
financial results from quarter to quarter. To normalize for short-term
fluctuations, we tend to look at our performance over several quarters or years
of activity rather than discrete short-term periods. As such, it can be
difficult to determine longer-term trends in our business based on quarterly
comparisons. Ad hoc business tends to vary based on the amount of disruption in
the market due to changes in aircraft build rates, new aircraft introduction,
customer or site consolidations, and other factors. Fluctuations in our ad hoc
business tend to be partially offset by our Contract business as a majority of
our ad hoc revenue comes from our Contract customers.
We will continue our strategy of seeking to expand our relationships with
existing ad hoc customers by transitioning them to Contracts, as well as
expanding relationships with our existing Contract customers to include
additional customer sites, additional SKUs and additional levels of service. New
Contract customers and expansion of existing Contract customers to additional
sites and SKUs sometimes leads to a corresponding decrease in ad hoc sales as a
portion of the SKUs sold under Contracts were previously sold to the same
customer as ad hoc sales. We believe this strategy serves to mitigate some of
the fluctuations in our net sales. Our sales to Contract customers may fail to
meet our expectations for a variety of reasons, in particular if industry build
rates are lower than expected or, for certain newer JIT customers, if their
consigned inventory, which must be exhausted before corresponding products are
purchased directly from us, is greater than we expected.
If any of our customers are acquired or controlled by a company that elects not
to utilize our services, or attempt to implement in-sourcing initiatives, it
could have a negative effect on our strategy to mitigate fluctuations in our net
sales. Additionally, although we derive a significant portion of our net sales
from the building of new commercial and military aircraft, we have not typically
experienced extreme fluctuations in our net sales when sales for an individual
aircraft program decrease, which we believe is attributable to our diverse base
of customers and programs.
Fluctuations in Margins
Our gross margins are impacted by changes in product mix, pricing and product
costing. Generally, our hardware products have higher gross profit margins than
chemicals and electronic components.
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We also believe that our strategy of growing our Contract sales and converting
ad hoc customers into Contract customers could negatively affect our gross
profit margins, as gross profit margins tend to be higher on ad hoc sales than
they are on Contract-related sales. However, we believe any potential adverse
impact on our gross profit margins would be outweighed by the benefits of a more
stable long-term revenue stream attributable to Contract customers.
Our Contracts generally provide for fixed prices, which can expose us to risks
if prices we pay to our suppliers rise due to increased raw material or other
costs. However, we believe our expansive product offerings and inventories, our
ad hoc sales and, where possible, our longer-term agreements with suppliers have
enabled us to mitigate this risk. Some of our Contracts are denominated in
foreign currencies and fixed prices in these Contracts can expose us to
fluctuations in foreign currency exchange rates with the U.S. dollar.
Fluctuations in Cash Flow
Our cash flows are principally affected by fluctuations in our inventory. When we are awarded new programs, we generally increase our inventory to prepare for expected sales related to the new programs, which often take time to materialize, and to achieve minimum stock requirements, if any. As a result, if certain programs for which we have procured inventory are delayed or if certain newer JIT customers' consigned inventory is larger than we expected, we may experience a more sustained inventory increase. Inventory fluctuations may also be attributable to general industry trends. Factors that may contribute to fluctuations in inventory levels in the future could include (1) purchases to take advantage of favorable pricing, (2) purchases to acquire high-volume products that are typically difficult to obtain in sufficient quantities; (3) changes in supplier lead times and the timing of inventory deliveries; (4) purchases made in anticipation of future growth; and (5) purchases made in connection with new customer Contracts or the expansion of existing Contracts. While effective inventory management is an ongoing challenge, we continuously take steps to enhance the sophistication of our procurement practices to mitigate the negative impact of inventory buildups on our cash flow. Our accounts receivable balance as a percentage of net sales may fluctuate from quarter to quarter. These fluctuations are primarily driven by changes, from quarter to quarter, in the timing of sales within the quarter and variation in the time required to collect the payments. The completion of customer Contracts with varied payment terms can also contribute to these quarter to quarter fluctuations. Similarly, our accounts payable may fluctuate from quarter to quarter, which is primarily driven by the timing of purchases or payments made to our suppliers. Segment Presentation We conduct our business through three reportable segments: theAmericas , EMEA (Europe ,Middle East andAfrica ) and APAC (Asia Pacific ). We evaluate segment performance based primarily on segment income or loss from operations. Each segment reports its results of operations and makes requests for capital expenditures and working capital needs to our chief operating decision maker (CODM). Our Chief Executive Officer serves as our CODM.
Key Components of Our Results of Operations
The following is a discussion of the key line items included in our financial statements for the periods presented below under the heading "Results of Operations." These are the measures that management utilizes to assess our results of operations, anticipate future trends and evaluate risks in our business.
Our net sales include sales of hardware, chemicals, electronic components,
bearings, tools and machined parts, and eliminate all intercompany sales. We
also provide certain services to our customers, including quality assurance,
kitting, JIT delivery, CMS, 3PL or 4PL programs and point-of-use inventory
management. However, these services are provided by us contemporaneously with
the delivery of the product, and as such, once the product is delivered, we do
not have a post-delivery obligation to provide services to the customer.
Accordingly, the price of such services is generally included in the price of
the products delivered to the customer, and revenue is recognized upon delivery
of the product, at which point, we have satisfied our obligations to the
customer. We do not account for these services as a separate element, as the
services generally do not have stand-alone value and cannot be separated from
the product element of the arrangement.
We serve our customers under Contracts, which include JIT contracts and LTAs,
and with ad hoc sales. Under JIT contracts, customers typically commit to
purchase specified products from us at a fixed price, on an as needed basis, and
we are
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responsible for maintaining stock availability of those products. LTAs are
typically negotiated price lists for customers or individual customer sites that
cover a range of pre-determined products, purchased on an as-needed basis. Ad
hoc purchases are made by customers on an as-needed basis and are generally
supplied out of our existing inventory. Contract customers often purchase
products that are not captured under their Contract on an ad hoc basis.
Income (Loss) from Operations
Income (loss) from operations is the result of subtracting the cost of sales and selling, general, and administrative expenses and other costs from net sales, and is used primarily to evaluate our performance and profitability. The principal component of our cost of sales is product cost, which was 94.3% of our total cost of sales for the year endedSeptember 30, 2019 . Product cost is determined by the current weighted average cost of each inventory item, except for chemical parts for which the first-in, first-out method is used. The remaining components are freight and expediting fees, import duties, tooling repair charges, packaging supplies, excess and obsolete (E&O) inventory and other inventory related charges, which collectively were 5.7% of our total cost of sales for the year endedSeptember 30, 2019 . Depreciation related to cost of sales, if any, was immaterial and not included in cost of sales. The E&O inventory provision is calculated to write down inventory to its net realizable value. We review inventory for excess quantities and obsolescence monthly. For a description of our E&O provision policy, see "-Critical Accounting Policies and Estimates-Inventories." Net adjustments to cost of sales related to E&O inventory related activities were$2.7 million ,$16.8 million and$12.9 million during the years endedSeptember 30, 2019 , 2018 and 2017, respectively. We believe that these amounts appropriately reflect the risk of E&O inventory inherent in our business and the proper net realizable value of inventories. For a more detailed description of the E&O provision, see Note 5 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K. Other inventory related charges are typically for shrinkage and spoilage that occurs in the warehouses. The total shrinkage and spoilage cost was$24.2 million ,$7.9 million and$15.6 million for the years endedSeptember 30, 2019 . 2018 and 2017, respectively. These charges typically are recorded as a normal part of our business. However,$13.0 million of the total charge recorded in 2019 resulted from the Wesco 2020 initiative focused on warehouse consolidation. The principal components of our selling, general and administrative expenses are salaries, wages, benefits and bonuses paid to our employees; stock-based compensation; warehouse and related costs, commissions paid to outside sales representatives; travel and other business expenses; training and recruitment costs; marketing, advertising and promotional event costs; rent; bad debt expense; professional services fees (including legal, audit and tax); and ordinary day-to-day business expenses. Depreciation and amortization expense is also included in selling, general and administrative expenses, and consists primarily of scheduled depreciation for leasehold improvements, machinery and equipment, vehicles, computers, software and furniture and fixtures. Depreciation and amortization also includes intangible asset amortization expense. Other Expenses Interest Expense, Net. Interest expense, net consists of the interest we pay on our long-term debt, interest and fees on our revolving facility (as defined below under "-Liquidity and Capital Resources-Credit Facilities"), capital lease interest and our line-of-credit and deferred debt issuance costs, net of interest income. Other (Expense) Income, Net. Other (expense) income, net is primarily comprised of foreign exchange gain or loss associated with transactions denominated in currencies other than the respective functional currency of the reporting subsidiary.
