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UNITED STATIONERS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act. Forward-looking statements often contain words such as "expects," "anticipates," "estimates," "intends," "plans," "believes," "seeks," "will," "is likely," "scheduled," "positioned to," "continue," "forecast," "predicting," "projection," "potential" or similar expressions. Forward-looking statements include references to goals, plans, strategies, objectives, projected costs or savings, anticipated future performance, results or events and other statements that are not strictly historical in nature. These forward-looking statements are based on management's current expectations, forecasts and assumptions. This means they involve a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied here. These risks and uncertainties include, without limitation, those set forth in "Item 1A. Risk Factors" in the Company's Annual Report on Form 10-K for the year-ended December 31, 2013. Readers should not place undue reliance on forward-looking statements contained in this Quarterly Report on Form 10-Q. The forward-looking information herein is given as of this date only, and the Company undertakes no obligation to revise or update it. Company Background United is a leading wholesale distributor of business products with 2013 net sales of approximately $5.1 billion. United stocks over 140,000 items from over 1,600 manufacturers. These items include a broad spectrum of manufacturer-branded and private brand technology products, traditional office products, office furniture, janitorial and breakroom supplies, and industrial supplies. United 15 -------------------------------------------------------------------------------- Table of Contents sells its products through a network of 65 distribution centers to its approximately 25,000 reseller customers, who in turn sell directly to end-consumers. The Company's customers include independent office products dealers; contract stationers; office products superstores; computer products resellers; office furniture dealers; mass merchandisers; mail order companies; sanitary supply, paper and foodservice distributors; drug and grocery store chains; healthcare distributors; e-commerce merchants; oil field, welding supply and industrial/MRO distributors; and other independent distributors. Additionally, newly acquired CPO Commerce, LLC ("CPO") is an e-retailer of brand name power tools and equipment who sells directly to end consumers. Overview of Strategy, Key Trends and Recent Results • Our strategy is comprised of three key initiatives: 1) strengthen our core business, including driving efficiency and cost improvements, 2) win the shift to online, and 3) diversify our offering of higher margin and higher growth channels and categories, such as janitorial and breakroom and industrial products. • We are repositioning United to become the premier supplier of digitally sourced business essentials by combining our office products and janitorial operating platforms. We believe this effort will help us become the most effective source for our customers' business essentials through our nationwide distribution network and logistics capabilities, order efficiency with enhanced ebusiness capabilities, broad product portfolio, and superior product category knowledge and commercial expertise. We have piloted this project with several customers and are receiving good feedback. • Online product procurement by end-consumers continues to gain a larger share of the markets our reseller customers serve. We continue to invest in digital and online capabilities and work with leading online resellers to help accelerate their growth in the categories we offer. Our business model allows these resellers to quickly enter new categories and scale their offerings. • During the quarter we acquired CPO, a leading e-retailer of brand name power tools and equipment, for a total cash purchase price of $42.2 million which assumes the full $10.0 million of contingent consideration will be paid by the end of the earn-out period. This transaction significantly expands United's digital resources and capabilities to support resellers as they transition to an increasingly online environment. CPO's expertise will strengthen United's ability to deliver such features as improved product content, real-time access to inventory and pricing, and digital marketing and merchandising. CPO also provides an enhanced digital platform to our manufacturing partners. We expect this acquisition to positively impact gross margin as a percent of sales (15 bps to 20 bps) and increase operating expenses as a percent of sales (25 bps to 30 bps), and have a slightly dilutive impact on earnings per share during 2014. • As previously detailed in the first quarter, we were named the second-call office products supplier to support Office Depot's office products business as well as the primary supplier for Office Depot's janitorial and breakroom business. These actions will result in the loss of some of our office products business but will bring new janitorial and breakroom business to United. We estimate that these changes will negatively impact net sales in a range