UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________________________________________
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended September 30, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from ____________ to ____________
Commission File No. 001-35253
(Exact Name of Registrant as Specified in Its Charter)
(State of Incorporation) | (I.R.S. Employer Identification Number) |
(Address of Principal Executive Offices and Zip Code)
(661 ) 775-7200
(Registrant’s Telephone Number, Including Area Code)
Securities Registered pursuant to Section 12(b) of the Act:
Title of Each Class | Trading Symbol | Name of Each Exchange on Which Registered | ||
Securities Registered pursuant to Section 12(g) of the Act: None
___________________________________________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
☒ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | |
Smaller reporting company | Emerging growth company | ||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of March 29, 2019, the aggregate market value of the voting and non-voting common equity held by non-affiliates based on the closing price as of that day was approximately $567,762,000 .
The number of shares of common stock (par value $0.001 per share) of the registrant outstanding as of November 15, 2019, was 100,031,244 .
Documents Incorporated by Reference
Certain portions of the registrant's definitive proxy statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 or an amendment to this Annual Report on Form 10-K, to be filed with the Securities and Exchange Commission, are incorporated by reference into Part III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
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CERTAIN DEFINITIONS AND RECENT DEVELOPMENTS
Unless otherwise noted in this Annual Report, the term “Wesco Aircraft” means Wesco Aircraft Holdings, Inc., our top-level holding company, and the terms “Wesco,” “the Company,” “we,” “us,” “our” and “our Company” mean Wesco Aircraft and its subsidiaries, including (1) Wesco Aircraft Hardware Corp. (Wesco Aircraft Hardware), which is our primary historical domestic operating company, and the sole member of Haas Group International, LLC, which we acquired, along with Haas Group, Inc. (now Haas Group, LLC) and its direct and indirect subsidiaries (collectively, Haas), on February 28, 2014, and (2) Wesco Aircraft EMEA, Ltd. (Wesco Aircraft EMEA), which succeeded Wesco Aircraft Europe, Ltd. (Wesco Aircraft Europe) as our primary foreign operating company.
On August 8, 2019, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Wolverine Intermediate Holding II Corporation, a Delaware corporation (Parent), and Wolverine Merger Corporation, a Delaware 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 of Platinum Equity Advisors, LLC. The closing of the Merger is subject to customary closing conditions, including regulatory approvals. For additional information about the Merger, see Part I, Item 1A. "Risk Factors - Risks Related to the Merger" and see Note 1 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
References to “fiscal year” mean the year ending or ended September 30. For example, “fiscal year 2019” or “fiscal 2019” means the period from October 1, 2018 to September 30, 2019.
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PART I
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements (including within the meaning of the Private Securities Litigation Reform Act of 1995) concerning Wesco and other matters. These statements may discuss goals, intentions and expectations as to future plans, trends, events, results of operations or financial condition, or otherwise, based on current beliefs of management, as well as assumptions made by, and information currently available to, management. Forward-looking statements may be accompanied by words such as “achieve,” “aim,” “anticipate,” “believe,” “can,” “continue,” “could,” “drive,” “estimate,” “expect,” “forecast,” “future,” “grow,” “improve,” “increase,” “intend,” “may,” “outlook,” “plan,” “possible,” “potential,” “predict,” “project,” “should,” “target,” “will,” “would” or similar words, phrases or expressions. These forward-looking statements are subject to various risks and uncertainties, many of which are outside our control. Therefore, you should not place undue reliance on such statements. Factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, the following:
• | our inability to consummate the Merger within the anticipated time period, or at all, due to any reason, including the failure to obtain required regulatory approvals or the failure to satisfy the other conditions to the consummation of the Merger; |
• | the risk that the Merger Agreement may be terminated in circumstances requiring us to pay a termination fee of $39.0 million; |
• | the risk that the Merger disrupts our current plans and operations or diverts management’s attention from our ongoing business; |
• | the effect of the announcement of the Merger on our ability to retain and hire key personnel and maintain relationships with our customers, suppliers and others with whom we do business; |
• | the effect of the announcement of the Merger on our operating results and business generally; the amount of costs, fees and expenses related to the Merger; |
• | the risk that our stock price may decline significantly if the Merger is not consummated; |
• | the nature, cost and outcome of any litigation and other legal proceedings, including any such proceedings related to the Merger and instituted against us and others; |
• | general economic and industry conditions; |
• | conditions in the credit markets; |
• | changes in military spending; |
• | risks unique to suppliers of equipment and services to the U.S. government; |
• | risks associated with the loss of significant customers, a material reduction in purchase orders by significant customers or the delay, scaling back or elimination of significant programs on which we rely; |
• | our ability to effectively compete in our industry; |
• | risks associated with our long-term, fixed-price agreements that have no guarantee of future sales volumes; |
• | our ability to effectively manage our inventory; |
• | our suppliers’ ability to provide us with the products we sell in a timely manner, in adequate quantities and/or at a reasonable cost, while also meeting our customers' quality standards; |
• | our ability to maintain effective information technology (IT) systems and effectively implement our new warehouse management system (WMS); |
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• | our ability to successfully execute and realize the expected financial benefits from our “Wesco 2020” initiative; |
• | our ability to retain key personnel; |
• | risks associated with our international operations, including exposure to foreign currency movements; |
• | changes in trade policies; |
• | risks associated with assumptions we make in connection with our critical accounting estimates (including goodwill, excess and obsolete inventory and valuation allowance of our deferred tax assets) and legal proceedings; |
• | changes in U.S. income tax law; |
• | our dependence on third-party package delivery companies; |
• | fuel price risks; |
• | fluctuations in our financial results from period-to-period; |
• | environmental risks; |
• | risks related to the handling, transportation and storage of chemical products; |
• | risks related to the aerospace industry and the regulation thereof; |
• | risks related to our indebtedness; and |
• | other risks and uncertainties. |
The foregoing list of factors is not exhaustive. You should carefully consider the foregoing factors and the other risks and uncertainties that affect our business, including those described under Part I, Item 1A. “Risk Factors” and the other documents we file from time to time with the Securities and Exchange Commission (SEC). All forward-looking statements included in this Annual Report on Form 10-K (including information included or incorporated by reference herein) are based upon information available to us as of the date hereof, and we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
ITEM 1. BUSINESS
Company Overview
We are one of the world’s leading distributors and providers of comprehensive supply chain management services to the global aerospace industry, based on annual sales. Our services range from traditional distribution to the management of supplier relationships, quality assurance, kitting, just-in-time (JIT) delivery, chemical management services (CMS), third-party logistics (3PL) or fourth-party logistics (4PL) programs and point-of-use inventory management. We supply over 550,000 active stock-keeping units (SKUs), including C-class hardware, chemicals, electronic components, bearings, tools and machined parts. In fiscal 2019, sales of hardware including bearings and other products represented 49.9% of our net sales, sales of chemicals represented 42.8% of our net sales and sales of electronic components represented 7.3% of our net sales. We serve our customers under both (1) long-term contractual arrangements (Contracts), which include JIT contracts that govern the provision of comprehensive outsourced supply chain management services and long-term agreements (LTAs) that typically set prices for specific products, and (2) ad hoc sales.
Founded in 1953 by the father of our current Chairman of the Board of Directors, we have grown to serve over 7,000 customers, which are primarily in the commercial, military and general aviation sectors, including the leading original equipment manufacturers (OEMs) and their subcontractors, through which we support nearly all major Western aircraft programs, and also sell products to airline-affiliated and independent maintenance, repair and overhaul (MRO) providers. We also service customers in the automotive, energy, health care, industrial, pharmaceutical and space sectors. We have approximately 3,300 employees and operate across 55 locations in 17 countries. The following charts illustrate the composition of our fiscal year 2019 net sales based on our sales data.
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Our Products and Services
Our Products
We offer more than 550,000 active SKUs, which fall into the following product categories during the year ended September 30, 2019 (dollars in thousands):
Hardware | Chemicals | Electronic Components | Bearings | Machined Parts and Tooling | ||||||
Net product sales | $777,946 | $726,873 | $123,054 | $33,143 | $35,434 | |||||
% of net product sales | 45.9% | 42.8% | 7.3% | 2.0% | 2.0% | |||||
Types of products offered | • | Blind fasteners | • | Adhesives Sealants | • | Connectors | • | Airframe control | • | Brackets |
• | Panel fasteners | and tapes | • | Relays | bearings | • | Milled parts | |||
• | Bolts and screws | • | Lubricants | • | Switches | • | Rod ends | • | Shims | |
• | Clamps | • | Oil and grease | • | Circuit breakers | • | Spherical Bearings | • | Stampings | |
• | Hi lok pins and | • | Paints and coatings | • | Lighted products | • | Ball bearing | • | Turned parts | |
collars | • | Industrial gases | • | Wire and cable | • | Needle roller | • | Welded assemblies | ||
• | Hydraulic fittings | • | Coolants and | • | Interconnect | bearings | • | Installation/ | ||
• | Inserts | metalworking fluids | accessories | • | Bushings | removal tooling | ||||
• | Lockbolts and | • | Cleaners and | • | Precision bearings | |||||
collars | cleaning solvents | |||||||||
• | Nuts | |||||||||
• | Rivets | |||||||||
• | Springs | |||||||||
• | Valves | |||||||||
• | Washers | |||||||||
Hardware
Sales of C-class aerospace hardware represented 46%, 47% and 47% of our fiscal 2019, 2018 and 2017 product sales, respectively. Fasteners, our largest category of hardware products, include a wide range of highly engineered aerospace parts that are designed to hold together two or more components, such as rivets (both blind and solid), bolts (including blind bolts), screws, nuts and washers. Many of these fasteners are designed for use in specific aircraft platforms and others can be used across multiple platforms. Materials used in the manufacture of these fasteners range from standard alloys, such as aluminum, steel or stainless steel, to more advanced materials, such as titanium, Inconel and Waspaloy.
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Chemicals
Chemical sales represented 43%, 42% and 42% of our fiscal 2019, 2018 and 2017 product sales, respectively. Our chemical product offerings include adhesives; sealants and tapes; lubricants; oil and grease; paints and coatings; industrial gases; coolants and metalworking fluids; and, cleaners and cleaning solvents.
Electronic Components
We offer highly reliable interconnect and electro-mechanical products, including connectors, relays, switches, circuit breakers, lighted products, wire and cable and interconnect accessories. We also offer value-added assembled products including mil-circular and rack and panel connectors and illuminated push button switches. We maintain large quantities of connector components in inventory, which allows us to respond quickly to customer orders. In addition, our lighted switch assembly operation affords customers same day service, including engraving capabilities in multiple languages.
Bearings
Our product offering includes a variety of standard anti-friction products designed to both commercial and military aircraft specifications, such as airframe control bearings, rod ends, spherical bearings, ball bearings, needle roller bearings, bushings and precision bearings.
Machined Parts and Tooling
Machined parts are designed for a specific customer and are assigned unique OEM-specific SKUs. The machined parts we distribute include laser cut or stamped brackets, milled parts, shims, stampings, turned parts and welded assemblies made of materials ranging from high-grade steel or titanium to nickel based alloys.
We stock a full range of tools needed for the installation and removal of many of our products, including air and hydraulic tools as well as drill motors, and we also offer factory authorized maintenance and repair services for these tools. In addition to selling these tools, we also rent or lease these tools to our customers.
Our Services
In addition to our traditional distribution services, we have developed innovative value-added services, such as quality assurance, kitting, JIT supply chain management, CMS and 3PL/4PL programs for our customers.
Quality Assurance
Our quality assurance (QA) function is a key component of our service offering, with approximately 6% of our employees dedicated to this area. We believe we offer an industry-leading QA function as a result of our rigorous processes, sophisticated testing equipment and dedicated QA staff. Our superior QA performance is demonstrated by a comparison of our customers’ aggregate rejection rate of the products we deliver, which was 0.09% during fiscal 2019, to our rejection rate of the products we receive from our suppliers, which was 2.22% during fiscal 2019.
Our QA department inspects the inventory we purchase to ensure the accuracy and completeness of documentation. For many of our customers, these inspections are conducted at our in-house laboratory, where we operate sophisticated testing equipment. We also maintain an electronic copy of the relevant certifications for the inventory, which can include a manufacturer certificate of conformance, test reports, process certifications, material distributor certifications and raw material mill certifications. Our industry-leading QA capabilities also allow our JIT customers to reduce the number of personnel dedicated to the QA function and reduce the delays caused by the rejection of improperly inspected products.
Kitting
Kitting involves the packaging of an entire bill of materials or a complete “ship-set” of products, which reduces the amount of time workers spend retrieving products from storage locations. Kits can be customized in varying configurations and sizes and can contain up to several hundred different products. All of our kits and components contain fully certified and traceable products and are assembled by our full-service kitting department at our Central Stocking Locations (CSLs), or at our customer sites.
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JIT Supply Chain Management and CMS
JIT supply chain management, which includes CMS, involves the delivery of products on an as-needed basis to the point-of-use at a customer’s manufacturing line. JIT programs are designed to prevent excess inventory build-up and shortages and improve manufacturing efficiency. Each JIT contract requires us to maintain an efficient inventory tracking, analysis and replenishment program and is designed to provide high levels of stock availability and on-time delivery. We believe customers that utilize our comprehensive JIT supply chain management services are frequently able to realize significant benefits including:
• | reduced inventory levels and lower inventory excess and obsolescence (E&O) expense, in part because such customers only purchase what they need, and make more efficient use of their floor space; |
• | increased accuracy in forecasting and planning, resulting in substantially improved on-time delivery, reduced expediting costs and fewer disruptions of production schedules; |
• | improved quality assurance resulting in a substantial reduction in customer product rejection rates; and |
• | reduced administrative and overhead costs relating to procurement, QA, supplier management and stocking functions. |
Before signing a JIT contract, our customers typically experience outages of many SKUs and, in some cases, have up to a year’s worth of inventory on hand for other SKU’s. As part of our JIT programs, we generally assume custody of the customer’s existing inventory at the onset of the contract, immediately reducing their management of their physical inventory on hand with lower costs. Customer inventory is generally assumed on a consignment basis and is entered in our perpetual inventory system in a distinct customer-specific “virtual warehouse.” Software protocol in our IT systems requires the system to first “look” to a customer’s consigned inventory when parts replenishment is required. In certain cases, we can sell this consigned inventory to our base of over 7,000 other active customers around the world, gradually drawing down the customer’s inventory. As the consigned inventory for each SKU is exhausted, our stock of Wesco-sourced product is then used for replenishment.
Another key strength of our JIT programs is our ability to utilize highly scalable and customizable point-of-use systems to develop an efficient supply chain management system and automated replenishment solution for any number of SKUs. In order to minimize inventory on hand, certain indicators are used to trigger the replenishment of product, with all replenishment activity done via hand-held scanners that transmit orders to our stocking locations.
In certain circumstances, we also provide our JIT and CMS customers with additional value-added services, including the implementation of process control and usage reduction programs; safety data-sheet management, support for environmental, health and safety compliance (EHS) and reporting; and assistance with the development of waste management strategies.
Customers are also increasingly seeking 3PL or 4PL arrangements to optimize supply chain management by outsourcing either specific logistics and distribution functions or their entire logistics function to a service provider like us.
Aftermarket Sales
We sell products to airline-affiliated, OEM-affiliated and independent MRO providers on both a Contract and ad hoc basis. We have expanded our efforts to increase our presence in both the commercial and military aerospace MRO markets, in part through the introduction of our updated Wesco e-commerce sales platform, which we believe provides us with a cost-effective way to further penetrate the aftermarket. In addition, we have targeted domestic and international airlines and maintenance centers that we believe are assuming an expanded role within the MRO market.
Going forward, we expect commercial MRO providers to benefit from many of the same trends as those impacting the commercial OEM market, including industry passenger volumes and capacity utilization, as well as requirements to maintain aging aircraft and the cost of fuel, which can lead to greater utilization of existing planes. The commercial MRO market may also benefit from directives or notifications announced by international industry regulators and trade associations. Such directives or notifications can serve to bolster required maintenance, and thus the demand for new and existing aerospace products. Furthermore, we expect demand in the military MRO market to be driven by changes in overall fleet size and the level of U.S. military operational activity domestically and overseas. We believe that our presence in this market helps us mitigate the volatility of new military aircraft sales with sales to the aftermarket.
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Customer Contracts
We sell products to our customers under two types of arrangements: (1) Contracts, which include JIT supply chain management contracts and LTAs, and (2) ad hoc sales.
Contracts
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.