Critical Accounting Policies and Estimates
The methods, estimates and judgments we use in applying our most critical
accounting policies have a significant impact on the results we report in our
financial statements. We base our estimates on historical experience and on
assumptions that we believe to be reasonable under the circumstances. Our
experience and assumptions form the basis for our judgments about the carrying
value of assets and liabilities that are not readily apparent from other
sources. We evaluate our estimates and judgments on an on-going basis and may
revise our estimates and judgments as circumstances change. Actual results may
materially differ from what we anticipate, and different assumptions or
estimates about the future could materially change our reported results. We
believe the following accounting policies are the most critical in that they
significantly affect our financial statements, and they require our most
significant estimates and complex judgments.
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Our inventory is comprised solely of finished goods. Inventories are stated at the lower of cost or net realizable value (LCNRV). The method by which amounts are removed from inventory are weighted average cost for all inventory, except for chemical parts and supplies for which the first-in, first-out method is used. Our inventory is impacted by shrinkage and spoilage as a normal course of operations, largely due to the high volume of purchases and sales and large quantities of small parts, which can be impacted by fluctuations in warehouse activity and operating efficiency. We will provide for shrinkage and spoilage on a periodic basis along with making provisions as required based upon operational activity. We charge cost of sales for inventory provisions to write down our inventory to the LCNRV. Inventory provisions relate to the write-down of excess quantities of products, based on our inventory levels compared to assumptions about future demand and market conditions. Once inventory has been written down, it creates a new cost basis for the inventory that is not subsequently written up. The process for evaluating E&O inventory often requires us to make subjective judgments and estimates concerning forecasted demand, including quantities and prices at which such inventories will be able to be sold in the normal course of business. The components of our inventory are subject to different risks of excess quantities or obsolescence. Our chemical inventory becomes obsolete when it has aged past its shelf life, cannot be recertified and is no longer usable or able to be sold, or the inventory has been damaged on-site or in-transit. In such instances, the value of such inventory is reduced to zero. Our hardware inventory, which largely does not expire or have a pre-determined shelf life, bears a higher risk of our having excess quantities than risk of becoming obsolete or spoiled. We continually assess and refine our methodology for evaluating E&O inventory based on current facts and circumstances. Our hardware inventory E&O assessment requires the use of subjective judgments and estimates including the forecasted demand for each part. The forecasted demand considers a number of factors, including historical sales trends, current and forecasted customer demand, customer purchase obligations based on contractual provisions, available sales channels and the time horizon over which we expect the hardware part to be sold. Demand for our products can fluctuate significantly. Our estimates of future product demand and selling prices may prove to be inaccurate, in which case we may have understated or overstated the write-down required for E&O inventories. In the future, if the net realizable value of our inventories is determined to be lower than the carrying value of our inventories, we will be required to reduce the carrying value of such inventories to the net realizable value and recognize the differences in our cost of goods sold at the time of such determination. However, if LCNRV is later determined to be higher than the carrying value of our inventories due to change in circumstances, we will not be allowed to recognize a reduction of cost of goods sold for such difference even when the difference resulted from previously recorded write-down of those inventories. For a more detailed description of the E&O provision, see Note 5 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
Goodwill represents the excess of the consideration paid over the fair value of the net assets acquired in a business combination.Goodwill and indefinite-lived intangible assets acquired in a business combination are not amortized, but instead tested for impairment at least annually or more frequently should an event or circumstances indicate that the carrying amount may be impaired. Such events or circumstances may be a significant change in business climate, economic and industry trends, legal factors, negative operating performance indicators, significant competition, changes in strategy, or disposition of a reporting unit or a portion thereof.Goodwill and indefinite lived intangibles impairment testing is performed at the reporting unit level onJuly 1 of each year, as well as when events or circumstances might indicate impairment. We have one reporting unit under each of the three operating segments,Americas , EMEA and APAC. We test goodwill for impairment by performing a qualitative assessment process, or using a two-step quantitative assessment process. If we choose to perform a qualitative assessment process and determine it is more likely than not (that is, a likelihood of more than 50 percent) that the carrying value of the net assets is more than the fair value of the reporting unit, the two-step quantitative assessment process is then performed; otherwise, no further testing is required. Factors utilized in the qualitative assessment include the following: macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; Wesco entity specific operating results and other relevant Wesco entity specific events. We may elect not to perform the qualitative assessment process and, instead, proceed directly to the two-step quantitative assessment process. 35 -------------------------------------------------------------------------------- The first step identifies potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. The fair value of our reporting units is determined using a combination of a discounted cash flow analysis (income approach) and market earnings multiples (market approach). These fair value approaches require significant management judgment and estimate. The determination of fair value using a discounted cash flow analysis requires the use of key judgments, estimates and assumptions including revenue growth rates, projected operating margins, changes in working capital, terminal values, and discount rates. We develop these key estimates and assumptions by considering our recent financial performance and trends, industry growth projections, and current sales pipeline based on existing customer contracts and the timing and amount of future contract renewals. The determination of fair value using market earnings multiples also requires the use of key judgments, estimates and assumptions related to projected earnings and applying those amounts to earnings multiples using appropriate peer companies. We develop our projected earnings using the same judgments, estimates, and assumptions used in the discounted cash flow analysis. If the fair value exceeds the carrying value of a reporting unit, goodwill is not considered impaired and the second step of the test is unnecessary. If the carrying amount of a reporting unit's goodwill exceeds the fair value of a reporting unit, the second step measures the impairment loss, if any. The second step compares the implied fair value of goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. The implied fair value of the reporting unit's goodwill is calculated by creating a hypothetical balance sheet as if the reporting unit had just been acquired. This balance sheet contains all assets and liabilities recorded at fair value (including any intangible assets that may not have any corresponding carrying value in our balance sheet). The implied value of the reporting unit's goodwill is calculated by subtracting the fair value of the net assets from the fair value of the reporting unit. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. As ofJuly 1, 2019 , we performed our Step 1 goodwill impairment tests on our three new reporting units,Americas , EMEA and APAC. The results of these tests indicated that the estimated fair values of our reporting units exceeded their carrying values. For theAmericas , EMEA and APAC reporting units, the fair value was in excess of carrying value by 29%, 10% and 85%, respectively. The EMEA reporting unit had goodwill of$51.2 million as ofSeptember 30, 2019 . We determined the estimated fair value of the EMEA reporting unit based on several factors including our recent financial performance and trends, industry growth projections, existing customer contracts, current sales pipeline and the timing and amount of future contract renewals, and our focused sales and operations improvement plans which are underway. The preparation of our fair value estimate requires significant judgments. In the event that market earnings multiples deteriorate or our future financial performance falls short of our projections due to internal operating factors, economic recession, changes in government regulations, deterioration of industry trends, increased competition, or other factors causing our revenue growth to be slower than anticipated or our margins or cash flow to deteriorate, we may be required to perform an interim impairment analysis with respect to the carrying value of goodwill for this reporting unit prior to our annual test. If the analysis indicates the fair value of the EMEA reporting unit has fallen close to or more than 10%, we may be required to take a non-cash impairment charge to reduce the carrying value of goodwill or other assets. As ofJuly 1, 2018 , we performed our annual Step 1 goodwill impairment tests on our three reporting units,Americas , EMEA and APAC. The results of these tests indicated that the estimated fair values of our reporting units exceeded their carrying values. Indefinite-lived intangibles consist of a trademark, for which we estimate fair value and compare such fair value to the carrying amount. If the carrying amount of the trademark exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. As ofSeptember 30, 2019 and 2018, our trademark was not impaired.