of $20.0 million to $30.0 million and EPS in a range of $0.05 to $0.08 in the second half of this year, and net sales by $75.0 million to $90.0 million and a decrease in EPS in a range of $0.14 to $0.22 in 2015, absent any offsetting actions. We are well positioned to mitigate this impact with our robust pipeline and strong service proposition as we pursue sustainable new business to drive growth and profitability. • Diluted earnings per share for the second quarter of 2014 were $0.85, compared with $0.86 in the prior-year period. • Second quarter sales were $1.32 billion, up 3.6% over the prior-year quarter. The sales increase was driven by growth in our janitorial and breakroom category and industrial supplies of 7.5% and 10.8%, respectively, quarter over quarter. • The gross margin rate in the second quarter of 2014 of 15.1% was down from the prior-year quarter gross margin rate of 15.8%. This decline reflects the impact of opportunistic technology sales, investments in our industrial business, and higher freight costs. • Operating expenses in the second quarter of 2014 were $142.2 million or 10.8% of sales, compared with $143.0 million or 11.2% of sales in the prior-year quarter. Operating expenses were down due primarily to lower operating costs across the organization, lower variable management incentive compensation, and an improvement in bad debt expense. We expect operating expenses to be higher in the second half of 2014 than in the prior year due to the impact of the loss of Office Depot sales, the CPO acquisition and favorable items in the prior year. • Operating income for the quarter ended June 30, 2014 was $57.3 million or 4.3% of sales, versus $58.9 million or 4.6% of sales in the second quarter of 2013. 16 -------------------------------------------------------------------------------- Table of Contents For a further discussion of selected trends, events or uncertainties the Company believes may have a significant impact on its future performance, readers should refer to "Key Trends and Recent Results" under Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K for the year-ended December 31, 2013. Critical Accounting Policies, Judgments and Estimates During the first six months of 2014, there were no significant changes to the Company's critical accounting policies, judgments or estimates from those disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Adjusted Operating Income, Net Income and Earnings Per Share The following table presents Adjusted Operating Expenses, Operating Income, Net Income, and Diluted Earnings Per Share for the six-month periods ended June 30, 2014 and 2013 (in thousands, except per share data) excluding the effects of $14.4 million pre-tax charge related to workforce reductions and facility closures in the first quarter of 2013. Generally Accepted Accounting Principles require that the effects of these items be included in the Condensed Consolidated Statements of Income. Management believes that excluding these items is an appropriate comparison of its ongoing operating results to last year. It is helpful to provide readers of its financial statements with a reconciliation of these items to its Condensed Consolidated Statements of Income reported in accordance with Generally Accepted Accounting Principles. For the Six Months Ended June 30, 2014 2013 % to % to Amount Net Sales Amount Net Sales Net Sales $ 2,574,176 100.00 % $ 2,524,979 100.00 % Gross profit $ 386,543 15.02 % $ 390,461 15.46 % Operating expenses $ 291,035 11.31 % $ 306,293 12.13 % Workforce reduction and facility closure charge - - (14,432 ) (0.57 )% Adjusted operating expenses $ 291,035 11.31 % $ 291,861 11.56 % Operating income $ 95,508 3.71 % $ 84,168 3.33 % Operating expense item noted above - - 14,432 0.57 % Adjusted operating income $ 95,508 3.71 % $ 98,600 3.90 % Net income $ 55,188 $ 48,544 Operating expense item noted above, net of tax - 8,948 Adjusted net income $ 55,188 $ 57,492 Diluted earnings per share $ 1.40 $ 1.20 Per share operating expense item noted above - 0.22 Adjusted diluted earnings per share $ 1.40 $ 1.42 Adjusted diluted earnings per share - change over the prior year period (1.4 )% Weighted average number of common shares - diluted 39,435 40,475 Results of Operations-Three Months Ended June 30, 2014 Compared with the Three Months Ended June 30, 2013 Net Sales. Net sales for the second quarter of 2014 were $1.32 billion. The following table summarizes net sales by product category for the three-month periods ended June 30, 2014 and 2013 (in thousands): Three Months Ended June 30, 2014 2013 (1) Technology products $ 367,293 $ 374,252 Janitorial and breakroom supplies 357,882 332,878 Traditional office products (including cut-sheet paper) 330,743 323,923 Industrial supplies 146,571 132,275 17 -------------------------------------------------------------------------------- Table of Contents Three Months Ended June 30, 2014 2013 (1) Office furniture 78,410 76,729 Freight revenue 29,638 25,365 Services, Advertising and Other 9,500 9,072 Total net sales $ 1,320,037 $ 1,274,494 (1) Certain prior period amounts have been reclassified to conform to the current presentation. Such reclassifications include changes between