JIT Contracts. JIT contracts, which include CMS contracts, are structured to supply the product requirement for specific SKUs, production lines or facilities. Given our direct involvement with JIT customers, volume requirements and purchasing frequency under these contracts is highly predictable. Under JIT contracts, customers purchase specified products from us at a fixed price or a pass-through price, on an as-needed basis, and we are often responsible for maintaining high levels of stock availability of those products. JIT contracts typically contain termination for convenience provisions, which generally allow our customers to terminate their contracts on short notice without meaningful penalties and often provide for us to be reimbursed for the cost of any inventory specifically procured for the customer or inventory that is not commonly sold to our other customers. JIT customers often purchase products from us that are not covered under their contracts on an ad hoc basis. For additional information about our JIT supply chain management services, see “-Our Products and Services-Our Services-JIT Supply Chain Management and CMS.”
LTAs. LTAs are essentially negotiated price lists for customers or individual customer sites that cover a range of pre-determined products, purchased on an as-needed basis. LTAs allow the customer to buy contracted SKUs from us and may obligate us to maintain stock availability for those products. Once an LTA is in place, the customer is then able to place individual purchase orders with us for any of the contractually specified products. LTAs typically contain termination for convenience provisions, which generally allow for our customers to terminate their contracts on short notice without meaningful penalties and often provide that we are reimbursed for the cost of any inventory specifically procured for the customer or inventory that is not commonly sold to our other customers. LTA customers also frequently purchase products from us on an ad hoc basis, which are not captured under the contractual pricing arrangement.
Ad Hoc Sales
Ad hoc sales represent products purchased from us on an as-needed basis and are generally supplied out of our existing inventory. Typically, ad hoc orders are for smaller quantities of products than those ordered under Contracts, and are often urgent in nature. Given our breadth and volume of inventory, it is not uncommon for even our competitors to purchase products from us on an ad hoc basis when their own stocks prove to be inadequate. In an environment of increasing aircraft production and oftentimes relatively long supplier lead-times, product shortages can become increasingly common for OEMs, subcontractors, MRO providers and distributors with less sophisticated forecasting abilities and procurement organizations.
Under each of the sales arrangements described above, we typically warrant that the products we sell conform to the drawings and specifications that are in effect at the time of delivery in the applicable contract, and that we will replace defective or non-conforming products for a period of time that varies from contract to contract. We, in turn, look to the product manufacturer to indemnify us for liabilities resulting from defective or non-conforming products. We do not accrue for warranty expenses as our claims related to defective and non-conforming products have not been significant.
Backlog
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.
Customers
We sell to over 7,000 active customers worldwide. During fiscal 2019, Lockheed Martin represented approximately 13% of our total net sales, consisting of multiple contracts across multiple independent programs such that no individual contract is material. Our top 10 customers collectively accounted for 53% of our total net sales during fiscal 2019.
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During fiscal 2019, 73% of our net sales were derived from major OEMs, such as Airbus, Boeing, BAE Systems, Bombardier, Cessna, Embraer, Gulfstream, Lockheed Martin, Northrop Grumman and Raytheon, and many of their subcontractors. Government sales comprised 16% of our net sales during fiscal 2019 and were derived from various military parts procurement agencies such as the U.S. Defense Logistics Agency, or from defense contractors buying on their behalf. Aftermarket sales to airline-affiliated or independent MRO providers made up 4% of our fiscal 2019 net sales. The remaining 7% of our net sales were to other distributors.
During fiscal 2019, 56% of our net sales were derived from customers supporting commercial programs and 44% of our net sales were derived from customers supporting military programs. We also service international customers in markets that include Australia, Canada, China, France, Germany, India, Ireland, Israel, Italy, Malaysia, Mexico, the Philippines, Poland, Saudi Arabia, Singapore, South Korea, Turkey and the United Kingdom. For additional information about our net sales and long-lived assets by geographic area, see Note 20 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
Procurement
We source our inventory from over 6,000 suppliers globally, including Amphenol, Arconic, CAAP Company, Esterline, Henkel, Lisi Aerospace, PPG Industries, Precision Castparts Corp., TriMas, and 3M. During fiscal 2019, Precision Castparts Corp. and Arconic supplied 9% and 8%, respectively, of the products we purchased, and our ten largest suppliers during fiscal 2019 accounted for 38% of our purchases. Suppliers typically prefer to deal with a relatively small number of large and sophisticated distributors in order to improve production efficiency; reduce finished goods inventory and related obsolescence costs; maintain pricing discipline; improve performance in meeting on-time-delivery targets to the end customers; and consolidate customer accounts, which can reduce administrative and overhead costs relating to sales and marketing, customer service and other functions. As a result of our size and our long-standing relationships with many of our suppliers, we are often able to take advantage of significant volume-based discounts when purchasing inventory. Given our industry position and close cooperation with suppliers, we believe that we are in an excellent position to become a distributor for new product lines as they become available.
Our management analyzes supply, demand, cost and pricing factors to make inventory investment decisions, which are facilitated by our highly customized IT systems, and we maintain close relationships with the leading suppliers in the industry. Our strong understanding of the global aerospace industry is derived from our long-term relationships with major OEMs, subcontractors and suppliers. In addition, our direct insight into our customers’ production rates often allows us to detect industry trends. Furthermore, our ability to forecast demand, share inventory and usage information, and place purchase orders with our suppliers well in advance of our customer requirements can provide us with a distinct advantage in an industry where inventory availability is critical for customers that need specific products within a stipulated timeframe to meet their own production and delivery commitments. However, despite our expertise in this area, effective inventory management is an ongoing challenge, and we continue to take steps to enhance the effectiveness of our procurement practices and mitigate the negative impact of inventory builds on our cash flow. For additional information about the impact of inventory on our business, including our cash flows, see Part I, Item 1A. “Risk Factors-Risks Related to Our Business and Industry-We may be unable to effectively manage our inventory, which could have a material adverse effect on our business, financial condition and results of operations,” Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Other Factors Affecting Our Financial Results-Fluctuations in Cash Flow,” and Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates-Inventories.”
Information Technology Systems
We have invested to build integrated, highly customized IT systems that enable our purchasing and sales organizations to make more informed decisions, our inventory management system to operate in an efficient manner and certain of our customers to make online purchases directly from us. Our primary scalable IT infrastructure is based on IBM and Oracle hardware and applications including the Oracle JD Edwards EnterpriseOne (JDE) enterprise resource planning (ERP) system and our proprietary chemical supply chain management system, tcmIS®, which was developed on the Oracle Enterprise database. These customized IT systems provide us visibility into quantities, stocking locations and purchases across our customer base by individual inventory item, enabling us to accurately fill an average of 17,300 orders per day and provide an exceptional level of customer service. These systems are fully capable of interfacing with external enterprise business systems. Additionally, we have developed functionality for JIT delivery, which can integrate directly into our customers’ manufacturing process. This functionality includes recognition of signals and actions to fill customer bins from hand-held scanners, min/max data or proprietary signals from a customer’s ERP system. JDE and tcmIS® also support our EDI functionality, which allows our system to interface with customers and suppliers, regardless of technology, data format or connectivity. tcmIS® also
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supports additional chemical-specific functionality, such as product labeling and Global Harmonized System compliance. We also continue to invest in our infrastructure and cyber-defense capabilities to enhance both availability and data protection.
For our shipping logistics and export compliance support, we employ Precision Software’s TRA/X. TRA/X enables us to ship globally while maintaining tracking numbers and rating information for each customer shipment. In addition, at several of our distribution facilities, we use Minerva’s AIMS inventory management system to provide the best possible warehouse flow and cycle times. AIMS is tailored to fit our global warehouse operational needs and allows us to provide an expandable warehouse management system that can also incorporate transaction processing, work-in-progress and other manufacturing operations. AIMS interfaces with a broad range of material handling equipment, including horizontal and vertical carousels, conveyors, sorting equipment, pick systems and cranes.
Going forward, we will continue to evaluate our IT infrastructure and expect to undertake efforts to modernize our capabilities, particularly through investments in additional state of the art software and hardware that is designed to improve our ability to service our customers.
Seasonality
Our net sales may fluctuate quarterly based on the number of production days at our customers' facilities, which is driven by holidays and planned production shutdowns, particularly the winter holidays during our first fiscal quarter and the summer months during our fourth fiscal quarter.
Competition
The industry in which we operate is highly competitive and fragmented. We believe the principal competitive factors in our industry include the ability to provide superior customer service and support, on-time delivery, sufficient inventory availability, competitive pricing and an effective QA program. Our competitors include both U.S. and foreign companies, including divisions of larger companies and certain of our suppliers, some of which have significantly greater financial resources than we do, and therefore may be able to adapt more quickly to changes in customer requirements than we can. In addition to facing competition for Contract customers from our primary competitors, Contract customers or potential Contract customers may also determine that it is more cost effective to establish or re-establish an in-house supply chain management capability. Under these circumstances, we may be unable to sufficiently reduce our costs to provide competitive pricing while also maintaining acceptable operating margins.
Employees
As of September 30, 2019, we employed 3,302 personnel worldwide, 1,161 of whom were located at customer sites. We have 876 employees located outside of North America. We are not a party to any collective bargaining agreements with our employees.
Regulatory Matters
Governmental agencies throughout the world, including the U.S. Federal Aviation Administration (FAA), prescribe standards for aircraft components, including virtually all commercial airline and general aviation products, as well as regulations regarding the repair and overhaul of airframes and engines. Specific regulations vary from country to country, although compliance with FAA requirements generally satisfies regulatory requirements in other countries. In addition, the products we distribute must also be certified by aircraft and engine OEMs. If any of the material authorizations or approvals that allow us to supply products is revoked or suspended, then the sale of the related products would be prohibited by law, which would have an adverse effect on our business, financial condition and results of operations.
From time to time, the FAA or equivalent regulatory agencies in other countries propose new regulations or changes to existing regulations, which are usually more stringent than existing regulations. If these proposed regulations are adopted and enacted, we could incur significant additional costs to achieve compliance, which could have a material adverse effect on our business, financial condition and results of operations.
We are also subject to government rules and regulations that include the U.S. Foreign Corrupt Practices Act (FCPA), the UK Bribery Act 2010 (Bribery Act), the International Traffic in Arms Regulations (ITAR), the Export Administration Regulations (EAR), economic sanctions and the False Claims Act. See “Risk Factors-Risks Related to Our Business and Industry-We are subject to unique business risks as a result of supplying equipment and services to the U.S. government directly and as a subcontractor, which could lead to a reduction in our net sales from, or the profitability of our supply
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arrangements with, the U.S. government” and “-Our international operations require us to comply with numerous applicable anti-corruption and trade control laws and regulations, including those of the U.S. government and various other jurisdictions, and our failure to comply with these laws and regulations could adversely affect our reputation, business, financial condition and results of operations.”
Environmental Matters
We are subject to extensive federal, state, local and foreign laws, regulations, rules and ordinances relating to pollution, protection of the environment and human health and safety, and the handling, transportation, storage, treatment, disposal and remediation of hazardous substances, including potentially with respect to historical chemical blending and other activities that pre-dated our purchase of Haas. Actual or alleged violations of EHS laws or permit requirements could result in restrictions or prohibitions on operations and substantial civil or criminal sanctions, as well as, under some EHS laws, the assessment of strict liability and/or joint and several liability.
Furthermore, we may be liable for the costs of investigating and cleaning up environmental contamination on or from our operations or at off-site locations, including potentially with respect to historical chemical blending and other activities that pre-dated our purchase of our businesses. We may therefore incur additional costs and expenditures beyond those currently anticipated to address all such known and unknown situations under existing and future EHS laws.
In addition, governmental, regulatory and societal demands for increasing levels of product safety and environmental protection are resulting in increased pressure for more stringent regulatory control with respect to the chemical industry. The European Union’s Registration, Evaluation, Authorization and Restriction of Chemicals (REACH) regulations enacted in 2009 have been a continuing source of compliance obligations and restrictions on certain chemicals, and REACH-like regimes have now been adopted in several other countries. In the United States, the core provisions of the Toxic Substances Control Act (TSCA) were amended in June 2016 for the first time in nearly 40 years. Among the more significant changes are that these amendments mandate safety reviews of existing “high priority” chemicals and regulatory action to control any “unreasonable risks” identified as result of such reviews. The Environmental Protection Agency (EPA) also now must make a no “unreasonable risk” finding before a new chemical can be fully commercialized. These new mandates create uncertainty about whether existing chemicals of importance to our business may be designated for restriction and whether the new chemical approval process may become more difficult and costly to comply with. These types of changes in the Company’s regulatory environment, particularly, but not limited to, in the United States, the European Union, Canada and China, could lead to heightened regulatory scrutiny and could adversely impact our ability to supply certain products and provide supply chain management services to our customers. Such changes also could result in compliance obligations for us directly or as part of our supply chain management services to customers, fines, ongoing monitoring and other future business activity restrictions, which could have a material adverse effect on the Company’s liquidity, financial position and results of operations. Finally, we have in the past sold products containing per- and polyfluoroalkyl substances (PFAS), including perfluorooctanoic acid (PFOA). Certain PFAS, including PFOA, have been targeted for risk assessment, restriction, and high priority remediation and have been the subject of ongoing and substantial litigation in the both the U.S. and European Union. We have not received any claims or enforcement actions from governments or third parties relating to PFOA or any other PFAS.
Available Information
We file annual, quarterly and current reports and other information with the SEC. The SEC maintains an Internet website (www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC, including us. You may also access, free of charge, our reports filed with the SEC (for example, our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K and any amendments to those forms) through the “Investor Relations” portion of our website (www.wescoair.com). We also make available on our website our (1) Corporate Governance Guidelines, (2) Code of Business Conduct and Ethics, which applies to our directors, officers and employees, (3) Whistleblower Policy, (4) Clawback Policy and (5) the charters of the Audit, Compensation and Nominating and Corporate Governance Committees. Reports filed with or furnished to the SEC will be available as soon as reasonably practicable after they are filed with or furnished to the SEC. Our website is included in this Annual Report as an inactive textual reference only. The information found on our website is not part of this or any other report filed with or furnished to the SEC.
ITEM 1A. RISK FACTORS
You should consider and read carefully all of the risks and uncertainties described below, as well as other information included in this Annual Report, including our consolidated financial statements and related notes. The risks described below are not the only ones facing us. The occurrence of any of the following risks or additional risks and uncertainties not presently
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known to us or that we currently believe to be immaterial could materially and adversely affect our business, financial condition or results of operations. This Annual Report also contains forward-looking statements and estimates that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of specific factors, including the risks and uncertainties described below.
Risks Related to the Merger
Our inability to complete the Merger, or to complete the Merger in a timely manner, including as a result of the failure to obtain required regulatory approvals or the failure to satisfy the other conditions to the consummation of the Merger could negatively affect our business, financial condition and results of operations.
The Merger is subject to various closing conditions such as receipt of required regulatory approval from the United Kingdom, among other customary closing conditions. It is possible that the government entity of the United Kingdom may prohibit, enjoin or refuse to grant approval for the consummation of the Merger. If any condition to the closing of the Merger is not satisfied or, if permissible, not waived, the Merger will not be completed. In addition, satisfying the conditions to the closing of the Merger may take longer than we expect. There can be no assurance that the remaining conditions to closing will be satisfied or waived or that other events will not intervene to delay or result in the failure to consummate the Merger.
If the Merger is not completed for any reason, our stockholders would not receive any payment for their shares in
connection with the Merger, and we would remain an independent public company, with our shares continuing to be traded on
the New York Stock Exchange. Depending on the circumstances that would have caused the Merger not to be completed, the
price of our common stock may decline materially. If that were to occur, it is uncertain when, if ever, our common stock would
return to the price levels at which the shares currently trade.
Failure to complete the Merger could trigger the payment of a termination fee, and, whether or not the Merger is
consummated, we have incurred and will continue to incur significant costs, fees and expenses relating to professional
services and transaction fees.
Under the Merger Agreement, we may be required to pay a termination fee of $39.0 million, if the Merger Agreement is terminated under specified circumstances. There can be no assurance that the Merger Agreement will not be terminated under
the circumstances triggering these termination fee obligations. Furthermore, whether or not the Merger is consummated, we
have incurred, and will continue to incur, significant costs, fees and expenses relating to professional services and transaction
fees in connection with the proposed Merger. Payment of these costs, fees and expenses could adversely affect our business,
financial condition and results of operations.
Uncertainties associated with the Merger may cause us to lose key customers or suppliers and make it more difficult to
retain and hire key personnel, and the Merger may disrupt our current plans and operations or divert management’s
attention from our ongoing business.