Revenue from Contracts with Customers
Pursuant to Accounting Standard Codification Topic 606, Revenue from Contracts
with Customers (ASC 606), we recognize revenue when our customer obtains control
of promised goods or services, in an amount that reflects the consideration that
we expect to receive in exchange for those goods or services. To determine
revenue recognition for arrangements that we determine are within the scope of
ASC 606, we perform the following five steps: (1) identify the contract(s) with
a customer; (2) identify the performance obligations in the contract; (3)
determine the transaction price; (4) allocate the transaction price to the
performance obligations in the contract; and (5) recognize revenue when (or as)
the entity satisfies a performance obligation. We recognize revenue in the
amount of the transaction price that is allocated to the respective performance
obligation when (or as) the performance obligation is satisfied.
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Typically, our master sales contracts with our customer run for three to five
years without minimum purchase requirements annually or over the term of the
contract, and contain termination for convenience provisions that generally
allow for our customers to terminate their contracts on short notice without
meaningful penalties. Pursuant to ASC 606, we have concluded that for revenue
recognition purposes, our customers' purchase orders (POs) are considered
contracts, which are supplemented by certain contract terms such as service fee
arrangements and variable price considerations in our master sales contracts.
The POs are typically fulfilled within one year.
Our contracts for hardware and chemical product sales have a single performance
obligation. Revenues from these contract sales are recognized when we have
completed our performance obligation, which occurs at a point in time, typically
upon transfer of control of the products to the customer in accordance with the
terms of the sales contract. Services under our hardware JIT arrangements are
provided by us contemporaneously with the providing of these products and are
not distinct from the products, and as such, once the products are provided, we
do not have an additional obligation to provide services to the customer.
Accordingly, the price of such services is generally included in the price of
the products delivered to the customer, and revenue is recognized upon providing
of the products. Payment is generally due within 30 to 90 days of delivery;
therefore, our contracts do not create significant financing components.
Warranties are limited to replacement of goods that are defective upon delivery;
and the Company does not give service-type warranties.
Our CMS contracts include the sale of chemical products as well as services such
as product procurement, receiving and quality inspection, warehouse and
inventory management, and waste disposal. The CMS contracts represent an
end-to-end integrated chemical management solution. While each of the products
and various services benefits the customer, we determined that they are a single
output in the context of the CMS contract due to the significant integration of
these products and services. Therefore, chemical products and services provided
under a CMS contract represent a single performance obligation and revenue is
recognized for these contracts over time using product deliveries as our output
measure of progress under the CMS contract to depict the transfer of control to
the customer.
We report revenue on a gross or net basis in our presentation of net sales and
costs of sales based on management's assessment of whether we act as a principal
or agent in the transaction. If we are the principal in the transaction and have
control of the specified good or service before that good or service is
transferred to a customer, the transactions are recorded as gross in the
consolidated statements of comprehensive income (loss). If we do not act as a
principal in the transaction, the transactions are recorded on a net basis in
the consolidated statements of comprehensive income (loss). This assessment
requires significant judgment to evaluate indicators of control within our
contracts. We base our judgment on various indicators that include whether we
take possession of the products, whether we are responsible for their
acceptability, whether we have inventory risk, and whether we have discretion in
establishing the price paid by the customer. The majority of our revenue is
recorded on a gross basis with the exception of certain gas, energy and chemical
management service contracts where the related sale of products are recorded on
a net basis.
With respect to variable consideration, we apply judgment in estimating its
impact to determine the amount of revenue to recognize. Sales rebates and
profit-sharing arrangements are accounted for as a reduction to gross sales and
recorded based upon estimates at the time products are sold. These estimates are
based upon historical experience for similar programs and products. We review
such rebates and profit-sharing arrangements on an ongoing basis and accruals
are adjusted, if necessary, as additional information becomes available. We
provide allowances for credits and returns based on historic experience and
adjust such allowances as considered necessary. To date, such provisions have
been within the range of our expectations and the allowances established.
Returns and refunds are allowed only for materials that are defective or not
compliant with the customer's order. Sales tax collected from customers is
excluded from net sales in the consolidated statements of comprehensive income
(loss).
We have determined that sales backlog is not a relevant measure of our business.
Our contracts generally do not include minimum purchase requirements, annually
or over the term of the agreement, and contain termination for convenience
provisions that generally allow for our customers to terminate their contracts
on short notice without meaningful penalties. As a result, we have no material
sales backlog.
Income Taxes
We recognize deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the carrying amounts and the tax
bases of assets and liabilities. Deferred income tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which these temporary differences are expected to be recovered or
settled. The effect of a change in tax rates on deferred tax assets and
liabilities is recognized in income in the period that includes the enactment
date. A valuation allowance is established, when necessary, to reduce net
deferred tax assets to the amount expected to be realized. The ultimate
realization of deferred tax assets depends upon the generation of future
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taxable income during the periods in which temporary differences become
deductible or includible in taxable income. We consider projected future taxable
income and tax planning strategies in our assessment. Our foreign subsidiaries
are taxed in local jurisdictions at local statutory rates. The Company includes
interest and penalties related to income taxes, including unrecognized tax
benefits, within income tax expense.
We determine whether it is more likely than not that some or all of the deferred
tax assets will not be realized. We have recorded valuation allowances of $13.3
million and $37.9 million as of September 30, 2019 and 2018, respectively,
against certain deferred tax assets, which consist of U.S. foreign tax credits
and foreign net operating losses. The valuation allowances are based on our
estimates of taxable income by jurisdictions in which we operate and the period
over which our deferred tax assets will be recoverable. If actual results differ
from these estimates or if we revise these estimates in future periods, we may
need to adjust the valuation allowances which could materially impact our
financial position and results of operations. We recognize and measure our
uncertain tax positions using the more likely than not threshold for financial
statement recognition and measurement for tax positions taken or expected to be
taken in a tax return.
Stock-Based Compensation
We account for all stock-based compensation awards to employees and members of
our Board of Directors based upon their fair values as of the date of grant
using a fair value method and recognize the fair value of each award as an
expense over the requisite service period using the graded vesting method for
awards with performance conditions and the straight-line method for awards with
service conditions only.
For purposes of calculating stock-based compensation, we estimate the fair value
of stock options using a Black-Scholes option pricing model, which requires the
use of certain subjective assumptions including expected term, volatility,
expected dividend, risk-free interest rate, and the fair value of our common
stock. These assumptions generally require significant judgment.
We estimate the expected term of employee options using the average of the
time-to-vesting and the contractual term. We derive our expected volatility from
the historical volatilities of the price of our common stock over the expected
term of the options. Our expected dividend rate is zero, as we have never paid
any dividends on our common stock and do not anticipate any dividends in the
foreseeable future. We base the risk-free interest rate on the U.S. Treasury
yield in effect at the time of grant for zero coupon U.S. Treasury notes with
maturities approximately equal to each grant's expected life.
We estimate the fair value of restricted stock units and awards based on the
market price of the shares underlying the awards on the grant date. Fair value
for performance-based awards reflects the estimated probability that the
performance condition will be met. Fair value for awards with total stockholder
return performance metrics reflects the fair value calculated using the Monte
Carlo simulation model, which incorporates stock price correlation and other
variables over the time horizons matching the performance periods.
Management estimates a forfeiture rate for each grant of awards based on its
judgment and expectations of employee turnover behavior and other factors.
Quarterly actual forfeiture could have a significant effect on reported
stock-based compensation expense, as the cumulative effect of adjusting the
amortization of stock-based compensation expense is recognized in the period
when the forfeiture occurs.
The following table summarizes the amount of stock-based compensation expense
recognized in our consolidated statements of comprehensive income (loss) (in
thousands):
2019 2018 2017
Stock-based compensation expense
If any of the factors change and/or we employ different assumptions, stock-based
compensation expense may differ significantly from what we have recorded in the
past. If there is a difference between the assumptions used in determining
stock-based compensation expense and the actual factors that become known over
time, we may change the input factors used in determining stock-based
compensation costs for future grants. Additionally, we may change the estimates
that the performance obligations may be met. These changes, if any, may
materially impact our results of operations in the period such changes are made.
In the event the Merger Agreement is terminated, we expect to continue to grant
stock options in the future, and to the extent that we do, our actual
stock-based compensation expense recognized in future periods will likely
increase.