several product categories due to several specific products being reclassified to different categories. These changes did not impact the Condensed Consolidated Statements of Income. Sales in the technology products category (primarily ink and toner) decreased in the second quarter of 2014 by 1.9% versus the second quarter of 2013. This category, which continues to represent the largest percentage of the Company's consolidated net sales, accounted for 27.8% of net sales for the second quarter of 2014. Sales declines in this category mainly resulted from a new distribution policy by our largest product line manufacturer that limits wholesalers to resell products only to certain authorized resellers. This negative impact was partially offset by large purchases by certain large customers during the quarter and the addition of new business to replace volume lost from the new distribution policy. Sales in the janitorial and breakroom supplies product category increased 7.5% in the second quarter of 2014 compared to the second quarter of 2013. This category accounted for 27.1% of the Company's second quarter 2014 consolidated net sales. Sales growth in this category was driven by enhanced product line launches which increased breakroom sales through our traditional channels. Sales of traditional office products grew in the second quarter of 2014 by 2.1% versus the second quarter of 2013. Traditional office supplies represented 25.1% of the Company's consolidated net sales for the second quarter of 2014. Within this category, we saw continued double-digit growth in e-tailers, a rebound in government spending, and growth with certain larger customers that were partially offset by lower sales of cut-sheet paper and the continued effects of workplace digitization which is lowering overall consumption. Industrial supplies sales in the second quarter of 2014 increased by 10.8% compared to the same prior-year period. Sales of industrial supplies accounted for 11.1% of the Company's net sales for the second quarter of 2014. Solid sales momentum in the general industrial channel, double digit growth in the safety and e-commerce channels and a moderate sales increase in the oilfield-pipeline channel were partially offset by the continued decline in the welding channel. The acquisition of CPO contributed $8.2 million in incremental sales which benefited the quarterly growth rate. Office furniture sales in the second quarter of 2014 increased 2.2% compared to the second quarter of 2013. Office furniture accounted for 5.9% of the Company's second quarter of 2014 consolidated net sales. Second quarter sales improved in this category driven by strong direct order sales and increased sales to new channel customers. The remainder of the Company's second quarter 2014 net sales was composed of freight and other revenues. Gross Profit and Gross Margin Rate. Gross profit (gross margin dollars) for the second quarter of 2014 was $199.5 million, compared to $201.9 million in the second quarter of 2013. The gross margin rate of 15.1% was down 70 basis points (bps) from the prior-year quarter gross margin rate of 15.8%. This decline was due primarily from lower product margin (45 bps) which included opportunistic lower margin sales in the technology category and targeted investments in our industrial business, offset by favorable supplier allowances and higher inflation. Gross margin was also unfavorably affected by higher freight costs (15 bps) and a higher LIFO charge (10 bps). Operating Expenses. Operating expenses for the latest quarter were $142.2 million or 10.8% of sales, compared with $143.0 million or 11.2% of sales in the same period last year. Current quarter operating expenses were impacted by savings from decreased variable management incentive compensation (25 bps), bad debt expense (10 bps), and professional services (10 bps). The Company incurred approximately $1.0 million in the quarter related to the initiative to combine the Company's office product and janitorial platforms. Interest Expense, net. Interest expense, net for the second quarter of 2014 was $3.8 million compared to $2.9 million in the second quarter of 2013. This was driven primarily by the issuance of seven-year notes in January 2014, which replaced floating rate debt with long term, fixed rate debt. Income Taxes. Income tax expense was $20.1 million for the second quarter of 2014, compared with $21.4 million for the same period in 2013. The Company's effective tax rate was 37.6% for the current-year quarter and 38.2% for the same period in 2013. 