As a result of the uncertainty surrounding the conduct of our business while the Merger is pending, our relationships
with customers, suppliers and other parties may be adversely affected. Due to uncertainty about our future while the Merger is
pending, we may lose customers or suppliers, or customers, suppliers and other parties may alter their business relationships
with us.
In addition, our employees, including key personnel, may be uncertain about their future roles and relationships with us following the completion of the Merger, which may adversely affect our ability to retain them or to hire new employees, and,
while the Merger is pending, the potential disruption of plans or diversion of management’s attention from our ongoing
business operations could adversely affect our business, financial condition and results of operations.
Risks Related to Our Business and Industry
We are directly dependent upon the condition of the aerospace industry, which is closely tied to global economic conditions, and if the aerospace industry or the U.S. or global economy were to experience a recession, our business, financial condition and results of operations could be negatively impacted.
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Demand for the products and services we offer are directly tied to the delivery of new aircraft, aircraft utilization, and repair of existing aircraft, which, in turn, are impacted by global economic conditions. For example, 2009 revenue passenger miles (RPMs) on commercial aircraft declined due to the global recession. During the same period, the industry experienced declines in large commercial, regional and business jet deliveries. A slowdown in the global economy, or a return to a recession, would negatively impact the aerospace industry, and could negatively impact our business, financial condition and results of operations.
Military spending, including spending on the products we sell, is dependent upon national defense budgets, and a reduction in military spending could have a material adverse effect on our business, financial condition and results of operations.
During the year ended September 30, 2019, 44% of our net sales were related to military aircraft. The military market is significantly dependent upon government budget trends, particularly the U.S. Department of Defense (DoD) budget. Future DoD budgets could be negatively impacted by several factors, including, but not limited to, a change in defense spending policy by the current and future presidential administrations and Congress, the U.S. government’s budget deficits, spending priorities, the cost of sustaining the U.S. military presence in overseas operations and possible political pressure to reduce U.S. Government military spending, each of which could cause the DoD budget to decline. A decline in U.S. military expenditures could result in a reduction in military aircraft production, which could have a material adverse effect on our business, financial condition and results of operations.
In particular, military spending may be negatively impacted by the Budget Control Act of 2011 (the Budget Control Act), which was passed in August 2011. The Budget Control Act established limits on U.S. government discretionary spending, including a reduction of defense spending to the extent that discretionary spending limits are exceeded. We are unable to predict the impact that the cuts associated with sequestration will ultimately have on funding for the military programs which we support. However, such cuts could result in reductions, delays or cancellations of these programs, which could have a material adverse effect on our business, financial condition and results of operations.
We are subject to unique business risks as a result of supplying equipment and services to the U.S. government directly and as a subcontractor, which could lead to a reduction in our net sales from, or the profitability of our supply arrangements with, the U.S. government.
Companies engaged in supplying defense-related equipment and services to U.S. government agencies are subject to business risks specific to the defense industry. We contract directly with the U.S. government and are also a subcontractor to customers contracting with the U.S. government. Accordingly, the U.S. government may unilaterally suspend or prohibit us from receiving new contracts pending resolution of alleged violations of procurement laws or regulations, revoke required security clearance, reduce the value of existing contracts or audit our contract-related costs and fees. In addition, most of our U.S. government contracts and subcontracts can be terminated by the U.S. government or the contracting party, as applicable, at its convenience. Termination for convenience provisions provide only for our recovery of costs incurred or committed, settlement expenses and profit on the work completed prior to termination.
In addition, we are subject to U.S. government inquiries and investigations, including periodic audits of costs that we determine are reimbursable under government contracts. U.S. government agencies routinely audit government contractors to review performance under contracts, cost structure and compliance with applicable laws, regulations, and standards, as well as the adequacy of and compliance with internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation and management information systems. Any costs found to be misclassified or inaccurately allocated to a specific contract are not reimbursable, and to the extent already reimbursed, must be refunded. Also, any inadequacies in our systems and policies could result in payments being withheld, penalties and reduced future business, which we are not aware of any.
Government rules require contracting officers to impose contractual withholdings at no less than certain minimum levels if a contracting officer determines that one or more of a contractor’s business systems have one or more significant deficiencies. If a contracting officer were to impose such a withholding on us or even one of our prime contractors, it would increase the risk that we would not be paid in full or paid timely. If future audit adjustments exceed our estimates, our profitability could be adversely affected.
If a government inquiry or investigation uncovers improper or illegal activities, we could be subject to civil or criminal penalties or administrative sanctions, including contract termination, fines, forfeiture of fees, suspension of payment and suspension or debarment from doing business with U.S. government agencies, any of which could materially adversely affect our reputation, business, financial condition and results of operations.
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We are also subject to the federal False Claims Act, which provides for substantial civil penalties and treble damages where a contractor presents a false or fraudulent claim to the government for payment. Actions under the False Claims Act may be brought by the government or by other persons on behalf of the government (who may then share in any recovery).
If we lose significant customers, significant customers materially reduce their purchase orders or significant programs on which we rely are delayed, scaled back or eliminated, our business, financial condition and results of operations may be adversely affected.
Our top ten customers for the year ended September 30, 2019 accounted for 53% of our net sales. A reduction in purchasing by or loss of one of our larger customers for any reason, including changes in manufacturing or procurement practices, loss of a customer as a result of the acquisition of such customer by a purchaser who does not fully utilize a distribution model or uses a competitor, in-sourcing by customers, a transfer of business to a competitor, an economic downturn, failure to adequately service our clients or to manage the implementation of new customer sites, decreased production or a strike, could have a material adverse effect on our business, financial condition and results of operations.
As an example of changes in manufacturing practices that could impact us, OEMs such as Boeing and Airbus have incorporated a higher proportion of composite materials in some of the aircraft they manufacture. Aircraft utilizing composite materials generally require the use of significantly fewer C-class aerospace parts than new aircraft made of more traditional non-composite materials, although the parts used are generally higher priced than C-class aerospace parts used in non-composite aircraft structures. To the extent Boeing, Airbus and other customers increase their reliance on composite materials, they may materially reduce their purchase orders from us.
As an example of the potential loss of business due to customer in-sourcing, a major OEM has undertaken an initiative to encourage its suppliers to source certain OEM-specific materials, including fasteners, directly from the OEM itself, rather than through distributors such as us. If this initiative is more broadly implemented by the OEM, or if other OEMs pursue similar initiatives, a portion of our sales to their suppliers, and consequently our business, financial condition and results of operations, could be adversely affected.
In addition, major OEMs have indicated that they are pursuing initiatives to increase the services portion of their business. These initiatives could lead to greater in-sourcing on the part of the OEMs, which could adversely affect a portion of our sales to the OEMs and their suppliers.
We expect to derive a significant portion of our net sales from certain aerospace programs in their early production stages. Our future growth will be dependent, in part, upon our sales to various OEMs and subcontractors as related to such programs. If production of any of the programs we support is terminated or delayed, or if our sales to customers affiliated with these programs are reduced or eliminated, our business, financial condition and results of operations could be adversely affected.
We operate in a highly competitive market, and our failure to compete effectively may negatively impact our results of operations.
We operate in a highly competitive global industry and compete against a number of companies, including divisions of larger companies and certain of our suppliers, some of which may have significantly greater financial resources than we do and therefore may be able to adapt more quickly to changes in customer requirements than we can. Our competitors consist of both U.S. and foreign companies and range in size from divisions of large public corporations to small privately held entities. We believe that our ability to compete depends on superior customer service and support, on-time delivery, sufficient inventory availability, competitive pricing and effective quality assurance programs. To remain competitive, we may have to adjust the prices of some of the products and services we sell and continue investing in our procurement, supply-chain management and sales and marketing functions, the costs of which could negatively impact our results of operations.
In addition, we face competition for our Contract customers from both competitors in our industry (including OEMs who are increasing the services portion of their business) and the in-sourcing of supply-chain management by our customers themselves. If any of our Contract customers decides to in-source the services we provide or switches to one of our competitors, we would be adversely affected.
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We do not have guaranteed future sales of the products we sell, and when we enter into Contracts with our customers we generally take the risk of certain cost increases, and our business, financial condition, results of operations and operating margins may be negatively affected if we purchase more products than our customers require, product costs increase unexpectedly, we experience high start-up costs on new Contracts or our Contracts are terminated.
A majority of our Contracts are long-term, fixed-price agreements with no guarantee of future sales volumes, and they may be terminated for convenience on short notice by our customers, often without meaningful penalties, and often provide that we are reimbursed for the cost of any inventory specifically procured for the customer or inventory that is not commonly sold to our other customers. In addition, we purchase inventory based on our forecasts of anticipated future customer demand. As a result, we may take the risk of having excess inventory if our customers do not place orders consistent with our forecasts, particularly with respect to inventory that has a more limited shelf-life. Also, even though we often enter into long-term pricing agreements with our suppliers, we do run the risk of not being able to pass along or otherwise recover unexpected increases in our product costs, including as a result of commodity price increases and tariffs, which may increase above our established prices at the time we entered into the Contract and established prices for products we provide. When we are awarded new Contracts, particularly JIT contracts, we may incur high costs, including salary and overtime costs, to hire and train on-site personnel, in the start-up phase of our performance. In the event that we purchase more products than our customers require, product costs increase unexpectedly, we experience high start-up costs on new Contracts or our Contracts are terminated, our business, financial condition, results of operations and operating margins could be negatively affected.
We may be unable to effectively manage our inventory, which could have a material adverse effect on our business, financial condition and results of operations.
Due to the lead times required by many of our suppliers, we typically order products, particularly hardware products, in advance of expected sales, and the volume of such orders may be significant. Lead times generally range from several weeks up to two years, depending on industry conditions, which makes it difficult to successfully manage our inventory as we plan for future demand. In addition, demand for our products can fluctuate significantly, which can also negatively impact our cash flows and inventory level. For example, in the three months ended September 30, 2015, we determined that inventory previously purchased in connection with a specific program that was subsequently terminated had no alternative use, and we recorded a provision to write-down such inventory by $33.0 million.
If suppliers are unable to supply us with the products we sell in a timely manner, in adequate quantities and/or at a reasonable cost, while also meeting our customers' quality standards, we may be unable to meet the demands of our customers, which could have a material adverse effect on our business, financial condition and results of operations.
Our inventory is primarily sourced directly from producers and manufacturing firms, and we depend on the availability of large supplies of the products we sell, which must also meet our customers' quality standards. Our largest suppliers for the year ended September 30, 2019 were Precision Castparts Corp. and Arconic, Inc. During fiscal 2019, 9% of the products we purchased were from Precision Castparts Corp. and 8% were purchased from Arconic, Inc. In addition, our ten largest suppliers during fiscal 2019 accounted for 38% of our purchases. These manufacturers and producers may experience capacity constraints that result in their being unable to supply us with products in a timely manner, in adequate quantities and/or at a reasonable cost. Contributing factors to manufacturer capacity constraints include, among other things, industry or customer demands in excess of manufacturing capacity, labor shortages and changes in raw material flows. In addition, changes in trade policies, such as the imposition of additional tariffs on certain products imported into the United States, could result in increased procurement costs. Any significant interruption in the supply of these products or termination of our relationship with any of our suppliers could result in us being unable to meet the demands of our customers, which would have a material adverse effect on our business, financial condition and results of operations.
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Our business is highly dependent on complex information technology and our business and operations could suffer in the event of cyber-security breaches.
The provision and application of IT is an increasingly critical aspect of our business. Among other things, our IT systems must frequently interact with those of our customers, suppliers and logistics providers. Our future success will depend on our continued ability to employ IT systems that drive operational efficiency and meet our customers’ demands. The failure or disruption of the hardware or software that supports our IT systems, including redundancy systems, could significantly harm our ability to service our customers and cause economic losses for which we could be held liable and which could damage our reputation. In addition, we are subject to the risk of cyber-security attacks, which includes, but is not limited to, malicious software, ransomware or terrorists attacks, unauthorized attempts to gain access to sensitive, confidential or otherwise protected information related to us, our customers and our suppliers and other cyber-security breaches. A cyber-related attack could cause a loss of data and interruptions or delays in our business (particularly with respect to our tcmIS® operating system), cause us to incur remediation costs, subject us to claims and damage our reputation. In addition, the failure or disruption of our IT systems, communications or utilities, or those of third parties on which we rely, could cause us to interrupt or suspend our operations or otherwise adversely affect our business. Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of any system or operational failure or disruption which could have a material adverse effect on our business, results of operations and financial condition. In addition, system improvements and other IT-related upgrades could require us to accelerate the depreciation of certain assets, which could have a material adverse effect on our operating results.
Our competitors may have or may develop IT systems that permit them to be more cost effective and otherwise better able to meet customer demands than we are able to with IT systems we are able to acquire or develop. Larger competitors may be able to develop or license IT systems more cost effectively than we can by spreading the cost across a larger revenue base, and competitors with greater financial resources may be able to acquire or develop IT systems that we cannot afford. If we fail to meet the demands of our customers or protect against disruptions of our IT systems, we may lose customers, which could seriously harm our business and adversely affect our operating results and operating cash flow.
Our implementation of a new WMS could adversely affect our business, financial condition and results of operations or the effectiveness of our financial reporting processes, including our internal controls over financial reporting.
We are currently implementing a new WMS, which we expect will provide our business with enhanced warehouse transaction management capabilities and improved labor efficiency around the globe. Such an implementation is a major undertaking, both financially and from a management and personnel perspective. Even if successfully implemented, we may not realize the anticipated productivity improvements or cost efficiencies from the WMS. In addition, any disruptions, delays or deficiencies in the design and implementation of the WMS could adversely affect our ability to manage our inventory, process orders, ship products in a timely manner or provide services and customer support, and could also result in loss of information, diminished management reporting capabilities, harm to our control environment, diminished employee productivity and unanticipated increases in costs. If we do not effectively implement the WMS or if the WMS does not operate as intended, it could adversely affect our business, financial condition and results of operations and the effectiveness of our financial reporting processes, including our internal controls over financial reporting.
If we are unable to successfully execute and realize the expected financial benefits from our “Wesco 2020” initiative, our business and financial results could be adversely affected.
In May 2018, we announced the launch of our “Wesco 2020” initiative, which is designed to broaden and institutionalize improvements already made to our business during fiscal 2018 and further improve the Company’s service excellence, inventory management, productivity and profitability. The Company expects “Wesco 2020” to deliver significant operational and financial benefits through footprint alignment, organizational refinement, productivity gains and investment in critical capabilities to serve customers better. However, we may be unable to effectively execute certain of these improvement initiatives, which could limit our realization of expected costs savings, anticipated synergies and efficiencies and customer service improvements. Moreover, the expenses associated with these initiatives can be difficult to predict, and we may incur substantial additional expenses in connection with the execution of “Wesco 2020” in excess of what is currently expected, particularly if any of these initiatives are unsuccessful or prove unsustainable, which may require us to incur additional costs. Furthermore, improvement initiatives of this sort are a complex and time-consuming process that can place substantial demands on management, which could divert attention from other business priorities or disrupt our daily operations. Any of these failures could, in turn, materially adversely affect our business, financial condition, results of operations and cash flows, and could negatively impact our ability to achieve our other strategic goals and business plans.
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We may be unable to retain personnel who are key to our operations.
Our success, among other things, is dependent on our ability to attract, develop and retain highly qualified senior management and other key personnel. Competition for key personnel is intense, and our ability to attract and retain key personnel is dependent on a number of factors, including prevailing market conditions and compensation packages offered by companies competing for the same talent. The inability to hire, develop and retain these key employees may adversely affect our operations.
There are risks inherent in international operations that could have a material adverse effect on our business, financial condition and results of operations.
While the majority of our operations are based in the United States, we have significant international operations, with facilities in Argentina, Australia, Canada, China, France, Germany, India, Israel, Ireland, Italy, Mexico, the Philippines, Poland, Singapore, Turkey and the United Kingdom, and customers throughout North America, South America, Europe, Asia, Australia and the Middle East. For the years ended September 30, 2019 and 2018, 32% and 33% of our net sales, respectively, were derived from customers located outside the United States.