38
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Results of Operations
Consolidated
Years Ended September 30,
Consolidated Result of Operations 2019 2018 2017
(dollars in thousands)
Net sales $ 1,696,450 $ 1,570,450 $ 1,429,429
Gross profit $ 403,093 $ 403,156 $ 361,907
Selling, general & administrative expenses 324,581 293,688 259,588
Goodwill impairment charge - - 311,114
Income (loss) from operations 78,512 109,468 (208,795 )
Interest expense, net (51,023 ) (48,880 ) (39,821 )
Other (expense) income, net (816 ) 24 369
Income (loss) before income taxes and equity
method investment impairment charge 26,673 60,612 (248,247 )
(Provision) benefit for income taxes (2,338 ) (27,958 ) 10,901
Income before equity method investment
impairment charge 24,335 32,654 (237,346 )
Equity method investment impairment charge (2,966 ) - -
Net income (loss) $ 21,369 $ 32,654 $ (237,346 )
(as a percentage of net sales, numbers rounded)
Gross profit 23.8 % 25.7 % 25.3 %
Selling, general & administrative expenses 19.1 % 18.7 % 18.2 %
Goodwill impairment charge - % - % 21.7 %
Income (loss) from operations 4.6 % 7.0 % (14.6 )%
Interest expense, net (3.0 )% (3.1 )% (2.8 )%
Other (expense) income, net - % - % - %
Income (loss) before income taxes and equity
method investment impairment charge 1.6 % 3.9 % (17.4 )%
(Provision) benefit for income taxes (0.2 )% (1.8 )% 0.8 %
Income before equity method investment
impairment charge 1.4 % 2.1 % (16.6 )%
Equity method investment impairment charge (0.1 )% - % - %
Net income (loss) 1.3 % 2.1 % (16.6 )%
Year ended
Consolidated net sales increased$126.0 million , or 8.0%, to$1,696.5 million for the year endedSeptember 30, 2019 compared with$1,570.5 million for the year endedSeptember 30, 2018 . The$126.0 million increase reflects higher sales across all major product categories including chemicals, ad hoc hardware and Contract hardware. For the year endedSeptember 30, 2019 , net sales increased$69.9 million ,$28.3 million and$27.8 million for chemical, ad hoc hardware and Contract hardware, respectively. The net sales increase benefited from continued market growth and reflects the Company's strong position with major customers. In addition, approximately$9.6 million of the$126.0 million net sales increase in the current year represents higher revenue from end-of-contract related sales compared with the prior year. Ad hoc and Contract sales as a percentage of net sales represented 24% and 76%, respectively, for 2019, which was unchanged from the prior year.
Income (loss) from Operations
39
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Consolidated income from operations was $78.5 million for the year ended
September 30, 2019 compared with $109.5 million for the year ended September 30,
2018 . The $31.0 million decline in income from operations was due to an increase
in SG&A expenses of $30.9 million and a decrease in gross profit of $0.1
million . Income from operations as a percentage of net sales declined 2.4
percentage points compared with the prior year.
The lower gross profit of $0.1 million was driven by a decline in gross margin
largely offset by increases in sales volume compared with the same period in the
prior year. Gross margins declined 1.9 percentage points, primarily reflecting
weaker margins in the EMEA segment resulting from more aggressive pricing for
hardware products including for certain Contract renewals, the impact of weaker
Euro and British Pound exchange rates versus the U.S. Dollar for local currency
denominated business primarily related to chemical sales, a higher volume of
chemical pass-through revenues, higher logistics costs for certain chemicals
Contracts, and higher shrinkage and spoilage inventory adjustment, partially
offset by lower E&O inventory write-downs to net realizable value. The gross
margin decline also reflects the effect of lower margins in the Americas segment
due to several factors: for Contract hardware sales, margins on end-of-contract
related sales were significantly higher in the prior year; for ad hoc sales of
hardware products, lower current year margins reflect more aggressive pricing to
gain sales volume; and a shift in product mix towards lower margin chemical and
certain Contract hardware sales. The overall consolidated gross profit was
impacted by higher inventory adjustments of $16.3 million primarily due to
shrinkage and spoilage, largely offset by lower net write-downs to net
realizable value for E&O inventory of $14.0 million , for the year ended
September 30, 2019 compared with the prior year. The shrinkage and spoilage
typically is incurred as a normal part of our business. However, $13.0 million
of the total charge recorded in 2019 resulted from the Wesco 2020 initiative
focused on warehouse consolidation.
The $30.9 million increase in SG&A expenses largely reflects higher payroll and
other personnel-related costs of $17.0 million , professional fees of $8.3
million , building and equipment costs of $4.3 million and marketing and travel
expenses of $1.7 million . Increases in these areas primarily were driven by
investments to execute Wesco 2020 initiatives, professional fees related to the
Merger and personnel-related costs to support revenue growth. Wesco 2020 related
costs totaled $35.6 million in the year ended September 30, 2019 , compared with
$20.4 million in the prior year. The majority of the increase is the result of
execution steps that have a defined end point. Key examples include professional
fees for consulting support, duplicative staffing costs required during
transition and consolidation of single product warehouses into multi-product
service centers, severance expense and project performance incentives.
Professional fees related to the Merger totaled $8.2 million in fiscal 2019. See
Note 1 of the Notes to the Consolidated Financial Statements in Part II, Item 8
of this Annual Report on Form 10-K for further discussion about the Merger.
Partially offsetting these higher costs were savings achieved through Wesco 2020
initiatives of approximately $11.1 million in the year ended September 30, 2019 .
SG&A as a percent of net sales increased 0.4 percentage points compared with the
prior year.
Interest Expense, Net
Interest expense, net was $51.0 million for the year ended September 30, 2019 ,
an increase of $2.1 million compared to the year ended September 30, 2018 . The
increase was primarily due to an increase in interest rates, partially offset by
lower average borrowings compared with the prior year.
(Provision) Benefit for Income Taxes
The income tax provision was$2.3 million for the year endedSeptember 30, 2019 , compared to$28.0 million for the year endedSeptember 30, 2018 . For the year endedSeptember 30, 2019 , our effective tax rate decreased 37.4 percentage points compared to the same period in the prior year primarily as a result of discrete tax adjustments. For the year endedSeptember 30, 2018 , the Company recorded as a result of the Tax Cuts and Jobs Act (the Tax Act) a provisional$37.7 million of charge to tax expense related to the remeasurement of deferred tax assets and liabilities, a provisional$37.7 million tax benefit related to the partial reversal of a previously recorded deferred tax liability for unremitted foreign earnings and a provisional$9.3 million charge to the tax expense related to the one-time tax imposed on accumulated earnings and profits of foreign operations (the Transition Tax). For the year endedSeptember 30, 2019 , we recorded a favorable$9.3 million adjustment to the Transition Tax which resulted from a higher utilization of foreign tax credits due to a change in the calculation method. Without consideration of discrete adjustments, our effective tax rate would have been 41.5% for the year endedSeptember 30, 2019 and 28.4% for the year endedSeptember 30, 2018 . The increase of our effective tax rate without consideration of discrete adjustments reflects the impact of deemed income inclusion of certain foreign earnings and changes to the foreign tax credit provisions as a result of the Tax Act. 40 --------------------------------------------------------------------------------
Equity Method Investment Impairment Charge
Our APAC segment has an investment in a joint venture inChina for which we apply the equity method of accounting. During the three months endedJune 30, 2019 , we recorded a$3.0 million impairment resulting from a decline in the carrying value of this investment, which was determined to be other than temporary in nature. See further discussion of this impairment under "-Equity Method Investment " section above and in Note 2 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K. As ofSeptember 30, 2019 , we did not identify any events or circumstances which would indicate a further decline in the fair value of our equity method investment that is other than temporary.
Net Income (Loss)
We reported net income of$21.4 million for the year endedSeptember 30, 2019 , compared to$32.7 million for the year endedSeptember 30, 2018 . The decrease of$11.3 million in net income primarily reflects a current year increase in SG&A expenses of$30.9 million ,$3.0 million equity method investment impairment charge, an increase in interest expense of$2.1 million and$0.8 million increase in other expense, net, and a decrease in gross profit of$0.1 million , partially offset by a lower income tax provisions of$25.7 million and, as discussed above.