18 -------------------------------------------------------------------------------- Table of Contents Net Income. Net income for the second quarter of 2014 totaled $33.3 million or $0.85 per diluted share, compared with net income of $34.7 million or $0.86 per diluted share for the same three-month period in 2013. Results of Operations-Six Months Ended June 30, 2014 Compared with the Six Months Ended June 30, 2013 Net Sales. Net sales for the first six months of 2014 were $2.57 billion. The following table summarizes net sales by product category for the six-month periods ended June 30, 2014 and 2013 (in thousands): Six Months Ended June 30, 2014 (1) 2013 (1) Technology products $ 720,748 $ 738,740 Janitorial and breakroom supplies 690,607 658,219 Traditional office products (including cut-sheet paper) 655,960 644,060 Industrial supplies 278,067 262,001 Office furniture 153,164 154,425 Freight revenue 58,818 50,674 Services, Advertising and Other 16,812 16,860 Total net sales $ 2,574,176 $ 2,524,979 (1) Certain prior period amounts have been reclassified to conform to the current presentation. Such reclassifications include changes between several product categories due to several specific products being reclassified to different categories. These changes did not impact the Condensed Consolidated Statements of Income. Sales in the technology products category (primarily ink and toner) decreased in the first six months of 2014 by 2.4% versus the first six months of 2013. This category, which continues to represent the largest percentage of the Company's consolidated net sales, accounted for 28.0% of net sales for the first six months of 2014. Sales declines in this category were partially due to a new distribution policy by our largest product line manufacturer that allows wholesalers to resell products only to certain authorized resellers. This negative impact was offset by adding new business to replace volume lost in the transition. Favorable timing of certain opportunistic customer sales and new business additions also contributed to the increase in sales for this category. Sales in the janitorial and breakroom supplies product category increased 4.9% in the first half of 2014 compared to the first half of 2013. This category accounted for 26.8% of the Company's first half of 2014 consolidated net sales. Sales growth in this category was driven by gains in breakroom as we launched an enhanced product line. Sales of traditional office products grew in the first six months of 2014 by 1.8% versus the first six months of 2013. Traditional office supplies represented 25.5% of the Company's consolidated net sales for the first six months of 2014. Within this category, higher sales of cut-sheet paper, continued double-digit growth in sales to e-tailers, and a rebound in government spending were partially offset by the continued effects of workplace digitization which is lowering overall consumption. Industrial supplies sales in the first half of 2014 increased by 6.1% compared to the same prior-year period. Sales of industrial supplies accounted for 10.8% of the Company's net sales for the first six months of 2014. Increases in the general industrial, oilfield-pipeline and safety channels were partially offset by the continued decline in welding. The acquisition of CPO contributed $8.2 million in incremental sales which benefited the growth rate. Office furniture sales in the first six months of 2014 were down 0.8% compared to the first six months of 2013. Office furniture accounted for 6.0% of the Company's first six months of 2014 consolidated net sales. Sales in this category were down slightly due to reduced sales to independent channel dealers and national accounts offset by growth with e-tailer customers. The remainder of the Company's first half of 2014 net sales was composed of freight and other revenues. Gross Profit and Gross Margin Rate. Gross profit (gross margin dollars) for the first six months of 2014 was $386.5 million, compared to $390.5 million in the first six months of 2013. The gross margin rate of 15.0% was down 50 basis points (bps) from the prior-year period gross margin rate of 15.5%. This decline was due primarily to lower product margin (35 bps) which included targeted investments in our industrial business and a shifting product mix compared to the prior-year period, offset by favorable supplier allowances and higher inflation. Gross margin was also unfavorably affected by higher freight costs (10 bps) and higher inventory-related items (5 bps). 19-------------------------------------------------------------------------------- Table of Contents Operating Expenses. Operating expenses for the first half of 2014 were $291.0 million or 11.3% of sales, compared with $306.3 million or 12.1% of sales in the same period last year. Excluding the $14.4 million network optimization and cost reduction charge in the first half of 2013, adjusted operating expenses were $291.9 million or 11.6% of sales in 2013. Current period operating expenses were affected by lower employee-related expenses (20 bps) and a decline in bad debt expense (10 bps), offset by a reversal of previously capitalized purchase, storage and handling costs (5 bps). The Company incurred approximately $2.0 million in the first half of 2014 related to the initiative to combine the Company's office product and janitorial platforms. Interest Expense, net. Interest expense, net for the first six months of 2014 was $7.2 million compared to $6.0 million in the first six months of 2013. This was driven primarily by the issuance of seven-year notes in January 2014 which replaced floating rate debt with long-term, fixed rate debt. Income Taxes. Income tax expense was $33.1 million for the first six months of 2014, compared with $29.7 million for the same period in 2013. The Company's effective tax rate was 37.5% for the current-year