Our international operations are subject to, without limitation, the following risks:
• | the burden of complying with multiple and possibly conflicting laws and any unexpected changes in regulatory requirements; |
• | political risks, including risks of loss due to civil disturbances, acts of terrorism, acts of war, guerilla activities and insurrection; |
• | unstable economic, financial and market conditions and increased expenses due to inflation, or higher interest rates; |
• | difficulties in enforcement of third-party contractual obligations and collecting receivables through foreign legal systems; |
• | changes in global trade policies; |
• | increasingly complex laws and regulations concerning privacy, data protection and data security, including the European Union’s General Data Protection Regulation; |
• | difficulties in staffing and managing international operations and the application of foreign labor regulations; |
• | differing local product preferences and product requirements; and |
• | potentially adverse tax consequences from changes in tax laws, requirements relating to withholding taxes on remittances and other payments by subsidiaries and restrictions on our ability to repatriate dividends from our subsidiaries. |
In addition, unhedged fluctuations in the value of foreign currencies affect the dollar value of our net investment in foreign subsidiaries, with these fluctuations being included in a separate component of stockholders’ equity. For years ended September 30, 2019, 2018 and 2017, we reported a foreign currency translation adjustment loss of $2.1 million, $1.9 million and $7.1 million, respectively, in our consolidated statements of comprehensive income (loss), and we may incur additional adjustments in future periods. In addition, operating results of certain of our foreign subsidiaries are translated into U.S. dollars for purposes of our statements of comprehensive income at average monthly exchange rates. Moreover, to the extent that our net sales are not denominated in the same currency as our expenses, our net earnings could be materially adversely affected. For example, a portion of labor, material and overhead costs for our facilities in the United Kingdom, Germany, France and Italy are incurred in British pounds or euros, but in certain cases the related net sales are denominated in U.S. dollars. Changes in the value of the U.S. dollar or other currencies could result in material fluctuations in foreign currency translation amounts or the U.S. dollar value of transactions and, as a result, our net earnings could be materially adversely affected. At times we engage in hedging transactions to manage or reduce our foreign currency exchange risk, but these transactions may not be successful and, as a result, our business, financial condition and results of operations could be materially adversely affected. During fiscal 2019 and 2018, fluctuations in foreign currency translation had a negative impact on net sales of $6.6 million and a positive impact of $1.1 million, respectively.
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Our international operations require us to comply with numerous applicable anti-corruption and trade control laws and regulations, including those of the U.S. government and various other jurisdictions, and our failure to comply with these laws and regulations could adversely affect our reputation, business, financial condition and results of operations.
Doing business on a worldwide basis requires us to comply with the laws and regulations of the U.S. government and various other jurisdictions, and our failure to successfully comply with these rules and regulations may expose us to liabilities. These laws and regulations can apply to companies, individual directors, officers, employees and agents, and may restrict our operations, trade practices, investment decisions and partnering activities. Our risk of violating anti-corruption laws is increased because some of the international locations in which we operate lack a highly developed legal system and have elevated levels of corruption, and because our industry is highly regulated.
In particular, our international operations are subject to U.S. and foreign anti-corruption laws and regulations, such as the FCPA, the Bribery Act and other applicable anti-corruption regimes. These laws generally prohibit us from corruptly providing anything of value, directly or indirectly, to foreign government officials for the purposes of improperly influencing official decisions, improperly obtaining or retaining business, or otherwise obtaining favorable treatment. As part of our business, we may deal with governments and state-owned business enterprises, the employees and representatives of which may be considered government officials for purposes of the FCPA, the Bribery Act or other applicable anti-corruption laws. Some anti-corruption laws, such as the Bribery Act, also prohibit commercial bribery and the acceptance of bribes. In addition, the FCPA further requires publicly traded companies to maintain adequate record-keeping that accurately reflects the transactions of the company, as well as a system of internal accounting controls.
As an exporter, we must comply with various laws and regulations relating to the export of products, services and technology from the United States and other countries having jurisdiction over our operations. In the U.S., these laws include, among others, the EAR administered by the U.S. Department of Commerce’s Bureau of Industry and Security, the ITAR administered by the U.S. Department of State’s Directorate of Defense Trade Controls, and trade sanctions, regulations and embargoes administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control. These laws and regulations may require us to obtain individual validated licenses from the relevant agency to export, re-export, or transfer commodities, software, technology, or services to certain jurisdictions, individuals, or entities. We cannot be certain that our applications for export licenses or other authorizations will be granted or approved. Furthermore, the export license and export authorization process is often time-consuming.
Violations of these legal requirements can be punishable by criminal fines and imprisonment, civil penalties, disgorgement of profits, injunctions, debarment from government contracts, seizure and forfeiture of unlawful attempted exports, and/or denial of export privileges, as well as other remedial measures. We have established policies and procedures designed to assist us, our personnel and our agents to comply with applicable U.S. and international laws and regulations. However, there can be no guarantee that our policies and procedures will effectively prevent us, our employees and our agents from violating these regulations in every transaction in which we may engage, and violations, allegations or investigations of such violations could materially adversely affect our reputation, business, financial condition and results of operations.
Changes in trade policies, including the imposition of additional tariffs, could negatively impact our business, financial condition and results of operations.
The current United States administration has implemented significant changes to certain trade policies, such as the imposition of additional tariffs on certain imported products and the withdrawal from or renegotiation of certain trade agreements, including the North American Free Trade Agreement. Such changes have also resulted, and could continue to result, in retaliatory actions by the United States’ trade partners. For example, the United States has imposed additional tariffs on certain imports from China, as well as on steel and aluminum products imported from various countries, and recently announced additional tariffs on certain products imported from the European Union. In response, China, the European Union, and several other countries have imposed or proposed additional tariffs on certain exports from the United States.
We procure certain of the products we sell directly or indirectly from outside of the United States, including from China. The imposition of tariffs and other recent or forthcoming changes in United States trade policy could increase the cost or limit the availability of such products, which could hurt our competitive position and adversely impact our business, financial condition and results of operations. In addition, we sell a significant proportion of our products to customers outside of the United States. Retaliatory actions by other countries could result in increases in the price of our products, which could limit demand for such products, hurt our global competitive position and have a material adverse effect on our business, financial condition and results of operations.
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Our total assets include substantial intangible assets, and the write-off of a significant portion of our intangible assets would negatively affect our financial results.
Our total assets reflect substantial intangible assets. At September 30, 2019, goodwill and intangible assets, net represented 23.1% of our total assets. Goodwill represents the excess of the purchase price of acquired businesses over the fair value of the assets acquired and liabilities assumed resulting from acquisitions, including the acquisition of our Company by affiliates of The Carlyle Group (Carlyle) and the acquisition of Haas. Intangible assets represent trademarks, backlogs, non-compete agreements, technology and customer relationships. On at least an annual basis, we assess whether there has been impairment in the value of goodwill and indefinite-lived intangible assets. If our testing identifies impairment under generally accepted accounting principles in the United States (GAAP), the impairment charge we calculate would result in a charge to income from operations. For example, during the three months ended June 30, 2017, we recorded a non-cash goodwill impairment of $311.1 million. Any future determination requiring the write-off of a significant portion of goodwill and unamortized identified intangible assets would negatively affect our results of operations and total capitalization, which could be material. For additional information, see “Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates-Goodwill and Indefinite-Lived Intangible Assets.”
Changes in U.S. tax law have affected and may continue to affect our business, financial condition and results of operations.
On December 22, 2017, the Tax Act was signed into law. As a fiscal year taxpayer, certain provisions of the Tax Act have impacted the Company for our fiscal year ended September 30, 2018, while other provisions of the Tax Act will impact the Company for our fiscal year beginning October 1, 2018 and beyond. Our ongoing evaluation of the full impact of the Tax Act on our liability for U.S. corporate tax and the related impact on our business, financial condition and results of operations may be affected by modifications of assumptions and further interpretation of the Tax Act based on U.S. Treasury regulations and guidance from the Internal Revenue Service and state tax authorities, and resulting changes could be material (see Note 15 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K).
If any of our customers were to become insolvent or experience substantial financial difficulties, our business, financial condition and results of operations may be adversely affected.
If any of the customers with whom we do business becomes insolvent or experiences substantial financial difficulties we may be unable to timely collect amounts owed to us by such customers and may not be able to sell the inventory we have purchased for such customers, which could have a material adverse effect on our business, financial condition and results of operations.
We or our suppliers or customers may experience damage to or disruptions at our or their facilities caused by natural disasters and other factors, which may result in our business, financial condition and results of operations being adversely affected.
Several of our facilities or those of our suppliers and customers could be subject to a catastrophic loss caused by earthquakes, tornadoes, floods, hurricanes, fire, power loss, telecommunication and information systems failure or other similar events. Should insurance be insufficient to recover all such losses or should we be unable to reestablish our operations, or if our customers or suppliers were to experience material disruptions in their operations as a result of such events, our business, financial condition and results of operations could be adversely affected.
We are dependent on access to and the performance of third-party package delivery companies.
Our ability to provide efficient distribution of the products we sell to our customers is an integral component of our overall business strategy. We do not maintain our own delivery networks, and instead rely on third-party package delivery companies. We cannot assure you that we will always be able to ensure access to preferred delivery companies or that these companies will continue to meet our needs or provide reasonable pricing terms. In addition, if the package delivery companies on which we rely experience delays resulting from inclement weather or other disruptions, we may be unable to maintain products in inventory and deliver products to our customers on a timely basis, which may adversely affect our business, financial condition and results of operations.
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A significant labor dispute involving us or one or more of our customers or suppliers, or a labor dispute that otherwise affects our operations, could reduce our net sales and harm our profitability.
Labor disputes involving us or one or more of our customers or suppliers could affect our operations. If our customers or suppliers are unable to negotiate new labor agreements and our customers’ or suppliers’ plants experience slowdowns or closures as a result, our net sales and profitability could be negatively impacted.
While our employees are not currently unionized, they may attempt to form unions in the future, and the employees of our customers, suppliers and other service providers may be, or may in the future be, unionized. We cannot assure you that there will not be any strike, lock out or material labor dispute with respect to our business or those of our customers or suppliers in the future that materially affects our business, financial condition and results of operations.
We may be materially adversely affected by high fuel prices.
Fluctuations in the global supply of crude oil and the possibility of changes in government policies on the production, transportation and marketing of jet fuel make it impossible to predict the future availability and price of jet fuel. In the event there is an outbreak or escalation of hostilities or other conflicts or significant disruptions in oil production or delivery in oil-producing areas or elsewhere, there could be reductions in the production or importation of crude oil and significant increases in the cost of jet fuel. If there were major reductions in the availability of jet fuel or significant increases in its cost, commercial airlines would face increased operating costs. Due to the competitive nature of the airline industry, airlines are often unable to pass on increases in fuel prices to customers by increasing fares. As a result, an increase in jet fuel could result in a decrease in net income from either lower margins or, if airlines increase ticket fares, lower net sales from reduced airline travel. Decreases in airline profitability could decrease the demand for new commercial aircraft, resulting in delays of or reductions in deliveries of commercial aircraft that utilize the products we sell, and, as a result, our business, financial condition and results of operations could be materially adversely affected.
Our financial results may fluctuate from period-to-period, making quarter-to-quarter comparisons of our business, financial condition and results of operations less reliable indicators of our future performance.
There are many factors, such as the cyclical nature of the aerospace industry, fluctuations in our ad hoc sales, delays in major aircraft programs, planned production shutdowns, downward pressure on sales prices and changes in the volume of our customers’ orders that could cause our financial results to fluctuate from period-to-period. For example, during the year ended September 30, 2019, 24% of our net sales were derived from ad hoc sales. The prices we charge for ad hoc sales are oftentimes higher than the prices under our Contract sales. However, customers may not continue to purchase the same amount of products from us on an ad hoc basic as they have in the past, so it cannot be assured that in any given year we will be able to generate similar levels of ad hoc net sales as we did in the past. We are also actively working to transition customers from ad hoc purchases to Contracts, which may also result in a reduction in our ad hoc net sales. In addition, our acquisition of Haas has contributed to lower our ad hoc sales as a percentage of total net sales. A significant diminution in our ad hoc sales in any given period could result in fluctuations in our financial results and operating margins. As a result of these factors, we believe that quarter-to-quarter comparisons of our financial results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance.
We incur significant costs as a result of operating as a publicly traded company, and our management is required to devote substantial time to public company compliance requirements and investor needs.
As a publicly traded company, we incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act) and the rules of the SEC and the New York Stock Exchange have imposed various requirements on public companies. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations result in increased legal and financial compliance costs compared to a private company and make some activities more time-consuming and costly. For example, we believe these rules and regulations make it more difficult and more expensive for us to maintain appropriate levels of director and officer liability insurance.
We are subject to health, safety and environmental laws and regulations, any violation of which could subject us to significant liabilities and penalties.
We are subject to extensive federal, state, local and foreign laws, regulations, rules and ordinances relating to pollution, protection of the environment and human health and safety, and the handling, transportation, storage, treatment, disposal and remediation of hazardous substances, including potentially with respect to historical chemical blending and other
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activities that pre-dated the purchase of the Haas business by us. Actual or alleged violations of EHS laws or permit requirements could result in restrictions or prohibitions on operations and substantial civil or criminal sanctions, as well as, under some EHS laws, the assessment of strict liability and/or joint and several liability.
Furthermore, we may be liable for the costs of investigating and cleaning up environmental contamination on or from our operations or at off-site locations, including potentially with respect to historical chemical blending and other activities that pre-dated the purchase of the Haas business by us. We may therefore incur additional costs and expenditures beyond those currently anticipated to address all such known and unknown situations under existing and future EHS laws.
Governmental, regulatory and societal demands for increasing levels of product safety and environmental protection are resulting in increased pressure for more stringent regulatory control with respect to the chemical industry. The European Union’s REACH regulations enacted in 2009 have been a continuing source of compliance obligations and restrictions on certain chemicals, and REACH-like regimes have now been adopted in several other countries. In the United States, the core provisions of the TSCA were amended in June 2016 for the first time in nearly 40 years. Among the more significant changes are that these amendments mandate safety reviews of existing “high priority” chemicals and regulatory action to control any “unreasonable risks” identified as result of such reviews. The EPA also now must make a no “unreasonable risk” finding before a new chemical can be fully commercialized. These new mandates create uncertainty about whether existing chemicals of importance to our business may be designated for restriction and whether the new chemical approval process may become more difficult and costly.
These types of changes in the Company’s regulatory environment, particularly, but not limited to, in the United States, the European Union, Canada and China, could lead to heightened regulatory scrutiny and could adversely impact our ability to supply certain products and provide supply chain management services to our customers. Such changes also could result in compliance obligations for us directly or as part of our supply chain management services to customers, fines, ongoing monitoring and other future business activity restrictions, which could have a material adverse effect on our business, financial condition and results of operations. Finally, we have in the past sold products containing PFAS, including PFOA. Certain PFAS, including PFOA, have been targeted for risk assessment, restriction, and high priority remediation and have been the subject of ongoing and substantial litigation in the both the U.S. and European Union. We have not received any claims or enforcement actions from governments or third parties relating to PFOA or any other PFAS.
In addition, these concerns could influence public perceptions regarding our operations and our ability to attract and retain customers and employees. Moreover, changes in EHS regulations could inhibit or interrupt our operations, or require us to modify our facilities or operations. Accordingly, environmental or regulatory matters may cause us to incur significant unanticipated losses, costs, capital expenditures or liabilities, which could reduce our profitability. Such losses, costs, capital expenditures or liabilities will be subject to evolving regulatory requirements and will depend on the timing of the promulgation and enforcement of specific standards which impose requirements on our operations. As a result, these losses, costs, capital expenditures or liabilities may be more than currently anticipated.
Our operations involve risks associated with the handling, transportation, storage and disposal of chemical products that may increase our operating costs and reduce our profitability.
Our business is subject to hazards inherent in the handling, transportation, storage and disposal of chemical products. These hazards include: chemical spills, storage tank leaks, discharges or releases of toxic or hazardous substances or gases and other hazards incident to the handling, transportation, storage and disposal of dangerous chemicals. We are also potentially subject to other hazards, including natural disasters and severe weather; explosions and fires; transportation problems, including interruptions, spills and leaks; mechanical failures; unscheduled downtimes; labor difficulties; and other risks. Many potential hazards can cause bodily injury and loss of life, severe damage to or destruction of property and equipment and environmental damage, and may result in suspension of our own or our customers’ operations and the imposition of civil or criminal penalties and liabilities. Furthermore, we are subject to present and future claims with respect to our employees when working within our own operations or when supplying chemicals to and/or providing chemical management services at our customer’s operations, other persons, including potentially our customers and their employees, workers’ compensation and other matters.
We maintain property, business interruption, products liability and casualty insurance policies which we believe are in accordance with customary industry practices, as well as insurance policies covering other types of risks, including pollution legal liability insurance, but we are not fully insured against all potential hazards and risks incident to our business. Each of these insurance policies is subject to customary exclusions, deductibles and coverage limits, in accordance with industry standards and practices. As a result of market conditions, premiums and deductibles for certain insurance policies can increase substantially and, in some instances, certain insurance may become unavailable or available only for reduced amounts of
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coverage. If we were to incur a significant liability for which we were not fully insured, it could have a material adverse effect on our business, results of operations, financial condition and liquidity.