Year ended
Consolidated net sales increased$141.0 million , or 9.9%, to$1,570.5 million for the year endedSeptember 30, 2018 compared with$1,429.4 million for the year endedSeptember 30, 2017 . The$141.0 million increase reflects growth in chemical product sales, ad hoc sales and hardware Contract sales. Chemical product sales and hardware Contract sales together added$91.4 million of net sales and reflect both new business and a net increase for existing Contracts, partially offset by declines from Contract expirations. Ad hoc sales were also higher, increasing$49.6 million when compared with the prior year, reflecting growth at several key customers. Ad hoc and Contract sales as a percentage of net sales represented 24% and 76%, respectively, for 2018, which was unchanged from the prior year. The$141.0 million increase in net sales included$16.9 million from end-of-contract related sales.
Income (Loss) from Operations
Consolidated income from operations was$109.5 million for the year endedSeptember 30, 2018 compared with a$208.8 million loss from operations for the year endedSeptember 30, 2017 . The increase in income from operations resulted primarily from a prior year non-cash goodwill impairment charge of$311.1 million recorded in the three months endedJune 30, 2017 . Excluding the goodwill impairment charge, income from operations increased$7.1 million compared with the prior year. The$7.1 million increase is comprised of higher gross profit of$41.2 million which was partially offset by an increase in SG&A expenses of$34.1 million . Excluding the prior year goodwill impairment charge, income from operations as a percentage of net sales was 7.0% for the year endedSeptember 30, 2018 compared to 7.2% for the prior year.
The increase in gross profit was primarily driven by the revenue growth described above. Average gross margins increased 0.4 percentage points, primarily due to higher margins on ad hoc sales and a stronger sales mix, partially offset by lower margins on chemical product sales, compared with the prior year.
The$34.1 million increase in SG&A expenses largely reflected increases in payroll and other personnel related costs of$15.5 million and professional fees of$15.9 million . The higher payroll and other personnel related costs were due in part to increased staffing in the second half of fiscal 2017 to implement new Contracts and to improve overall service to customers. Higher professional fees primarily reflect costs for outside consultants supporting the execution of the Company's Wesco 2020 initiative. Higher SG&A costs are reflected in a 0.5 percentage points increase in SG&A measured as a percent of net sales.
Interest Expense, Net
Interest expense, net was$48.9 million for the year endedSeptember 30, 2018 , which increased$9.1 million , compared to the year endedSeptember 30, 2017 . The increase was primarily due to both higher short-term borrowings and interest rates, partially offset by a lower amortization of deferred debt issuance costs when compared with the prior year which included a$2.3 million write-off of deferred debt issuance costs. 41
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(Provision) Benefit for Income Taxes
The income tax provision was$28.0 million for the year endedSeptember 30, 2018 , compared to the income tax benefit of$10.9 million for the year endedSeptember 30, 2017 . For the year endedSeptember 30, 2017 , we recorded a consolidated pre-tax loss of$248.2 million which resulted in an income tax benefit yielding an effective tax rate of 4.4%. For the year endedSeptember 30, 2018 , our effective tax rate was 46.1%. The 41.7 percentage point change of the effective tax rate compared to the same period in the prior year resulted primarily from (1) a$311.1 million goodwill impairment charge, a portion of which is permanently not deductible for tax purposes resulting in a lower income tax benefit and (2) the establishment of a$15.1 million valuation allowance with respect to deferred tax assets for foreign tax credits resulting in a lower income tax benefit, both of which occurred during the year endedSeptember 30, 2017 as well as (3) an unfavorable provisional tax adjustment related to the enactment of the Tax Act which occurred during the year endedSeptember 30, 2018 . The difference in effective tax rates between years was partially offset in the current year by a decrease of theU.S. federal statutory tax rate from 35% to 21% related to the enactment of the Tax Act. The tax rate change became effective as ofJanuary 1, 2018 and therefore favorably impacts only a portion of our fiscal year endingSeptember 30, 2018 .
Net Income (Loss)
We reported net income of$32.7 million for the year endedSeptember 30, 2018 , compared to a net loss of$237.3 million for the year endedSeptember 30, 2017 . The increase in net income primarily reflects the goodwill impairment charge of$311.1 million in 2017, as well as a current year increase in gross profit of$41.2 million , partially offset by current year increases in SG&A expenses of$34.1 million , interest expense of$9.1 million and the provision for income taxes, as discussed above. Americas Segment Years Ended September 30, Americas Results of Operations 2019 2018 2017 (dollars in thousands) Net sales$ 1,384,675 $ 1,271,893 $ 1,142,366 Gross profit 340,692 329,828 284,285
Selling, general & administrative expenses 223,453 200,920
189,383 Goodwill impairment charge - - 308,403 Income (loss) from operations$ 117,239 $ 128,908 $ (213,501 ) (as a percentage of net sales, numbers rounded) Gross profit 24.6 % 25.9 % 24.9 % Selling, general & administrative expenses 16.1 % 15.8 % 16.6 % Goodwill impairment charge - % - % 27.0 % Income (loss) from operations 8.5 % 10.1 % (18.7 )%
Year ended
Net sales for ourAmericas segment increased$112.8 million , or 8.9%, to$1,384.7 million for the year endedSeptember 30, 2019 , compared with$1,271.9 million for the year endedSeptember 30, 2018 . The$112.8 million increase reflects growth across all product groups including chemicals, ad hoc hardware and Contract hardware sales. For the year endedSeptember 30, 2019 , sales increased$67.2 million ,$30.5 million and$15.1 million for chemical, ad hoc hardware and Contract hardware, respectively. In addition, approximately$9.6 million of the$112.8 million net sales increase in the current year represents higher revenue from end-of-contract related sales compared with the prior year. 42 --------------------------------------------------------------------------------
Income (Loss) from Operations
Income from operations for ourAmericas segment for the year endedSeptember 30, 2019 was$117.2 million compared with$128.9 million for the year endedSeptember 30, 2018 , a decrease of$11.7 million . The$11.7 million decrease resulted from an increase in SG&A expenses of$22.5 million , partially offset by higher gross profit of$10.9 million . Income from operations as a percentage of net sales was 8.5% for the year endedSeptember 30, 2019 compared with 10.1% for the year endedSeptember 30, 2018 . The$10.9 million increase in gross profit reflects the result of sales increases, partially offset by a decline in gross margin. A gross margin decline of 1.3 percentage points reflects lower margins on ad hoc hardware and Contract hardware sales. For ad hoc sales of hardware products, lower current year margins reflect more aggressive pricing to gain sales volume. For Contract hardware sales, margins on end-of-contract related sales were significantly higher in the prior year. In addition, there was a shift in product mix towards lower margin chemical and certain contracted hardware sales during the current year. The overall gross profit was impacted by$15.4 million of lower net write-downs to net realizable value for excess and obsolete inventory, largely offset by higher shrinkage and spoilage inventory adjustments of$14.1 million , for the year endedSeptember 30, 2019 compared with the prior year. The shrinkage and spoilage typically is recorded as a normal part of our business. However,$13.0 million of the total charge recorded in 2019 resulted from the Wesco 2020 initiative focused on warehouse consolidation. The$22.5 million increase in SG&A expenses largely reflects increases in payroll and other personnel related costs of$18.4 million , building and equipment costs of$3.5 million , professional fees of$0.4 million and marketing and travel expense of$1.2 million . Increases in these areas primarily were driven by investments to execute Wesco 2020 initiatives and personnel-related costs to support revenue growth. Wesco 2020 related costs totaled$15.5 million in fiscal 2019. The majority of the increase is the result of execution steps that have a defined end point. Key examples include professional fees for consulting support, duplicative staffing costs required during transition and consolidation of single product warehouses into multi-product service centers, severance expense and project performance incentives. Partially offsetting these higher costs were savings achieved through Wesco 2020 initiatives of approximately$8.9 million in the year endedSeptember 30, 2019 . SG&A as a percent of net sales increased 0.3 percentage points.
Year ended
Net sales for ourAmericas segment increased$129.5 million , or 11.3%, to$1,271.9 million for the year endedSeptember 30, 2018 , compared with$1,142.4 million for the year endedSeptember 30, 2017 . The$129.5 million increase was due primarily to an increase in ad hoc sales, chemical product sales and hardware Contract sales, and$16.9 million from end-of-contract related sales.