period and 37.9% for the same period in 2013. Net Income. Net income for the first six months of 2014 totaled $55.2 million or $1.40 per diluted share, compared with net income of $48.5 million or $1.20 per diluted share for the same six-month period in 2013. Adjusted for the impact of the network optimization and cost reduction charge in the first half of 2013, net income was $57.5 million or $1.42 per diluted share in the prior-year period. Cash Flows The following discussion focuses on information included in the accompanying Condensed Consolidated Statements of Cash Flows. Operating Activities Net cash provided by operating activities for the six months ended June 30, 2014 totaled $78.9 million, compared with $45.3 million in the same six-month period of 2013. The current six-month period cash flow was positively affected by a reduction in inventory levels from December 31, 2013 and increased net income, offset by slightly higher accounts receivables. Additionally in the first quarter of 2013, the Company paid a cash contribution to its pension plans totaling $13.0 million. The cash contribution to the pension plan in the first quarter of 2014 was $2.0 million. Investing Activities Net cash used in investing activities for the first six months of 2014 was $35.6 million, compared to net cash used in investing activities of $13.5 million for the six months ended June 30, 2013. This included the $26.2 million acquisition, net of cash acquired, of CPO in May 2014. For the full year 2014, the Company expects capital spending to be approximately $25.0 million to $30.0 million. Financing Activities Net cash used in financing activities for the six months ended June 30, 2014 totaled $34.1 million, compared with $41.4 million in the prior-year period. Net cash used in financing activities during the first six months of 2014 was impacted by $9.8 million in net borrowings under debt arrangements offset by $31.2 million in share repurchases and $11.0 million in payments of cash dividends. Liquidity and Capital Resources United's growth has historically been funded by a combination of cash provided by operating activities and debt financing. The Company believes that its cash from operations and collections of receivables, coupled with its sources of borrowings and available cash on hand, are sufficient to fund its currently anticipated requirements. These requirements include payments of interest and dividends, scheduled debt repayments, capital expenditures, working capital needs, restructuring activities, the funding of pension plans, and funding for additional share repurchases and acquisitions, if any. Due to our credit profile over the years, external funds have been available at an acceptable cost. We believe that current credit arrangements are sound and that the strength of our balance sheet affords us the financial flexibility to respond to both internal growth opportunities and those available through acquisitions. 20-------------------------------------------------------------------------------- Table of Contents Financing available from debt and the sale of accounts receivable as of June 30, 2014, is summarized below (in millions): Availability Maximum financing available under: 2013 Credit Agreement $ 700.0 2013 Note Purchase Agreement 150.0 Receivables Securitization Program (1) 200.0 Maximum financing available $ 1,050.0 Amounts utilized: 2013 Credit Agreement 192.4 2013 Note Purchase Agreement 150.0 Receivables Securitization Program (1) 200.0 Outstanding letters of credit 11.1 Total financing utilized 553.5 Available financing, before restrictions 496.5 Restrictive covenant limitation 77.8 Available financing as of June 30, 2014 $ 418.7 (1) The Receivables Securitization Program provides for maximum funding available of the lesser of $200.0 million or the total amount of eligible receivables less excess concentrations and applicable reserves. The Company's outstanding debt consisted of the following amounts (in millions): As of As of June 30, December 31, 2014 2013 2013 Credit Agreement $ 192.4 $ 206.8 2013 Note Purchase Agreement 150.0 - 2007 Note Purchase Agreement (2) - 135.0 Receivables Securitization Program 200.0 190.7 Mortgage & Capital Lease 1.1 1.2 Debt 543.5 533.7 Stockholders' equity 841.7 825.5 Total capitalization $ 1,385.2 $ 1,359.2 Debt-to-total capitalization ratio 39.2 % 39.3 % (2) The parties to the 2007 Note Purchase Agreement have satisfied their obligations under that agreement. The Company will not issue any new debt under the 2007 Note Purchase Agreement. The Company believes that its operating cash flow and financing capacity, as described, provide adequate liquidity for operating the business for the foreseeable future. Refer to Note 7, "Debt", for further descriptions of the provisions of the Company's financing facilities as well as Note 9 "Debt" in the Company's Annual Report on Form 10-K for the year-ended December 31, 2013. Contractual Obligations During the six-month period ended June 30, 2014, contractual obligations increased $13.7 million from those disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, primarily driven by a new software license and maintenance agreement and renewed building leases. |