If the temperature control systems on which we rely fail, certain of the chemical products we sell may become “non-conforming” while in storage or in transit, and as a result, we may be responsible for providing replacement products to our customers, which could have a material adverse effect on our business, financial condition and results of operations.
Many of the chemical products we sell are sensitive to temperature. Our storage facilities and the vehicles maintained by the third-party delivery companies on whom we rely utilize sophisticated temperature control systems to ensure safe storage and handling of these products. If these temperature control systems fail, products that are sensitive to temperature may become
non-conforming to the customer’s specifications, and we may be responsible for providing replacement products, which could have a material adverse effect on our business, financial condition and results of operations.
Our reputation and/or our business, financial condition and results of operations could be adversely affected if one of the products we sell causes an aircraft to crash.
We may be exposed to liabilities for personal injury, death or property damage due to the failure of a product we have sold. We typically agree to indemnify our customers against certain liabilities resulting from the products we sell, and any third-party indemnification we seek from our suppliers and our liability insurance may not fully cover our indemnification obligations to customers. We also may not be able to maintain insurance coverage in the future at an acceptable cost. Any liability for which third-party indemnification is not available that is not covered by insurance could have a material adverse effect on our business, financial condition and results of operations.
In addition, a crash caused by one of the products we have sold could damage our reputation for selling quality products. We believe our customers consider safety and reliability as key criteria in selecting a provider of aircraft products and believe our reputation for quality assurance is a significant competitive strength. If a crash were to be caused by one of the products we sold, or if we were to otherwise fail to maintain a satisfactory record of safety and reliability, our ability to retain and attract customers may be materially adversely affected.
We sell products to a highly regulated industry and our business may be adversely affected if our suppliers or customers lose government approvals, if more stringent government regulations are enacted or if industry oversight is increased.
The aerospace industry is highly regulated in the United States and in other countries. The FAA prescribes standards and other requirements for aircraft components in the U.S. and comparable agencies, such as the European Aviation Safety Agency, the Civil Aviation Administration of China and the Japanese Civil Aviation Bureau, regulate these matters in other countries. Our suppliers and customers must generally be certified by the FAA, the DoD and similar agencies in foreign countries. If any of our suppliers’ government certifications are revoked, we would be less likely to buy such supplier’s products, and, as a result, would need to locate a suitable alternate supply of such products, which we may be unable to accomplish on commercially reasonable terms or at all. If any of our customers’ government certifications are revoked, their demand for the products we sell would decline. In each case, our business, financial condition and results of operations may be adversely affected.
In addition, if new and more stringent government regulations are adopted or if industry oversight increases, our suppliers and customers may incur significant expenses to comply with such new regulations or heightened industry oversight. In the case of our suppliers, these expenses may be passed on to us in the form of price increases, which we may be unable to pass along to our customers. In the case of our customers, these expenses may limit their ability to purchase products from us. In each case, our business, financial condition and results of operations may be adversely affected.
In the event the Merger Agreement is terminated, we may be unable to successfully consummate or integrate future acquisitions, which could negatively impact our business, financial condition and results of operations.
In the event the Merger Agreement is terminated, we may consider future acquisitions, some of which could be material to us. Depending upon the acquisition opportunities available, we may need to raise additional funds through the capital markets or arrange for additional debt financing to consummate such acquisitions. We may be unable to raise the capital required for future acquisitions on satisfactory terms or at all, which could adversely affect our business, financial condition and results of operations. Economics related to acquisitions including valuation, purchase price, synergies and competitive advantage may rely on our ability to efficiently integrate an acquired business with our existing enterprise, which we may not be able to execute successfully.
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The results of the United Kingdom’s referendum on withdrawal from the European Union may have a negative effect on global economic conditions, financial markets and our business, which could reduce the price of our common stock.
We have material business operations in both the United Kingdom and the broader European Union. In June 2016, a majority of voters in the United Kingdom elected to withdraw from the European Union in a national referendum. Following the national referendum, the government of the United Kingdom formally initiated the process for withdrawal in March 2017. The terms of any withdrawal are subject to a complex and ongoing negotiation between the United Kingdom and the European Union whose result and timing remain unclear and which has created significant political and economic uncertainty about the future trading relationship between the United Kingdom and the European Union in the event of a withdrawal, particularly in light of the possibility that an immediate, so-called “no deal” withdrawal could occur without a negotiated agreement.
These developments, or the perception that any of them could occur, have had and may continue to have a material adverse effect on global economic conditions and the stability of global financial markets, and could significantly reduce global market liquidity and restrict the ability of key market participants to operate in certain financial markets. Asset valuations, currency exchange rates and credit ratings may be especially subject to increased market volatility. Lack of clarity about future United Kingdom laws and regulations as the United Kingdom determines which European Union laws to replace or replicate in the event of a withdrawal, including financial laws and regulations, tax and free trade agreements, intellectual property rights, supply chain logistics, environmental, health and safety laws and regulations, immigration laws and employment laws, could decrease foreign direct investment in the United Kingdom, increase costs, depress economic activity and restrict our access to capital. If the United Kingdom and the European Union are unable to negotiate acceptable withdrawal terms or if other European Union member states pursue withdrawal, barrier-free access between the United Kingdom and other European Union member states or among the European economic area overall could be diminished or eliminated. Any of these factors could have a direct or indirect impact on our business in the United Kingdom and the broader European Union, on our suppliers and customers in the United Kingdom and the broader European Union and on our business outside the United Kingdom and the broader European Union, which could have a material adverse effect on our business, financial condition and results of operations and reduce the price of our common stock.
Our substantial indebtedness could adversely affect our financial health and could harm our ability to react to changes to our business.
As of September 30, 2019, our total indebtedness outstanding under our Credit Facilities (as defined in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities”) was $786.6 million, which was 52% of our total capitalization.
In addition, in the event the Merger Agreement is terminated, we may incur substantial additional indebtedness in the future. Our Credit Facilities contain certain significant qualifications and exceptions that allow us to incur additional indebtedness, and the indebtedness incurred in compliance with these qualifications and exceptions could be substantial. If we incur additional debt, the risks associated with our substantial leverage would increase.
Our substantial indebtedness could have important consequences to investors. For example, it could:
• | increase our vulnerability to general economic downturns and industry conditions; |
• | require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate requirements; |
• | limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; |
• | place us at a competitive disadvantage compared to competitors that have less debt; and |
• | limit, along with the financial and other restrictive covenants contained in the documents governing our indebtedness, among other things, our ability to borrow additional funds, make investments and incur liens. |
In addition, all of our debt under the Credit Facilities bears interest at floating rates, causing us to enter into interest rate swap derivative instruments to partially offset our exposure to interest rate fluctuations, which result in additional risks. As of September 30, 2019, we had a current interest rate hedge liability of $3.9 million. For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in Accumulated Other Comprehensive
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Income and subsequently reclassified into interest expense in the same period(s) during which the hedged transaction affects earnings. Derivatives not qualifying as cash flow hedges will default to a mark-to-market accounting treatment and are recorded directly to the income statement. Our derivatives also expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement, which could negate the intended protection from our hedge instruments. See further discussion on our derivative financial instruments in Note 12 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
In the event the Merger Agreement is terminated, our level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay, when due, the principal of, interest on or other amounts due in respect of our indebtedness, and we cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under the Credit Facilities or otherwise in amounts sufficient to enable us to service our indebtedness. In the event the Merger Agreement is terminated, if we cannot service our debt, we will have to take actions such as reducing or delaying capital investments, selling assets, restructuring or refinancing our debt or seeking additional equity capital and cannot assure you that we will be successful in implementing any such actions or that any actions we take will allow us to stay in compliance with the terms of the Credit Facilities or our other indebtedness.
The terms of the Credit Facilities and other debt instruments may restrict our current and future operations, particularly our ability to respond to changes or to take certain actions.
The Credit Facilities contain a number of restrictive covenants that impose significant operating and financial restrictions on us and may limit our ability to engage in acts that may be in our long-term best interests. The Credit Facilities include covenants restricting, among other things, our ability to:
• | incur or guarantee additional indebtedness or issue preferred stock; |
• | pay distributions on, redeem or repurchase our capital stock; |
• | make investments; |
• | sell assets; |
• | enter into agreements that restrict distributions or other payments from our restricted subsidiaries to us; |
• | incur or allow liens; |
• | consolidate, merge or transfer all or substantially all of our assets; |
• | engage in transactions with affiliates; |
• | enter into sale leaseback transactions; |
• | change fiscal periods; |
• | enter into agreements that restrict the granting of liens or the making of subsidiary distributions; |
• | enter into certain hedging arrangements outside of the ordinary course of business; |
• | make optional prepayments and modifications of certain debt instruments; and |
• | engage in certain business activities. |
In addition, the Credit Facilities contain a maximum leverage ratio covenant. A breach of this financial covenant could result in a default under the Credit Facilities. If any such default occurs, the lenders under the Credit Facilities may elect to declare all outstanding borrowings, together with accrued interest and other amounts payable thereunder, to be immediately due and payable. The lenders under the Credit Facilities also have the right in these circumstances to terminate any commitments to provide further borrowings. In addition, following an event of default under the Credit Facilities, the lenders under those facilities will have the right to proceed against the collateral granted to them to secure the debt, which includes our available cash. If the debt under the Credit Facilities was to be accelerated, we cannot assure you that our assets would be sufficient to repay in full our debt. See Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of
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Operations-Liquidity and Capital Resources-Credit Facilities” for additional information about the Company’s compliance with the Consolidated Total Leverage Ratio (as defined in the Credit Agreement) maintenance covenant contained in the Credit Agreement.
Risks Related to our Common Stock
The price of our common stock may fluctuate significantly, and you could lose all or part of your investment.
Volatility in the market price of our common stock may prevent you from being able to sell your common stock at or above the price you paid for your common stock. The market price of our common stock could fluctuate significantly for various reasons, including:
• | our inability to complete the Merger, or to complete the Merger in a timely manner; |
• | our operating and financial performance and prospects; |
• | our quarterly or annual earnings or those of other companies in our industry; |
• | the public’s reaction to our press releases, our other public announcements and our filings with the SEC; |
• | changes in, or failure to meet, earnings estimates or recommendations by research analysts who track our common stock or the stock of other companies in our industry; |
• | the failure of securities analysts to cover our common stock or changes in analyst recommendations; |
• | credit ratings downgrades or other negative actions by ratings agencies for us or our subsidiaries; |
• | strategic actions by us or our competitors, such as acquisitions or restructurings; |
• | new laws or regulations or new interpretations of existing laws or regulations applicable to our business; |
• | changes in accounting standards, policies, guidance, interpretations or principles; |
• | the delay in impact on our profitability caused by the time lag between when we experience cost increases until these increases flow through cost of sales because of our method of accounting for inventory, or the impact from our inability to pass on such cost increases to our customers; |
• | material litigation or government investigations; |
• | changes in general conditions in the United States and global economies or financial markets, including those resulting from war, incidents of terrorism or responses to such events; |
• | changes in key personnel; |
• | sales of common stock by us or members of our management team; |
• | the volume of trading in our common stock; and |
• | the realization of any risks described under “Risk Factors.” |
In addition, in recent years, the U.S. stock market has experienced significant price and volume fluctuations. This volatility has significantly impacted the market price of securities issued by many companies, including companies in our industry. The changes have often been unrelated or disproportionate to the operating performance of the affected companies. Hence, the price of our common stock could fluctuate based upon factors that have little or nothing to do with our Company, and these fluctuations could materially reduce our share price and cause you to lose all or part of your investment.
We have no plans to pay regular dividends on our common stock.
We have no plans to pay regular dividends on our common stock. The Merger Agreement restricts our ability to pay dividends, and in the event the Merger Agreement is terminated, we expect to continue to invest our future earnings, if any, to fund our growth and reduce debt. Any payment of future dividends will be at the discretion of our Board of Directors and will depend on, among other things, our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends and other considerations that our Board of Directors deems relevant. The Credit Facilities also effectively limit our ability to pay dividends.
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In the event the Merger Agreement is terminated, provisions of our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law might discourage, delay or prevent a subsequent change of control of our Company or changes in our management and, as a result, depress the trading price of our common stock.
In the event the Merger Agreement is terminated, our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could discourage, delay or prevent a subsequent change in control of our Company or changes in our management that the stockholders of our Company may deem advantageous. These provisions:
• | establish a classified Board of Directors, with three classes of directors; |
• | authorize the issuance of blank check preferred stock that our Board of Directors could issue to increase the number of outstanding shares and to discourage a takeover attempt; |
• | limit the ability of stockholders to remove directors; |
• | prohibit our stockholders from calling a special meeting of stockholders; |
• | prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of stockholders; |
• | provide that our Board of Directors is expressly authorized to amend, or to alter or repeal our bylaws; and |
• | establish advance notice requirements for nominations for election to our Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings. |
In the event the Merger Agreement is terminated, these anti-takeover defenses could discourage, delay or prevent a subsequent transaction involving a change in control of our Company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing, which could result in us taking corporate actions other than those you desire.
In the event the Merger Agreement is terminated, future sales of our common stock in the public market could lower our share price, and any additional capital raised by us through the sale of equity or convertible debt securities may dilute your ownership in our Company and may adversely affect the market price of our common stock.
In the event the Merger Agreement is terminated, we and our existing stockholders may sell additional shares of common stock in subsequent public offerings. We may also issue additional shares of common stock or convertible debt securities to finance future investments including acquisitions. As of September 30, 2019, we had 950,000,000 shares of common stock authorized and 100,031,244 shares of common stock outstanding. In addition, we have 2,135,597 shares of common stock issuable upon the exercise of options outstanding as of September 30, 2019 and 6,731,517 available shares of common stock reserved for issuance under the Wesco Aircraft Holdings, Inc. 2014 Incentive Award Plan, as amended (the 2014 Plan).
In the event the Merger Agreement is terminated, we would be unable to predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of our common stock will have on the market price of our common stock. In the event the Merger Agreement is terminated, sales of substantial amounts of our common stock (including sales pursuant to Carlyle’s registration rights and shares issued in connection with an acquisition), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our global headquarters is located at 24911 Avenue Stanford, Valencia, California 91355. As of September 30, 2019, we have a total of 55 administrative, sales and/or stocking facilities, all of which are leased, except for our global headquarters, which is owned by us. These facilities, including facilities in Tempe, Arizona; Rancho Cordova, California; McDonough, Georgia; Wichita, Kansas; Jonestown, Pennsylvania; Austin, Texas; Northlake, Texas; Mississauga, Ontario; Wroclaw, Poland; Clayton West, United Kingdom; Cleckheaton, United Kingdom; and Crawley, United Kingdom, are located in 17 countries (the U.S., Argentina, Australia, Canada, China, France, Germany, India, Israel, Ireland, Italy, Mexico, the Philippines, Poland, Singapore, Turkey and the United Kingdom).
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Our warehouse operations are divided between CSLs and Forward Stocking Locations (FSLs). Our CSLs serve as the primary supply warehouses for most of our net sales and also house our procurement, customer service, document control, IT, material support and quality assurance functions. Our CSLs are supported by sales offices throughout the U.S., Australia, Canada, China, France, Germany, India, Israel, Italy, Mexico, Singapore, Poland and the United Kingdom.
Complementing our CSLs and sales offices are FSLs. An FSL is a specialized stocking point for one or more Contracts located within a geographic region. FSLs are typically located either near or within a customer facility and are established to support large Contracts. In certain instances, FSLs initially established to service a single customer are expanded to service other regional customers.
We believe that our existing facilities, including both owned and leased, are in good condition and suitable for the conduct of our business. For additional information regarding obligations under operating leases, see Note 17 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
Since the announcement of the Merger, five putative class action complaints have been filed by and purportedly on behalf of alleged Company stockholders: Gray v. Wesco Aircraft Holdings, Inc., et al., No. 1:19-cv-08528 filed September 13, 2019 in the United States District Court for the Southern District of New York, Stein v. Wesco Aircraft Holdings, Inc., et al., No. 2:19-cv-08053 filed September 17, 2019 in the United States District Court for the Central District of California, Kent v. Wesco Aircraft Holdings, Inc., et al., No. 1:19-cv-01750 filed September 17, 2019 in the United States District Court for the District of Delaware, Sweeney v. Wesco Aircraft Holdings, Inc., et al., No. 19STCV33392 filed September 19, 2019 in the Superior Court of the State of California County of Los Angeles, and Bushansky v. Wesco Aircraft Holdings, Inc., et al., No. 2:19-cv-08274 filed September 24, 2019 in the United States District Court for the Central District of California (together, the Actions).