Income (Loss) from Operations
Income from operations for ourAmericas segment for the year endedSeptember 30, 2018 was$128.9 million compared with a$213.5 million loss from operations for the year endedSeptember 30, 2017 . The increase in income from operations reflects primarily a prior year non-cash goodwill impairment charge of$308.4 million . Excluding the prior year goodwill impairment charge, income from operations increased$34.0 million compared with the prior year. The$34.0 million increase is comprised of higher gross profit of$45.5 million which was partially offset by an increase in SG&A expenses of$11.5 million . Income from operations as a percentage of net sales was 10.1% for the year endedSeptember 30, 2018 , compared with 8.3% for the year endedSeptember 30, 2017 excluding the goodwill impairment charge. The$45.5 million increase in gross profit was primarily driven by increases in ad hoc, hardware Contract and chemical product sales compared with the prior year. Average gross margins increased 1.0 percentage point, due primarily to higher margins for ad hoc and hardware Contract sales, offset partially by lower margins for chemical product sales, compared with the same period in the prior year. The$11.5 million increase in SG&A expenses reflected increases in payroll and other personnel related costs of$11.9 million , bad debt expense of$0.7 million and depreciation expense of$0.7 million . These increases were partially offset by lower stock-based compensation expense of$0.3 million , IT related costs of$0.2 million , integration costs of$0.5 million and marketing and travel costs of$0.5 million . The increase in payroll and other personnel related costs was due in part to increased staffing required to implement new Contracts and improve overall service to customers. SG&A as a percent of net sales declined 0.8 percentage points. 43 --------------------------------------------------------------------------------
EMEA Segment
Years Ended September 30,
EMEA Results of Operations 2019 2018 2017
(dollars in thousands)
Net sales $ 260,617 $ 262,087 $ 258,072
Gross profit 51,401 $ 64,499 70,209
Selling, general & administrative expenses 49,622 46,573 45,071
Income from operations $ 1,779 $ 17,926 $ 25,138
(as a percentage of net sales, numbers rounded)
Gross profit 19.7 % 24.6 % 27.2 %
Selling, general & administrative expenses 19.0 % 17.8 % 17.5 %
Income from operations 0.7 % 6.8 % 9.7 %
Year ended
Net sales for our EMEA segment decreased$1.5 million , or 0.6%, to$260.6 million for the year endedSeptember 30, 2019 , compared with$262.1 million for the year endedSeptember 30, 2018 . For the year endedSeptember 30, 2019 , sales declined$5.3 million and$1.6 million for ad hoc hardware and chemical, respectively, partially offset by an increase in Contract hardware sales of$5.4 million , compared with the prior year. The$1.5 million decrease primarily reflects unfavorable pricing and a decline in ad hoc hardware sales volume, and to lesser degree, chemical product sales volume. The chemical sales volume decline was caused primarily by temporary execution issues.
Income from Operations
Income from operations for our EMEA segment declined$16.1 million , or 90.1%, to$1.8 million for the year endedSeptember 30, 2019 , compared to$17.9 million for the year endedSeptember 30, 2018 . The$16.1 million decline in income from operations was comprised of a decline in gross profit of$13.1 million and an increase in SG&A expenses of$3.0 million . Income from operations as a percentage of net sales was 0.7% for the year endedSeptember 30, 2019 , compared to 6.8% for the year endedSeptember 30, 2018 , a decrease of 6.1 percentage points. The$13.1 million decline in gross profit was primarily driven by lower ad hoc hardware sales volume and chemical sales volume as well as a gross margin decline on hardware Contract sales, chemical sales and ad hoc hardware sales compared with the same period in the prior year. Average gross margins declined 4.9 percentage points primarily reflecting more aggressive pricing for hardware products including for certain Contract renewals, the impact of weaker Euro and British Pound exchange rates versus theU.S. Dollar for local currency denominated business primarily related to chemical sales, a higher volume of chemical pass-through revenues, higher logistics costs for certain chemicals Contracts, and higher shrinkage and spoilage inventory adjustment, partially offset by lower E&O inventory write-downs to net realizable value. The$3.0 million increase in SG&A expenses primarily reflects increases in professional fees of$1.8 million , warehouse-related expense incurred to dispose of expired chemicals of$0.4 million , travel expense of$0.3 million , and depreciation expense of$0.4 million . Increases in these areas primarily were driven by investments to execute Wesco 2020 initiatives. Wesco 2020 related costs totaled$3.5 million in the year endedSeptember 30, 2019 . The majority of the increase is the result of execution steps that have a defined end point. Key examples include professional fees for consulting support, duplicative staffing costs required during transition and consolidation of single product warehouses into multi-product service centers, severance expense and project performance incentives. Partially offsetting these higher costs were savings achieved through Wesco 2020 initiatives of approximately$2.2 million in the year endedSeptember 30, 2019 . SG&A as a percent of net sales increased 1.2 percentage points. 44 --------------------------------------------------------------------------------
Year ended
Net sales for our EMEA segment increased$4.0 million , or 1.6%, to$262.1 million for the year endedSeptember 30, 2018 , compared with$258.1 million for the year endedSeptember 30, 2017 . The$4.0 million increase reflects higher chemical product sales, partially offset by a decline in Ad hoc sales and hardware Contract sales.
Income from Operations
Income from operations for our EMEA segment declined$7.2 million , or 28.7%, to$17.9 million for the year endedSeptember 30, 2018 , compared to$25.1 million for the year endedSeptember 30, 2017 . The$7.2 million decline in income from operations was comprised of a decrease in gross profit of$5.7 million and an increase in SG&A expenses of$1.5 million . Income from operations as a percentage of net sales was 6.8% for the year endedSeptember 30, 2018 , compared to 9.7% for the year endedSeptember 30, 2017 , a decrease of 2.9 percentage points. The$5.7 million decline in gross profit was primarily driven by lower Contracts sales of hardware products and a weaker sales mix compared with the prior year. Average gross margins declined 2.6 percentage points, due primarily to a weaker sales mix and lower margins for hardware Contract sales and chemical product sales compared with the prior year. The$1.5 million increase in SG&A expenses primarily reflects a negative$1.8 million impact resulting from strengthening of the British Pound vs. theU.S. dollar. Excluding the exchange rate impact of$1.8 million , SG&A decreased slightly compared to the prior year, primarily driven by decreases in marketing and travel expenses of$0.5 million , bad debt expense of$0.7 million , partially offset by increases in payroll and other people costs of$1.1 million . APAC Segment Years Ended September 30, APAC Results of Operations 2019 2018 2017 (dollars in thousands) Net sales$ 51,158 $ 36,470 $ 28,991 Gross profit 11,000 8,829 7,413 Selling, general & administrative expenses 6,420 6,812 4,874 Goodwill impairment charge - - 2,711 Income (loss) from operations$ 4,580 $ 2,017 $ (172 ) (as a percentage of net sales, numbers rounded) Gross profit 21.5 % 24.2 % 25.6 % Selling, general & administrative expenses 12.5 % 18.7 % 16.8 % Goodwill impairment charge - % - % 9.4 % Income (loss) from operations 9.0 % 5.5 % (0.6 )%
Year ended
Net sales for our APAC segment increased$14.7 million , or 40.3%, to$51.2 million for the year endedSeptember 30, 2019 , compared with$36.5 million for the year endedSeptember 30, 2018 . For the year endedSeptember 30, 2019 , sales increased$7.4 million ,$4.3 million and$3.0 million for Contract hardware, chemical and ad hoc hardware, respectively. The increase reflects volume increases in Contract hardware sales, chemical sales and ad hoc hardware sales, compared with the prior year, partially offset by decreases in pricing of ad hoc hardware sales.
Income (Loss) from Operations
45
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Income from operations of our APAC segment for the year ended September 30, 2019
was $4.6 million compared with $2.0 million for the prior year. The $2.6 million
increase in income from operations was primarily due to an increase in gross
profit of $2.2 million and a decrease in SG&A expenses of $0.4 million . Income
from operations as a percentage of net sales increased 3.5 percentage points
compared with the same period in the prior year.
The $2.2 million increase in gross profit was primarily driven by increases in
hardware Contract sales, chemical sales and ad hoc hardware sales compared with
the same period in the prior year. Average gross margins declined 2.7 percentage
points due primarily to a weaker sales mix and lower margins for ad hoc hardware
sales, partially offset by higher margins for hardware Contract sales and
chemical sales compared with the prior year.
The $0.4 million decrease in SG&A expenses was due primarily to decreases in
payroll and other personnel related costs of $0.9 million , partially offset by
an increase in other SG&A expenses of $0.5 million , reflecting investment made
to grow the business in this region. SG&A as a percent of net sales decreased
6.2 percentage points.