The Actions name as defendants the Company and the members of the Company’s Board of Directors. The Actions allege, among other things, that the definitive proxy statement on Schedule 14A filed by the Company on September 13, 2019 omits certain information regarding the confidentiality agreements between the Company and the potentially interested parties, the Company’s updated projections, the analysis performed by the financial advisors, and services the financial advisors previously provided to certain parties. The Actions seek, among other things, damages, attorneys’ fees and injunctive relief to prevent the Merger from closing. The Stein, Kent, Sweeney and Bushansky actions have been voluntarily dismissed.
We are involved in various other legal matters that arise in the ordinary course of our business. We believe that the ultimate outcome of such matters will not have a material adverse effect on our business, financial condition or results of operations. However, there can be no assurance that such actions will not be material or adversely affect our business, financial condition or results of operations. For more information see Note 17 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Stockholders and Market Information About Our Common Stock
Our common stock began trading on the New York Stock Exchange under the symbol “WAIR” on July 28, 2011. As of November 15, 2019, we had approximately 17 holders of record of our common stock and the closing price reported on the New York Stock Exchange of our common stock was $10.99 per share.
Dividends
We have no plans to pay regular dividends on our common stock. The Merger Agreement restricts our ability to pay dividends, and in the event the Merger Agreement is terminated, we intend to retain earnings, if any, for the future operation and expansion of our business and the repayment of debt. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon our results of operations, cash requirements, financial condition, contractual restrictions, restrictions imposed by applicable laws and other factors that our Board of Directors may deem relevant. The Credit Facilities also effectively limit our ability to pay dividends.
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
During the quarter ended September 30, 2019, we repurchased 160,252 shares of common stock in connection with shares surrendered to satisfy statutory minimum tax withholding obligations in connection with the vesting of restricted stock awards and restricted stock unit awards under the 2014 Plan. We expended approximately $1,758,000 to repurchase these shares.
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in millions) | ||||||||||||||||||
July 1, 2019 - July 31, 2019 | — | $ | — | — | $ | — | ||||||||||||||||
August 1, 2019 - August 31, 2019 | — | — | — | — | ||||||||||||||||||
September 1, 2019 - September 30, 2019 | 160,252 | 10.97 | — | — | ||||||||||||||||||
Total | 160,252 | $ | 10.97 | — | $ | — | ||||||||||||||||
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ITEM 6. SELECTED FINANCIAL DATA
The selected income statement and other data for each of the years ended September 30, 2019, 2018 and 2017 and the selected balance sheet data as of September 30, 2019 and 2018 have been derived from our audited consolidated financial statements that are included in this Annual Report. The selected income statement and other data for the years ended September 30, 2016, and 2015 and the selected balance sheet data as of September 30, 2017, 2016 and 2015 have been derived from audited consolidated financial statements that are not included in this Annual Report on Form 10-K.
The financial data set forth below are not necessarily indicative of future results of operations. This data should be read in conjunction with, and is qualified in its entirety by reference to, Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto included elsewhere in this Annual Report.
Years Ended September 30, | |||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
(in thousands except per share data) | |||||||||||||||||||
Consolidated statements of income data: | |||||||||||||||||||
Net sales | $ | 1,696,450 | $ | 1,570,450 | $ | 1,429,429 | $ | 1,477,366 | $ | 1,497,615 | |||||||||
Income (loss) from operations | $ | 78,512 | $ | 109,468 | $ | (208,795 | ) | $ | 158,750 | $ | (206,365 | ) | |||||||
Interest expense, net | (51,023 | ) | (48,880 | ) | (39,821 | ) | (36,901 | ) | (37,092 | ) | |||||||||
Other (expense) income, net | (816 | ) | 24 | 369 | 3,741 | 1,841 | |||||||||||||
Income (loss) before income taxes and equity method investment impairment charge | 26,673 | 60,612 | (248,247 | ) | 125,590 | (241,616 | ) | ||||||||||||
(Provision) benefit for income taxes | (2,338 | ) | (27,958 | ) | 10,901 | (34,212 | ) | 86,872 | |||||||||||
Income (loss) before equity method investment impairment charge | 24,335 | 32,654 | (237,346 | ) | 91,378 | (154,744 | ) | ||||||||||||
Equity method investment impairment charge | (2,966 | ) | |||||||||||||||||
Net income (loss) | $ | 21,369 | $ | 32,654 | $ | (237,346 | ) | $ | 91,378 | $ | (154,744 | ) | |||||||
Per share data: | |||||||||||||||||||
Net income (loss) per share | |||||||||||||||||||
Basic | $ | 0.21 | $ | 0.33 | $ | (2.40 | ) | $ | 0.94 | $ | (1.60 | ) | |||||||
Diluted | $ | 0.21 | $ | 0.33 | $ | (2.40 | ) | $ | 0.93 | $ | (1.60 | ) | |||||||
Weighted average shares outstanding | |||||||||||||||||||
Basic | 99,607 | 99,157 | 98,701 | 97,634 | 96,955 | ||||||||||||||
Diluted | 100,239 | 99,500 | 9,701 | 98,166 | 96,955 | ||||||||||||||
Consolidated Balance Sheet Data: | |||||||||||||||||||
Cash and cash equivalents | $ | 38,034 | $ | 46,222 | $ | 61,625 | $ | 77,061 | $ | 82,866 | |||||||||
Total assets (3) | 1,794,798 | 1,789,476 | 1,754,107 | 1,948,578 | 2,020,973 | ||||||||||||||
Long-term debt and capital lease obligations (1) (2) | 726,584 | 774,106 | 790,854 | 835,989 | 954,730 | ||||||||||||||
Total stockholders’ equity | 713,340 | 692,469 | 649,731 | 882,915 | 817,573 | ||||||||||||||
(1) | Total long-term debt and capital lease obligations excludes current portion. |
(2) | Total long-term debt related to term loan A and term loan B as of September 30, 2019, 2018, 2017 and 2016 was reduced by deferred debt issuance costs of $4.9 million, $8.8 million, $11.7 million and $7.6 million, respectively, as required by ASC 2015-03 which we adopted on October 1, 2016. Total long-term debt was not retroactively recast to include deferred debt issuance costs as of September 30, 2015. |
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(3) | Total assets as of September 30, 2016 was retroactively recast to reflect the reclassification of $7.6 million of deferred debt issuance costs related to term loan A and term loan B from long-term assets to long-term debt as required by ASC 2015-03. Total assets was not retroactively recast to exclude deferred debt issuance costs as of September 30, 2015. |
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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
On August 8, 2019, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Wolverine Intermediate Holding II Corporation, a Delaware corporation (Parent), and Wolverine Merger Corporation, a Delaware 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 of Platinum Equity Advisors, LLC, a U.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 the United 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 evolving U.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 of U.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 the FAA 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.
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Military Aerospace Market
Military production has fluctuated for many aircraft programs in the past few years. Increases in the U.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 upon U.S. government discretionary spending by the Budget Control Act and the Bipartisan Budget Act of 2013 remain in effect for these fiscal years, unless Congress 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.
Equity Method Investment
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 in China, the carrying value of which was $7.1 million and $10.4 million as of September 30, 2019 and 2018, respectively, and was included in “Other assets” in the unaudited Consolidated Balance Sheets. During the three months ended June 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 of September 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: the Americas, EMEA (Europe, Middle East and Africa) 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.
Net Sales
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 ended September 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 ended September 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 ended September 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 ended September 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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Inventories
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 and Indefinite-Lived Intangible Assets
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 on July 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.
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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 of July 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 the Americas, 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 of September 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 of July 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 of September 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 | $ | 9,303 | $ | 9,252 | $ | 7,335 | ||||||
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.
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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 September 30, 2019 compared with the year ended September 30, 2018
Net Sales
Consolidated net sales increased $126.0 million, or 8.0%, to $1,696.5 million for the year ended September 30, 2019 compared with $1,570.5 million for the year ended September 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 ended September 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
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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 ended September 30, 2019, compared to $28.0 million for the year ended September 30, 2018. For the year ended September 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 ended September 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 ended September 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 ended September 30, 2019 and 28.4% for the year ended September 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.
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Equity Method Investment Impairment Charge
Our APAC segment has an investment in a joint venture in China for which we apply the equity method of accounting. During the three months ended June 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 of September 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 ended September 30, 2019, compared to $32.7 million for the year ended September 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 September 30, 2018 compared with the year ended September 30, 2017
Net Sales
Consolidated net sales increased $141.0 million, or 9.9%, to $1,570.5 million for the year ended September 30, 2018 compared with $1,429.4 million for the year ended September 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 ended September 30, 2018 compared with a $208.8 million loss from operations for the year ended September 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 ended June 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 ended September 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 ended September 30, 2018, which increased $9.1 million, compared to the year ended September 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.
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(Provision) Benefit for Income Taxes
The income tax provision was $28.0 million for the year ended September 30, 2018, compared to the income tax benefit of $10.9 million for the year ended September 30, 2017. For the year ended September 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 ended September 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 ended September 30, 2017 as well as (3) an unfavorable provisional tax adjustment related to the enactment of the Tax Act which occurred during the year ended September 30, 2018. The difference in effective tax rates between years was partially offset in the current year by a decrease of the U.S. federal statutory tax rate from 35% to 21% related to the enactment of the Tax Act. The tax rate change became effective as of January 1, 2018 and therefore favorably impacts only a portion of our fiscal year ending September 30, 2018.
Net Income (Loss)
We reported net income of $32.7 million for the year ended September 30, 2018, compared to a net loss of $237.3 million for the year ended September 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 September 30, 2019 compared with the year ended September 30, 2018
Net Sales
Net sales for our Americas segment increased $112.8 million, or 8.9%, to $1,384.7 million for the year ended September 30, 2019, compared with $1,271.9 million for the year ended September 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 ended September 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.
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Income (Loss) from Operations
Income from operations for our Americas segment for the year ended September 30, 2019 was $117.2 million compared with $128.9 million for the year ended September 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 ended September 30, 2019 compared with 10.1% for the year ended September 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 ended September 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 ended September 30, 2019. SG&A as a percent of net sales increased 0.3 percentage points.
Year ended September 30, 2018 compared with the year ended September 30, 2017
Net Sales
Net sales for our Americas segment increased $129.5 million, or 11.3%, to $1,271.9 million for the year ended September 30, 2018, compared with $1,142.4 million for the year ended September 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 our Americas segment for the year ended September 30, 2018 was $128.9 million compared with a $213.5 million loss from operations for the year ended September 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 ended September 30, 2018, compared with 8.3% for the year ended September 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.
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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 September 30, 2019 compared with the year ended September 30, 2018
Net Sales
Net sales for our EMEA segment decreased $1.5 million, or 0.6%, to $260.6 million for the year ended September 30, 2019, compared with $262.1 million for the year ended September 30, 2018. For the year ended September 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 ended September 30, 2019, compared to $17.9 million for the year ended September 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 ended September 30, 2019, compared to 6.8% for the year ended September 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 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 $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 ended September 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 ended September 30, 2019. SG&A as a percent of net sales increased 1.2 percentage points.
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Year ended September 30, 2018 compared with the year ended September 30, 2017
Net Sales
Net sales for our EMEA segment increased $4.0 million, or 1.6%, to $262.1 million for the year ended September 30, 2018, compared with $258.1 million for the year ended September 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 ended September 30, 2018, compared to $25.1 million for the year ended September 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 ended September 30, 2018, compared to 9.7% for the year ended September 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. the U.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 September 30, 2019 compared with the year ended September 30, 2018
Net Sales
Net sales for our APAC segment increased $14.7 million, or 40.3%, to $51.2 million for the year ended September 30, 2019, compared with $36.5 million for the year ended September 30, 2018. For the year ended September 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
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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 September 30, 2018 compared with the year ended September 30, 2017
Net Sales
Net sales for our APAC segment increased $7.5 million, or 25.8%, to $36.5 million for the year ended September 30, 2018, compared with $29.0 million for the year ended September 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 ended September 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 ended June 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 | ||||||||||||||||||||
Years Ended September 30, | Americas | EMEA | APAC | Unallocated 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 Americas, EMEA and APAC segments are discussed previously. Following are discussions on SG&A expenses not allocated to the three segments.
Year ended September 30, 2019 compared with the year ended September 30, 2018
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 ended September 30, 2019 compared to $17.8 million
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for the prior year. Total SG&A expenses related to Wesco 2020 initiatives were $35.6 million for the year ended September 30, 2019, of which $15.5 million was allocated to the Americas 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 ended September 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 September 30, 2018 compared with the year ended September 30, 2017
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 of September 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 of September 30, 2019 and 2018, respectively. None of our cash and cash equivalents consisted of restricted cash and cash equivalents as of September 30, 2019 or 2018. All of our foreign cash and cash equivalents are readily convertible into U.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 of September 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 of September 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 ended September 30, 2019. The decrease primarily reflects our focus to reduce cash balances while we have borrowings under our revolving facility.
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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 September 30, 2019 compared with the year ended September 30, 2018
Our operating activities generated $86.4 million of cash in the year ended September 30, 2019, an increase of $68.5 million as compared to the year ended September 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 $17.1 million unfavorable impact due to higher accounts receivable 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 $1.4 million unfavorable net change in income taxes payable and income taxes receivable. |
Year ended September 30, 2018 compared with the year ended September 30, 2017
Our operating activities generated $17.9 million of cash in the year ended September 30, 2018, an increase of $44.8 million as compared to the year ended September 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.
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Investing Activities
Our investing activities used $21.1 million, $5.7 million and $8.9 million of cash in the years ended September 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 ended September 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 ended September 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 ended September 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 of December 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 of September 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 of September 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 on February 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 ended September 30, 2019. As of September 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 ended September 30,
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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 by February 24, 2020. In accordance with the terms of the Credit Agreement, we will make a final determination of the Excess Cash Flow payment by February 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 of September 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 September 30, 2019 (in thousands):
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 September 30, 2019, which was 5.05% for the term loan A 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 September 30, 2019. 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. |
(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 $1.6 million were presented as one aggregated amount in the total column on a separate line in this table. |
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(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 September 30, 2019, the Company had approximately $537.0 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Our exposure to market risk consists of foreign currency exchange rate fluctuations, changes in interest rates and fluctuations in fuel prices.
Foreign Currency Exposure
We operate on an international basis with a portion of our revenue and expenses transacted in currencies other than the U.S. dollar. During the years ended September 30, 2019 and 2018, 27% and 28%, respectively, of our net sales were made by our foreign subsidiaries, and our total net sales to customers outside the U.S. represented 32% and 33%, respectively, of our total net sales. The majority of our foreign sales are denominated in U.S. dollars and our major foreign subsidiaries have U.S. dollar functional currencies. We are exposed to three types of foreign currency exposure: economic exposure (which could impact our operating margins where the proportions of revenue and expenses denominated in a foreign currency are different), transactional exposure (which could result in foreign currency transaction gains or losses) and translation impacts (which could impact the amount of revenues, expenses, assets and liabilities reported in U.S. dollars).
Wesco Aircraft EMEA’s revenues and product costs are predominately denominated in U.S. dollars while its operating expenses are predominately denominated in British pounds. When our subsidiaries have revenues or expenses denominated in currencies other than their functional currencies, exchange rate movements can impact the operating margins reported by the subsidiaries. Due to the relative size of its operations, Wesco Aircraft EMEA represents our primary economic exposure with respect to foreign currency fluctuations. A hypothetical 10% weakening of the U.S. dollar against the British pound would have decreased our operating profit by $4.1 million and a hypothetical 10% weakening of the U.S. dollar against the euro would have decreased our operating profit by $1.3 million.
Certain assets, including certain bank accounts and accounts receivables of some of our business units, and certain liabilities, including accounts payable, exist in currencies other than the functional currency of the related business units. As a result, these assets and liabilities are affected by foreign currency exchange rate fluctuations. These balances are principally denominated in U.S. dollars, British pounds, euros, Canadian dollars, and Mexican pesos. When these transactions are entered into, outstanding or settled in a currency other than the functional currency, we may recognize a foreign currency transaction gain or loss. We attempt to limit this exposure by seeking to maintain a low net asset or net liability exposure to each currency.
The results of operations of our foreign subsidiaries are translated into U.S. dollars at the average foreign currency exchange rate for each relevant period. This impact is sometimes partially offset by the economic impact when the underlying sale or expense is denominated in U.S. dollars making the net exposure difficult to quantify, predict, or mitigate. Any adjustments resulting from the translation are recorded in accumulated other comprehensive loss on our statements of changes in stockholders’ equity.