Year ended
Net sales for our APAC segment increased$7.5 million , or 25.8%, to$36.5 million for the year endedSeptember 30, 2018 , compared with$29.0 million for the year endedSeptember 30, 2017 . The increase primarily reflects increases in ad hoc sales, hardware Contract sales and chemical product sales.
Income (Loss) from Operations
Income from operations of our APAC segment for the year endedSeptember 30, 2018 was$2.0 million compared with a$0.2 million of loss from operations for the same period in the prior year. The$2.2 million increase in income from operations primarily resulted from a non-cash goodwill impairment charge of$2.7 million recorded for the three months endedJune 30, 2017 . Excluding the prior year's goodwill impairment charge of$2.7 million , income from operations declined$0.5 million when compared with the prior year. Gross profit increased$1.4 million , which was more than offset by an increase in SG&A expenses of$1.9 million . Excluding the prior year's goodwill impairment charge, income from operations as a percentage of net sales declined 3.3 percentage points compared with the prior year. The$1.4 million increase in gross profit was primarily driven by increases in ad hoc sales and hardware Contract sales and a lower E&O provision, partially offset by lower chemical product sales compared with the prior year. Average gross margins declined 1.4 percentage points due primarily to lower gross margins in ad hoc sales, hardware Contract sales and chemical product sales, offset partially by a stronger sales mix and a lower E&O provision, compared with the prior year. The$1.9 million increase in SG&A expenses was due primarily to increases in payroll and other personnel related costs of$1.1 million and building and equipment related expenses of$0.6 million as part of our growth in the APAC region. SG&A as a percent of net sales increased 1.9 percentage points. Unallocated Corporate Costs Selling, General and Administrative Expenses Unallocated Years Ended September 30, Americas EMEA APAC
Corporate Costs Consolidated
2019 $ 223,453 $ 49,622 $ 6,420 $ 45,086 $ 324,581
2018 200,920 46,573 6,812 39,383 293,688
2017 189,383 45,071 4,874 20,260 259,588
SG&A expenses for the
Year ended
Unallocated corporate costs were$5.7 million higher than the prior year, primarily driven by an increase in professional fees of$6.1 million , partially offset by decreases in payroll and other personnel related costs of$0.4 million . Unallocated costs included$16.6 million of Wesco 2020 costs in the year endedSeptember 30, 2019 compared to$17.8 million 46 -------------------------------------------------------------------------------- for the prior year. Total SG&A expenses related to Wesco 2020 initiatives were$35.6 million for the year endedSeptember 30, 2019 , of which$15.5 million was allocated to theAmericas segment,$3.5 million was allocated to the EMEA segment and$16.6 million was included in the unallocated corporate costs. Professional fees were$28.3 million for the year endedSeptember 30, 2019 as compared to$22.2 million for the period year, an increase of$6.1 million due primarily to$8.2 million professional fee costs related to the Merger, partially offset by a decrease of$2.1 million in other professional fees. See Note 1 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion about the Merger.
Year ended
Unallocated corporate costs were$19.1 million higher than the prior year, primarily driven by increases in professional fees of$15.9 million mainly reflecting costs for outside consultants assisting with the Company's Wesco 2020 initiative, stock-based compensation expense of$2.3 million , and payroll and other personnel related costs of$0.3 million .
Liquidity and Capital Resources
Overview
Our primary sources of liquidity are cash flow from operations and available borrowings under our revolving facility. We have historically funded our operations, debt payments, capital expenditures and discretionary funding needs from our cash from operations. We had total available cash and cash equivalents of$38.0 million and$46.2 million as ofSeptember 30, 2019 and 2018, respectively, of which$20.3 million , or 53.4%, and$21.3 million , or 46.1%, was held by our foreign subsidiaries as ofSeptember 30, 2019 and 2018, respectively. None of our cash and cash equivalents consisted of restricted cash and cash equivalents as ofSeptember 30, 2019 or 2018. All of our foreign cash and cash equivalents are readily convertible intoU.S. dollars or other foreign currencies.
Our primary uses of cash currently are for:
• operating expenses;
• working capital requirements to fund the growth of our business;
• capital expenditures that primarily relate to IT equipment, software
development and implementation and our warehouse operations; and
• debt service requirements for borrowings under the Credit Facilities
(as defined below under "-Credit Facilities").
Generally, cash provided by operating activities has been adequate to fund our operations. Due to fluctuations in our cash flows, including for investment in working capital to fund growth in our operations, it is necessary from time to time to borrow under our revolving facility to meet cash demands. Provided we are in compliance with applicable covenants, we can borrow up to$180.0 million on our revolving credit facility, of which$173.0 million was available as ofSeptember 30, 2019 . We anticipate that cash provided by operating activities, cash and cash equivalents and borrowing capacity under our revolving facility will be sufficient to meet our cash requirements for the next twelve months. For additional information about our revolving facility, see "-Credit Facilities" below. As ofSeptember 30, 2019 , we did not have any material capital expenditure commitments.
Cash Flows
Our cash and cash equivalents decreased by$8.2 million during the year endedSeptember 30, 2019 . The decrease primarily reflects our focus to reduce cash balances while we have borrowings under our revolving facility. 47 --------------------------------------------------------------------------------
A summary of our operating, investing and financing activities are shown in the following table (in thousands):
Years Ended September 30,
Consolidated statements of cash flows data: 2019 2018 2017
Net Income (loss)$ 21,369 $ 32,654 $ (237,346 ) Adjustments to reconcile net income (loss) to net cash provided by operating activities: 53,605 69,753
346,433
Subtotal 74,974 102,407
109,087
Changes in working capital assets and liabilities 11,398 (84,539 ) (136,015 ) Net cash provided by (used in) operating activities 86,372 17,868
(26,928 )
Net cash used in investing activities (21,121 ) (5,666 )
(8,923 )
Net cash (used in) provided by financing activities (73,104 ) (27,144 )
20,645
Effect of foreign currency exchange rate on cash and cash equivalents (335 ) (461 ) (230 ) Net decrease in cash and cash equivalents$ (8,188 ) $ (15,403 ) $ (15,436 ) Operating Activities Our cash flows from operations fluctuates based on the level of profitability during the period as well as the timing of investments in inventory, collections of cash from our customers, payments of cash to our suppliers, and the timing of cash payments or receipts associated with other working capital accounts such as changes in our prepaid expenses and accrued liabilities or the timing of our tax payments.
Year ended
Our operating activities generated$86.4 million of cash in the year endedSeptember 30, 2019 , an increase of$68.5 million as compared to the year endedSeptember 30, 2018 . The$68.5 million increase in net cash provided by operating activities reflects a series of year-over-year differences reflected in working capital changes which increased cash provided by operations for$95.9 million , partially offset by a$27.4 million decrease in cash provided from net income excluding non-cash items. Comparing 2019 to 2018, the key working capital changes include: • a$92.5 million favorable change as a result of lower cash used for inventory due to improved inventory management, • a$40.4 million favorable difference in the change for accounts payable due to the timing of payments and accruals,
• a
largely driven by the timing of collections along with increased sales,
• a $12.7 million unfavorable impact due to a change in accrued expenses
and other liabilities as a result of the timing of accruals and actual
payments, $8.2 million of which was for professional fees related to
the Merger (see Note 1 of the Notes to the Consolidated Financial
Statements in Part II, Item 8 of this Annual Report on Form 10-K for
further discussion about the Merger),
• a $5.8 million unfavorable difference in the change in prepaid expenses
and other assets, and
• a net
income taxes receivable.
Year ended
Our operating activities generated$17.9 million of cash in the year endedSeptember 30, 2018 , an increase of$44.8 million as compared to the year endedSeptember 30, 2017 . The increase in net cash provided by operating activities of$44.8 million reflects a$6.7 million decline in cash provided from net income excluding non-cash items, which was more than offset by a series of year-over-year differences reflected in balance sheet changes reducing cash used for operations by$51.5 million . 48 --------------------------------------------------------------------------------
Investing Activities
Our investing activities used$21.1 million ,$5.7 million and$8.9 million of cash in the years endedSeptember 30, 2019 , 2018 and 2017, respectively. Investing activities consist primarily of software development and implementation and the purchase of property and equipment related to Wesco 2020 initiatives. Financing Activities Our financing activities used$73.1 million of cash in the year endedSeptember 30, 2019 , which consisted of a net$48.0 million reduction of borrowings under our revolving credit facility ($143.0 million repayment and$95.0 million of borrowings) and$20.0 million repayments of our long-term debt,$2.9 million for repayments of our capital lease obligations and a$2.2 million settlement for restricted stock tax withholding. Our financing activities used$27.1 million of cash in the year endedSeptember 30, 2018 consisted of a net$1.0 million reduction of borrowings under our revolving credit facility ($68.5 million repayment and$67.5 million of borrowings) and$20.0 million repayments of long-term debt,$3.0 million for repayments of our capital lease obligations, a$1.9 million payment for debt issuance costs and a$1.3 million settlement for restricted stock tax withholding. Our financing activities generated$20.6 million of cash in the year endedSeptember 30, 2017 , which consisted primarily of$55.0 million of short-term borrowings and$3.0 million of proceeds received in connection with the exercise of stock options, partially offset by$21.3 million for repayments of our long-term debt,$2.1 million for repayments of our capital lease obligations and a$12.8 million payment for debt issuance costs.
Credit Facilities
The credit agreement, dated as ofDecember 7, 2012 (as amended, the Credit Agreement), by and among the Company,Wesco Aircraft Hardware Corp. and the lenders and agents party thereto, which governs our senior secured credit facilities, provides for (1) a$400.0 million senior secured term loan A facility (the term loan A facility), (2) a$180.0 million revolving facility (the revolving facility) and (3) a$525.0 million senior secured term loan B facility (the term loan B facility). We refer to the term loan A facility, the revolving facility and the term loan B facility, together, as the "Credit Facilities." See Note 11 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for a summary of the Credit Facilities and the Credit Agreement. As ofSeptember 30, 2019 , our outstanding indebtedness under our Credit Facilities was$786.6 million , which consisted of (1)$340.0 million of indebtedness under the term loan A facility, (2)$440.6 million of indebtedness under the term loan B facility, and (3)$6.0 million of indebtedness under the revolving facility. As ofSeptember 30, 2019 ,$173.0 million was available for borrowing under the revolving facility to fund our operating and investing activities under the terms and any covenants contained in the Credit Agreement. The term loan B facility amortizes in equal quarterly installments of 0.25% of the original principal amount of$525.0 million , with the balance due at maturity onFebruary 28, 2021 . We have paid in advance all the required quarterly installments until the term loan B reaches its maturity. The term loan A facility amortizes in equal quarterly installments of 1.25% of the original principal amount of$400.0 million with the balance due on the earlier of (1) 90 days before the maturity of the term loan B facility, and (2)October 4, 2021 . The revolving facility expires on the earlier of (1) 90 days before the maturity of the term loan B facility, and (2)October 4, 2021 . In the event the Merger Agreement is terminated, we may need to refinance our outstanding indebtedness under our Credit Facilities or take other actions in advance of these maturity dates to allow us to service our debt. See Part I, Item 1A. "Risk Factors-Risks Related to Our Business and Industry-Our substantial indebtedness could adversely affect our financial health and could harm our ability to react to changes to our business." As disclosed in Note 11 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K, our borrowings under the Credit Facilities are subject to a financial covenant based upon our Consolidated Total Leverage Ratio, with the maximum ratio set at 4.75 for the quarter endedSeptember 30, 2019 . As ofSeptember 30, 2019 , we were in compliance with the financial covenant as our Consolidated Total Leverage Ratio was 3.86. As also disclosed in Note 11 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K, the Excess Cash Flow Percentage (as such term is defined in the Credit Agreement) is 75%, provided that the Excess Cash Flow Percentage shall be reduced to (1) 50%, if the Consolidated Total Leverage Ratio is less than 4.00 but greater than or equal to 3.00, (2) 25%, if the Consolidated Total Leverage Ratio is less than 3.00 but greater than or equal to 2.50, and (3) 0%, if the Consolidated Total Leverage Ratio is less than 2.50. Based on full year results for the year endedSeptember 30 , 49 -------------------------------------------------------------------------------- 2019, we expect there will be a requirement to make a prepayment under the Excess Cash Flow requirement as defined in the Credit Agreement if the Credit Facilities have not been terminated as related to the Merger or otherwise. The payment is currently estimated to be approximately$30.1 million and will be required byFebruary 24, 2020 . In accordance with the terms of the Credit Agreement, we will make a final determination of the Excess Cash Flow payment byFebruary 5, 2020 . The finally determined payment is not expected to exceed the current estimate of$30.1 million and may be less than$30.1 million . The Excess Cash Flow payment can be funded out of the revolving facility which we believe will have adequate available borrowing capacity to make such payment. See Note 1 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion about the Merger. The Credit Agreement also contains customary negative covenants, including restrictions on our and our restricted subsidiaries' ability to merge and consolidate with other companies, incur indebtedness, grant liens or security interests on assets, make acquisitions, loans, advances or investments, pay dividends, sell or otherwise transfer assets, optionally prepay or modify terms of any junior indebtedness or enter into transactions with affiliates. As ofSeptember 30, 2019 , we were in compliance with all of the foregoing covenants. A breach of the Consolidated Total Leverage Ratio covenant or any of other covenants contained in the Credit Agreement could result in an event of default in which case the lenders may elect to declare all outstanding amounts to be immediately due and payable. If the debt under the Credit Facilities were to be accelerated, our available cash would not be sufficient to repay our debt in full. Contractual Obligations
The following table is a summary of contractual cash obligations at
Payments Due by Period
Total < 1 Year 1 - 3 Years 3 - 5 Years > 5 Years
Long-term debt obligations
(1) $ 827,992 $ 86,828 $ 741,164 $ - $ -
Borrowings under the
revolving facility (2) 7,137 7,015 122 - -
Capital lease obligations 2,584 1,600 860 124 -
Operating lease obligations 104,776 13,973 20,010 14,134 56,659
Total by period 942,489 $ 109,416 $ 762,156 $ 14,258 $ 56,659
Other long-term liabilities
(uncertainty in the timing
of future payments) (3) 1,584
Total (4) $ 944,073 (1) Includes both principal and estimated variable interest expense payments. The
interest rate used to calculate the estimated future variable interest
expense is based on the actual interest rate applicable to the Company's
indebtedness as of
facility and 4.55% for the term loan B facility. The actual variable interest
expense paid by the Company in the future may vary from what is presented
above. Investors should refer to the "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital
Resources-Credit Facilities" and "Quantitative and Qualitative Disclosures
About Market Risk-Interest Rate Risk" for additional information.
(2) Includes both principal, estimated variable interest expense payments and
estimated undrawn fees. The interest rate used to calculate the estimated
future variable interest expense is based on the weighted-average actual
interest rate of 5.04% applicable to the Company's borrowings under the
revolving facility as of
expense paid by the Company in the future may vary from what is presented
above. Investors should refer to the "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital
Resources-Credit Facilities" and "Quantitative and Qualitative Disclosures
About Market Risk-Interest Rate Risk" for additional information.
(3) Other long-term liabilities include long-term hedge liabilities. Due to the
uncertainty in the timing of future payments, long-term hedge liabilities of
approximately
total column on a separate line in this table.
50--------------------------------------------------------------------------------
(4) In addition to the contractual obligations noted in the table below, the
Company may issue purchase orders to suppliers in the ordinary course of
business to purchase inventory in advance of expected delivery at lead-times
that vary based on a variety of factors specific to individual suppliers and
circumstances. As of
million of these open purchase orders that are not included in the table
below. In most cases, open purchase orders for products that have not yet
entered the supplier's production process can be cancelled without incurring
significant termination fees or other penalties. For industry standard
products, once production has begun, cancellation of an open purchase order
may require payment of a termination fee or other adjustments to the pricing
of the uncancelled portion of the applicable order which generally are
insignificant in amount and typically subject to negotiation. For proprietary
products, a cancellation fee may apply or we may be required to pay up to the
full purchase price for the cancelled product if we cancel after the start of
the production process. However, in many cases, our customers are
contractually obligated to pay the costs associated with the cancellation of
such proprietary parts.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements.
Recently Issued and Adopted Accounting Pronouncements
See Note 3 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for a summary of recently issued and adopted accounting pronouncements.
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