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From time to time, we enter into currency forward and option contracts to limit exposure to foreign currency exchange rate changes and will continue to monitor our exposure to foreign currency exchange rate changes. As of September 30, 2019, we had no outstanding currency forward and option contracts. We do not enter into currency forward and option contracts for trading or speculative purposes.
Interest Rate Risk
Our principal interest rate exposure relates to our Credit Facilities, which bear interest at a variable rate. See Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities.” If interest rates rise, our debt service obligations on the borrowings under the Credit Facilities would increase even though the amount borrowed remained the same, which would affect our results of operations, financial condition and liquidity. If variable interest rates were to increase by 1.0%, our interest expense would increase $7.9 million per year, without taking into account the effect of any hedging instruments.
We periodically enter into interest rate swap agreements to manage interest rate risk on our borrowing activities. On September 30, 2019, we had two interest rate swap agreements, which effectively fixed our interest rate on variable rate debt of $380.8 million to 2.7900% plus the applicable margin. See further discussion on our derivative financial instruments in Note 12 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
We do not hold or issue derivative financial instruments for trading or speculative purposes.
Fuel Price Risk
Our principal direct exposure to increases in fuel prices is as a result of potential increased freight costs caused by fuel surcharges or other fuel cost-driven price increases implemented by the third-party package delivery companies on which we rely. Our annual freight costs (which consists of in-bound and out-bound freight-related costs, net of freight revenue) during the years ended September 30, 2019 and 2018 were $34.1 million and $29.7 million, respectively, and as a result, we do not believe the impact of these potential fuel surcharges or fuel cost-driven price increases would have a material impact on our business, financial condition and results of operations. However, increases in fuel prices may have an indirect material adverse effect on our business, financial condition and results of operations, as such increases may contribute to decreased airline profitability and, as a result, decreased demand for new commercial aircraft that utilize the products we sell. See Part I, Item 1A. “Risk Factors—Risks Related to Our Business and Industry—We may be materially adversely affected by high fuel prices.” We do not use derivatives to manage our exposure to fuel prices.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page | |
Audited Consolidated Financial Statements: | |
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Wesco Aircraft Holdings, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Wesco Aircraft Holdings, Inc. and its subsidiaries (the “Company”) as of September 30, 2019 and 2018, and the related consolidated statements of comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended September 30, 2019 including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of September 30, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Goodwill Impairment Assessment -- Americas and Europe, Middle East and Africa (EMEA) reporting units
As described in Notes 2 and 8 to the consolidated financial statements, the Company’s consolidated goodwill balance was $266.6 million as of September 30, 2019, and the goodwill associated with the Americas and EMEA reporting units was $204.2 million and $51.2 million, respectively. Goodwill impairment testing is performed at the reporting unit level on July 1 of each year, or more frequently when an event occurs or circumstances change such that it is more likely than not that the carrying amount may be impaired. Potential impairment is identified by comparing the fair value of a reporting unit with its carrying amount, including goodwill. The fair value of the Company’s reporting units is determined using a combination of a discounted cash flow analysis and market earnings multiples. As described in Note 2 by management, 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. The determination of fair value using market earnings multiples requires the use of key judgments, estimates and assumptions related to projected earnings and applying those amounts to earnings multiples using appropriate peer companies. Management develops the Company’s projected earnings using the same judgments, estimates, and assumptions used in the discounted cash flow analysis. As disclosed by management, for the Americas and EMEA reporting units, the fair value was in excess of carrying value by 29% and 10%, respectively.
The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment is a critical audit matter are there was significant judgment by management when developing the fair value measurement of the Americas and EMEA reporting units. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating significant assumptions used in management’s cash flow projections including revenue growth rates, projected operating margins, changes in working capital, terminal values, and discount rates. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in evaluating the audit evidence obtained from these procedures.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment assessment, including controls over the valuation of the Company’s reporting units. These procedures also included, among others, testing management’s process for developing the fair value estimate; evaluating the appropriateness of the discounted cash flow model and market earnings multiples model; testing the completeness, accuracy and relevance of underlying data used in the models; and evaluating the significant assumptions used by management, including revenue growth rates, projected operating margins, changes in working capital, terminal values and discount rates. Evaluating management’s assumptions related to revenue growth rates, projected operating margins and changes in working capital involved evaluating whether the assumptions used by management were reasonable considering (i) the current and past performance of each reporting unit, (ii) the consistency with external market and industry data, and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the Company’s discounted cash flow model, market earnings multiples model, and certain significant assumptions, including the terminal values and discount rates.
Valuation of Hardware Inventory
As described in Notes 2 and 5 to the consolidated financial statements, the Company’s inventory is stated at the lower of cost or net realizable value and includes hardware inventory. As of September 30, 2019, the consolidated inventory balance was $863 million. Management recorded an additional expense for excess and obsolete (E&O) related provisions of $28 million for the year ended September 30, 2019 to write down E&O hardware inventory to net realizable value. Management records provisions to write down hardware inventory to estimated net realizable value and uses subjective judgments and estimates
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including the forecasted demand for each part. The forecasted demand considers a number of factors, including historical sales trends, current and forecasted customer demand, including customer liability provisions based on selected contractual rights, consideration of available sales channels and the time horizon over which management expects the hardware part to be sold.
The principal considerations for our determination that performing procedures relating to the valuation of inventory is a critical audit matter are there was significant judgment by management when developing the forecasted demand for each part which is used to determine E&O hardware inventory. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating the reasonableness of forecasted demand, including judgments and estimates over historical sales trends, current and forecasted customer demand, including customer liability provisions based on selected contractual rights, consideration of available sales channels, and the time horizon over which parts are expected to be sold.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of the Company’s inventory, including judgments and estimates related to the forecasted demand, including factors related to historical sales trends, current and forecasted customer demand, including customer liability provisions based on selected contractual rights, consideration of available sales channels, and the time horizon over which parts are expected to be sold. These procedures also included, among others, testing source data, inputs, assumptions and methods used by management in the estimate of forecasted demand to determine E&O hardware inventory. Evaluating management’s factors related to forecasted demand involved evaluating whether judgments and estimates used by management were reasonable considering (i) whether the quantities were reasonable considering historical demand and projected demand based on customer purchasing patterns, (ii) customer contracts, and (iii) industry trends.
/s/ PricewaterhouseCoopers LLP |
Los Angeles, California |
November 25, 2019 |
We have served as the Company's auditor since 2006.
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Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
(dollars in thousands, except share and per share data)
As of September 30, | |||||||
2019 | 2018 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | $ | |||||
Accounts receivable, net of allowance for doubtful accounts of $2,849 and $2,877 at September 30, 2019 and 2018, respectively | |||||||
Inventories | |||||||
Prepaid expenses and other current assets | |||||||
Income taxes receivable | |||||||
Total current assets | |||||||
Property and equipment, net | |||||||
Deferred debt issuance costs, net | |||||||
Goodwill | |||||||
Intangible assets, net | |||||||
Deferred income tax assets | |||||||
Other assets | |||||||
Total assets | $ | $ | |||||
Liabilities and Stockholders’ Equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | $ | |||||
Accrued expenses and other current liabilities | |||||||
Income taxes payable | |||||||
Capital lease obligations, current portion | |||||||
Short-term borrowings and current portion of long-term debt | |||||||
Total current liabilities | |||||||
Capital lease obligations, less current portion | |||||||
Long-term debt, less current portion | |||||||
Deferred income tax liabilities | |||||||
Other liabilities | |||||||
Total liabilities | |||||||
Commitments and contingencies (see Note 4) | |||||||
Stockholders’ equity: | |||||||
Preferred stock, $0.001 par value per share: 50,000,000 shares authorized; no shares issued and outstanding | |||||||
Common stock, class A, $0.001 par value, 950,000,000 shares authorized, 100,031,244 and 99,557,885 shares issued and outstanding at September 30, 2019 and 2018, respectively | |||||||
Additional paid-in capital | |||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | |||
Retained earnings | |||||||
Total stockholders’ equity | |||||||
Total liabilities and stockholders’ equity | $ | $ | |||||
See the accompanying notes to the consolidated financial statements.
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Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
(in thousands, except per share data)
Years Ended September 30, | |||||||||||
2019 | 2018 | 2017 | |||||||||
Net sales | $ | $ | $ | ||||||||
Cost of sales | |||||||||||
Gross profit | |||||||||||
Selling, general and administrative expenses | |||||||||||
Goodwill impairment charge | |||||||||||
Income (loss) from operations | ( | ) | |||||||||
Interest expense, net | ( | ) | ( | ) | ( | ) | |||||
Other (expense) income, net | ( | ) | |||||||||
Income (loss) before income taxes and equity method investment impairment charge | ( | ) | |||||||||
(Provision) benefit for income taxes | ( | ) | ( | ) | |||||||
Income (loss) before equity method investment impairment charge | ( | ) | |||||||||
Equity method investment impairment charge | ( | ) | |||||||||
Net income (loss) | ( | ) | |||||||||
Other comprehensive loss, net of income taxes: | |||||||||||
Change in net foreign currency translation adjustment | ( | ) | ( | ) | ( | ) | |||||
Change in net unrealized holding (loss) gain on derivatives | ( | ) | |||||||||
Other comprehensive (loss) income, net of income taxes | ( | ) | ( | ) | |||||||
Comprehensive income (loss) | $ | $ | $ | ( | ) | ||||||
Net income (loss) per share: | |||||||||||
Basic | $ | $ | $ | ( | ) | ||||||
Diluted | $ | $ | $ | ( | ) | ||||||
Weighted average shares outstanding: | |||||||||||
Basic | |||||||||||
Diluted | |||||||||||
See the accompanying notes to the consolidated financial statements.
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Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
(dollars in thousands)
Common Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Loss | Retained Earnings | Total Shareholders' Equity | ||||||||||||||||||
Shares | Amount | |||||||||||||||||||||
Balance at September 30, 2016 | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
Issuance of common stock | — | — | — | |||||||||||||||||||
Settlement on restricted stock tax withholding | — | — | ( | ) | — | — | ( | ) | ||||||||||||||
Stock-based compensation expense | — | — | — | — | ||||||||||||||||||
Net loss | — | — | — | — | ( | ) | ( | ) | ||||||||||||||
Other comprehensive loss | — | — | — | ( | ) | — | ( | ) | ||||||||||||||
Balance at September 30, 2017 | ( | ) | ||||||||||||||||||||
Issuance of common stock | — | — | — | |||||||||||||||||||
Settlement on restricted stock tax withholding | — | — | ( | ) | — | — | ( | ) | ||||||||||||||
Effect of adoption of accounting standard | — | — | — | ( | ) | — | ||||||||||||||||
Stock-based compensation expense | — | — | — | — | ||||||||||||||||||
Net income | — | — | — | — | ||||||||||||||||||
Other comprehensive income | — | — | — | — | ||||||||||||||||||
Balance at September 30, 2018 | ( | ) | ||||||||||||||||||||
Issuance of common stock | — | — | ||||||||||||||||||||
Settlement on restricted stock tax withholding | — | — | ( | ) | — | — | ( | ) | ||||||||||||||
Stock-based compensation expense | — | — | — | — | ||||||||||||||||||
Net income | — | — | — | — | ||||||||||||||||||
Other comprehensive loss | — | — | — | ( | ) | — | ( | ) | ||||||||||||||
Balance at September 30, 2019 | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
See the accompanying notes to the consolidated financial statements.
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Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(dollars in thousands)
Years Ended September 30, | |||||||||||
2019 | 2018 | 2017 | |||||||||
Operating activities | |||||||||||
Net income (loss) | $ | $ | $ | ( | ) | ||||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | |||||||||||
Depreciation and amortization | |||||||||||
Amortization of deferred debt issuance costs | |||||||||||
Bad debt and sales return reserve | |||||||||||
Stock-based compensation expense | |||||||||||
Net inventory provision (see Note 5) | |||||||||||
Goodwill impairment charge | |||||||||||
Equity method investment impairment charge | |||||||||||
Deferred income taxes | ( | ) | |||||||||
Other non-cash items | ( | ) | ( | ) | |||||||
Subtotal | |||||||||||
Changes in assets and liabilities: | |||||||||||
Accounts receivable | ( | ) | ( | ) | ( | ) | |||||
Income tax receivable | ( | ) | ( | ) | |||||||
Inventories | ( | ) | ( | ) | |||||||
Prepaid expenses and other assets | ( | ) | ( | ) | |||||||
Accounts payable | ( | ) | |||||||||
Accrued expenses and other liabilities | |||||||||||
Income tax payable | ( | ) | ( | ) | |||||||
Net cash provided by (used in) operating activities | ( | ) | |||||||||
Investing activities | |||||||||||
Purchase of property and equipment | ( | ) | ( | ) | ( | ) | |||||
Net cash used in investing activities | ( | ) | ( | ) | ( | ) | |||||
Financing activities | |||||||||||
Proceeds from short-term borrowings | |||||||||||
Repayments of short-term borrowings | ( | ) | ( | ) | ( | ) | |||||
Repayments of long-term debt | ( | ) | ( | ) | ( | ) | |||||
Debt issuance costs | ( | ) | ( | ) | |||||||
Repayments of capital lease obligations | ( | ) | ( | ) | ( | ) | |||||
Net proceeds from exercise of stock options | |||||||||||
Settlement on restricted stock tax withholding | ( | ) | ( | ) | ( | ) | |||||
Net cash (used in) provided by financing activities | ( | ) | ( | ) | |||||||
Effect of foreign currency exchange rate on cash and cash equivalents | ( | ) | ( | ) | ( | ) | |||||
Net decrease in cash and cash equivalents | ( | ) | ( | ) | ( | ) | |||||
Cash and cash equivalents, beginning of period | |||||||||||
Cash and cash equivalents, end of period | $ | $ | $ | ||||||||
Supplemental disclosure of cash flow information (see Note 18)
See the accompanying notes to the consolidated financial statements.
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Wesco Aircraft Holdings, Inc. & Subsidiaries
Notes to the Consolidated Financial Statements
Note 1. Organization and Business
Our company, Wesco Aircraft Holdings, Inc., is a distributor and provider of comprehensive supply chain management services to the global aerospace industry. Our services range from traditional distribution to the management of supplier relationships, quality assurance, kitting, just-in-time (JIT) delivery, chemical management services, third-party logistics or fourth-party logistics programs and point-of-use inventory management.
In addition to the central stocking facilities, we use a network of forward stocking locations to service customers in a JIT and or ad hoc manner. There are 55 administrative, sales and/or stocking facilities around the world with concentrations in North America and Europe. In addition to product fulfillment, we also provide comprehensive supply chain management services for selected customers. These services include procurement and JIT inventory management and delivery services.
Acquisition of Wesco by Platinum
On August 8, 2019, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Wolverine Intermediate Holding II Corporation, a Delaware corporation (Parent), and Wolverine Merger Corporation, a Delaware corporation and a direct wholly owned subsidiary of Parent (Merger Sub). Parent and Merger Sub are affiliates of Platinum Equity Advisors, LLC, a U.S.-based private equity firm.
The Merger Agreement provides that, among other things and subject to the terms and conditions set forth therein, (1) Merger Sub will be merged with and into the Company, with the Company surviving as a wholly owned subsidiary of Parent (the Merger), and (2) at the effective time of the Merger (the Effective Time), and as a result of the Merger, each share of common stock, par value $0.001 per share, of the Company (each a Share and collectively, the Shares), that is issued and outstanding immediately prior to the Effective Time, other than shares to be cancelled pursuant to the terms of the Merger Agreement or Dissenting Shares (as defined in the Merger Agreement), shall be automatically converted into the right to receive $11.05 in cash, without interest, subject to any withholding of taxes required by applicable law.
The closing of the Merger is subject to various closing conditions, including, as of the date hereof, (1) the receipt of requisite competition and merger controls approval in the United Kingdom, (2) the absence of any order of any court of competent jurisdiction or any other Governmental Entity (as defined in the Merger Agreement) enjoining or prohibiting the consummation of the Merger which continues to be in effect, and (3) subject to Company Material Adverse Effect (as defined in the Merger Agreement) and other customary materiality qualifications, the accuracy of the representations and warranties contained in the Merger Agreement and compliance with the covenants and agreements contained in the Merger Agreement as of the closing of the Merger. The closing of the Merger is not subject to a financing condition. Assuming the satisfaction of the conditions set forth in the Merger Agreement, the Merger may close in the fourth calendar quarter of 2019 or early in the first calendar quarter of 2020. Upon the closing of the Merger, the Shares will be delisted from the New York Stock Exchange and deregistered under the Securities Exchange Act of 1934.
Note 2. Basis of Presentation and Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of majority-owned and controlled subsidiaries. All intercompany accounts, transactions and profits have been eliminated. When we do not have a controlling interest in an entity, but exert significant influence over the entity, we apply the equity method of accounting. Our financial statements have been prepared under the assumption that our Company will continue as a going concern. Our fiscal year ends September 30.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to, variable considerations in contract revenue recognition, receivable valuations and allowance for sales returns, inventory valuations of excess and
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obsolescence (E&O) inventories, the useful lives of long-lived assets including property, equipment and intangible assets, annual goodwill and indefinite-lived asset impairment assessment, stock-based compensation, income taxes and contingencies. Actual results could differ from such estimates.
Cash and Cash Equivalents
We consider all highly liquid investments with original maturities from date of purchase of three months or less to be cash equivalents.
Accounts Receivable
Accounts receivable consist of amounts owed to us by customers. We perform periodic credit evaluations of the financial condition of our customers, monitor collections and payments from customers, and generally do not require collateral. Accounts receivable are generally due within 30 to 60 days. We provide for the possible inability to collect accounts receivable by recording an allowance for doubtful accounts. We reserve for an account when we doubt whether it is collectible. We estimate our allowance for doubtful accounts based on historical experience, aging of accounts receivable and information regarding the creditworthiness of our customers. To date, losses have been within the range of management’s expectations. If the estimated allowance for doubtful accounts subsequently proves to be insufficient, additional allowances may be required.
Our allowance for doubtful accounts activity consists of the following (in thousands):
Allowance for Doubtful Accounts | Balance at Beginning of Period | Charges to Expenses | Write-offs | Balance at End of Period | |||||||||||
Year ended September 30, 2019 | $ | $ | $ | ( | ) | $ | |||||||||
Year ended September 30, 2018 | ( | ) | ( | ) | |||||||||||
Year ended September 30, 2017 | ( | ) | ( | ) | |||||||||||
Inventories
Inventories are stated at the lower of cost or net realizable value. The method by which amounts are removed from inventory and relieved to cost of sales is the weighted average cost for all inventory, except for chemical products for which the first-in, first-out method is used. In-bound freight-related costs of $1.5 million, $1.2 million and $1.5 million as of September 30, 2019, 2018, and 2017, respectively, are included as part of the cost of inventory held for resale.
Property and Equipment
Property and equipment are stated at cost, less accumulated amortization and depreciation, generally computed using the straight-line method over the estimated useful life of each asset. Leasehold improvements are amortized over the lesser of the remaining lease term or the estimated useful life of the assets. Expenditures for repair and maintenance costs are expensed as incurred, and expenditures for major renewals and improvements are capitalized. When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from the accounts and any gain or loss is reflected in the consolidated statements of comprehensive income (loss). The useful lives for depreciable assets are as follows:
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Buildings and improvements | 2 - 39.5 years |
Machinery and equipment | 5 - 7 years |
Furniture and fixtures | |
Vehicles | |
Computer hardware and software | 3 - 7 years |
Impairment of Long-Lived Assets
We assess potential impairments of our long-lived assets whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Factors we consider include, but are not limited to, significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of the acquired assets or the strategy for the overall business; and significant negative industry or economic trends. We have determined that our asset group for impairment testing comprises assets and liabilities of each of our reporting units, which consist of the Americas, Europe, Middle-East and Africa (EMEA) and Asia Pacific (APAC) reporting units (see change in our reporting units discussed under "Goodwill and Indefinite-Lived Intangible Assets" below). We have identified customer relationships as the primary asset because it is the principal asset from which the reporting units derive their cash flow generating capacity and has the longest remaining useful life. Recoverability is assessed by comparing the carrying value of the asset group to the undiscounted cash flows expected to be generated by these assets, which is a Level 3 fair value measurement (see fair value hierarchy discussion under Fair Value of Financial Instruments below). Impairment losses are measured as the amount by which the carrying values of the primary assets exceed their fair values.
Deferred Debt Issuance Costs
Goodwill
Goodwill, which represents the excess of the consideration paid over the fair value of the net assets acquired in a business combination, and other acquired intangible assets with indefinite lives are not amortized, but are tested for impairment at least annually or more frequently when an event occurs or circumstances change such that it is more likely than not 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 asset impairment testing is performed at the reporting unit level on July 1 of each year. 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. We may elect not to perform the qualitative assessment process and, instead, proceed directly to the two-step quantitative assessment process.
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
63
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.
Fair Value of Financial Instruments
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To determine fair value, we primarily utilize reported market transactions and discounted cash flow analysis. We use a three-tier fair value hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of us. Unobservable inputs are inputs that reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy prioritizes the inputs to valuation techniques into three broad levels whereby the highest priority is given to Level 1 inputs and the lowest to Level 3 inputs. The three broad categories are:
Level 1: | Quoted prices in active markets for identical assets or liabilities. | |
Level 2: | Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. | |
Level 3: | Unobservable inputs for the asset or liability. | |
The definition of fair value includes the consideration of nonperformance risk. Nonperformance risk refers to the risk that an obligation (either by a counterparty or us) will not be fulfilled. For financial assets traded in an active market (Level 1), the nonperformance risk is included in the market price. For certain other financial assets and liabilities (Level 2 and 3), our fair value calculations have been adjusted accordingly.
Fair value measurements are classified according to the lowest level input or value-driver that is significant to the valuation. A measurement may therefore be classified within Level 3 even though there may be significant inputs that are readily observable.
We use observable market-based inputs to calculate fair value of our interest rate swap agreements and outstanding debt instruments, in which case the measurements are classified within Level 2. If quoted or observable market prices are not available, fair value is based upon internally developed models that use, where possible, current market-based parameters such as interest rates, yield curves and currency rates. These measurements are classified within Level 3.
Where available, we utilize quoted market prices or observable inputs rather than unobservable inputs to determine fair value.
Derivative Financial Instruments
We periodically enter into cash flow derivative transactions, such as interest rate swap agreements, to hedge exposure to various risks related to interest rates. We recognize all derivatives at their fair value as either assets or liabilities. For derivatives designated and that qualify as cash flow hedges of interest rate risk, the changes in fair value of the derivative contract are recorded in accumulated other comprehensive loss, net of taxes, and subsequently reclassified into interest expense
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in the same period(s) during which the hedged transaction affects earnings. Derivatives not qualifying as cash flow hedges will default to a mark-to-market accounting treatment and will be recorded directly to the income statement. We present derivative instruments in operating, investing, or financing activities in our consolidated statements of cash flows consistent with the cash flows of the hedged item.
Comprehensive Income or Loss
Comprehensive income or loss generally represents all changes in stockholders’ equity, except those resulting from investments by or distributions to stockholders. Our comprehensive income or loss consists of net income or loss, foreign currency translation adjustments and fair value adjustments for cash flow hedges.
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.
Typically, our master purchase contracts with our customers run for three to five years without minimum purchase requirements annually or for 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 purchase 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 just-in-time (JIT) arrangements are provided by us contemporaneously with the delivery of these products and are not distinct from the products, and as such, once the products are 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 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. The Company does not provide service-type warranties.
Our chemical management services (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 commercial 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 over time for these contracts 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 that are recorded on a net basis.
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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 allowance 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.
In connection with our JIT supply chain management programs, at times, we assume customer inventory on a consignment basis. This consigned inventory remains the property of the customer but is managed and distributed by us. We earn a fixed fee per unit on each shipment of the consigned inventory; such amounts represent less than 1 % of consolidated net sales.
Equity Method Investment
Shipping and Handling Costs
We record revenue for shipping and handling billed to our customers. Shipping and handling revenues were $4.4 million, $3.9 million and $4.6 million for the years ended September 30, 2019, 2018 and 2017, respectively.
Shipping and handling costs are primarily included in cost of sales. Total shipping and handling costs were $38.5 million, $33.5 million and $31.4 million for the years ended September 30, 2019, 2018 and 2017, respectively.
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 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.
Concentration of Credit Risk and Significant Vendors and Customers
We maintain our cash and cash equivalents in bank deposit accounts which, at times, may exceed federally insured limits. We have not experienced any losses in such accounts and do not believe we are exposed to any significant credit risk from cash and cash equivalents.
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We purchase our products on credit terms from vendors located throughout North America and Europe. For the years ended September 30, 2019, 2018 and 2017, we made 9 %, 12 %, and 13 %, respectively, of our purchases from Precision Castparts Corp. and the amounts payable to this supplier were 3 % and 4 % of total accounts payable at September 30, 2019 and 2018, respectively. Additionally, for the years ended September 30, 2019, 2018 and 2017, we made 8 %, 8 %, and 9 %, respectively, of our purchases from Arconic and the amounts payable to this supplier were 3 % and 6 % of total accounts payable at September 30, 2019 and 2018, respectively. The majority of the products we sell are available through multiple channels and, therefore, this reduces the risk related to any vendor relationship.
For the years ended September 30, 2019, 2018 and 2017, we derived approximately 13 %, 11 % and 11 % of our total net sales, respectively, from Lockheed Martin. Government sales, which were derived from various military parts procurement agencies such as the U.S. Defense Logistics Agency, or from defense contractors buying on their behalf, comprised 16 %, 14 % and 16 % of our net sales for the years ended September 30, 2019, 2018 and 2017, respectively.
Foreign Currency Translation and Transactions
September 30, 2019, 2018 and 2017, realized foreign currency transaction (losses) gains were $(0.8 ) million, $0.3 million and $0.1 million, respectively.
Stock-Based Compensation
We recognize all stock-based awards to employees and directors as stock-based compensation expense based upon their fair values on the date of grant.
We estimate the fair value of stock-based payment awards on the date of grant. The value of the portion of the award that is ultimately expected to vest is recognized as an expense during the requisite service periods. We have estimated the fair value for each option award as of the date of grant using the Black-Scholes option pricing model. The Black-Scholes option pricing model considers, among other factors, the expected life of the award and the expected volatility of our stock price. We recognize the stock-based compensation expense over the requisite service period (generally a vesting term of three years ) using the graded vesting method for performance condition awards and the straight-line method for service condition only awards, which is generally a vesting term of three years . Stock options typically have a contractual term of 10 years. The stock options granted have an exercise price equal to the closing stock price of our common stock on the grant date. Compensation expense for restricted stock units and awards are based on the market price of the shares underlying the awards on the grant date. Compensation expense for performance-based awards reflects the estimated probability that the performance condition will be met. Compensation expense 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.
Net Income or Net Loss Per Share
Note 3. Recent Accounting Pronouncements
Changes to generally accepted accounting principles in the United States (GAAP) are established by the Financial Accounting Standards Board (FASB), in the form of Accounting Standards Updates (ASUs), to the FASB’s Accounting Standards Codification.
We consider the applicability and impact of all ASUs. ASUs not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial position and results of operations.
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New Accounting Standards Updates
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the current requirements for testing goodwill for impairment by eliminating the second step of the two-step impairment test to measure the amount of an impairment loss. ASU 2017-04 is effective for the Company in fiscal year 2021, including interim reporting periods within that reporting period, and all annual and interim reporting periods thereafter. Early adoption is permitted. The adoption of ASU 2017-04 is not expected to have a material impact on our consolidated financial statements.
Leases
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 is amended by ASU 2018-01, ASU 2018-10, ASU 2018-11, ASU 2018-20 and ASU 2019-01, which FASB issued in January 2018, July 2018, July 2018, December 2018 and March 2019, respectively (collectively, the amended ASU 2016-02). The amended ASU 2016-02 requires lessees to recognize on the balance sheet a right-of-use asset, representing its right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from current GAAP. The amended ASU 2016-02 retains a distinction between finance leases (i.e. capital leases under current GAAP) and operating leases. The classification criteria for distinguishing between finance leases and operating leases will be substantially similar to the classification criteria for distinguishing between capital leases and operating leases under current GAAP. The amended ASU 2016-02 also requires qualitative and quantitative disclosures designed to assess the amount, timing, and uncertainty of cash flows arising from leases. A modified retrospective transition approach is permitted to be used when an entity adopts the amended ASU 2016-02, which includes a number of optional practical expedients that entities may elect to apply.
We adopted the amended ASU 2016-02 on October 1, 2019. As allowed under this guidance, we have elected to apply it using a modified retrospective approach. This approach applies to all leases that exist at or commence after the date of our initial application. As such, prior year comparative periods will not be adjusted. We will elect the package of practical expedients permitted under the transition guidance within the new standard, which among other things, permits companies not to reassess prior conclusions about lease identification, lease classification and initial direct costs. We did not elect the hindsight practical expedient. The Company has designed and implemented internal controls, policies and processes to comply with the new standard. The adoption of the amended ASU 2016-02 will result in the recognition of operating lease right-of-use (ROU) assets and lease liabilities of approximately $56.0 million and $60.0 million, respectively, based on the operating lease portfolio as of October 1, 2019. The operating lease liability and the corresponding ROU asset primarily relate to our worldwide office space and distribution center leases, including leases for certain third party operated distribution center locations. The prospective impact on the consolidated statements of comprehensive income (loss) under the new standard is substantially similar compared to the current lease accounting model. Our accounting for capital leases related to computer hardware and equipment, which are referred to as financing leases under the new standard, is substantially unchanged under the new standard. The adoption of the amended ASU 2016-02 is not expected to have a material impact on our liquidity or cash flows.
Adopted Accounting Standards Updates
On October 1, 2018, we adopted ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. The adoption of ASU 2016-01 did not have a material impact on our consolidated financial statements.
On October 1, 2018, we adopted ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which specifies the modification accounting applicable to any entity that changes the terms or conditions of a share-based payment award. The adoption of ASU 2017-09 did not have a material impact on our consolidated financial statements.
Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 is amended by ASU 2015-14, ASU 2016-08, ASU 2016-10, ASU 2016-11, ASU 2016-12, ASU 2016-20, ASU 2017-10, ASU 2017-13 and ASU 2017-14, which the FASB issued in August 2015, March 2016, April 2016, May 2016, May 2016, December 2016, May 2017, September 2017 and November 2017, respectively (collectively, the amended ASU 2014-09). The amended ASU 2014-09 provides a single comprehensive model for the recognition of revenue arising from contracts with customers and
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supersedes most current revenue recognition guidance, including industry-specific guidance. It requires an entity to recognize revenue when the entity transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amended ASU 2014-09 creates a five-step model that requires entities to exercise judgment when considering the terms of contract(s), which includes (1) identifying the contract(s) with the customer, (2) identifying the separate performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to the separate performance obligations, and (5) recognizing revenue as each performance obligation is satisfied. The amended ASU 2014-09 requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including qualitative and quantitative information about contracts with customers, significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract.
Effective October 1, 2018, we adopted the amended ASU 2014-09 (ASC 606) using the modified retrospective method of adoption, which resulted in no material changes to our opening consolidated balance sheet at the beginning of October 1, 2018. Our initial and incremental contract acquisition costs including sign up commissions and set up costs, which are required to be capitalized under ASC 606, are insignificant and expensed as incurred. Our revenues recognized under ASC 606 for the year ended September 30, 2019 were not materially different from what would have been recognized under the previous revenue standard, ASC 605, that is superseded. Prior period consolidated statements of comprehensive income (loss) remain unchanged.
We have designed and implemented internal controls, policies and processes to comply with ASC 606. The additional disclosures required by ASC 606 are included in Note 2 and Note 20.
Note 4. Commitments and Contingencies
Operating Leases
We lease office and warehouse facilities (certain of which are from related parties) and warehouse equipment under various non-concealable operating leases that expire at various dates through June 30, 2044. Certain leases contain escalation clauses based on the Consumer Price Index. We are also committed under the terms of certain of these operating lease agreements to pay property taxes, insurance, utilities and maintenance costs.
Future minimum rental payments under operating leases as of September 30, 2019 are as follows (dollars in thousands):
Third Party | Related Party | Total | |||||||||
Years Ended September 30, | |||||||||||
2020 | $ | $ | $ | ||||||||
2021 | |||||||||||
2022 | |||||||||||
2023 | |||||||||||
2024 | |||||||||||
Thereafter | |||||||||||
$ | $ | $ | |||||||||
Total rent expense for the years ended September 30, 2019, 2018 and 2017 was $14.4 million, $13.4 million and $12.6 million, respectively.
Capital Lease Commitments
We lease certain equipment under capital lease agreements that require minimum monthly payments that expire at various dates through June 30, 2023. The gross amount of these leases at September 30, 2019 and September 30, 2018 are $2.7 million and $4.8 million, respectively.
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Future minimum lease payments under capital lease agreements as of September 30, 2019 are as follows (in thousands):
Years Ended September 30, | |||
2020 | $ | ||
2021 | |||
2022 | |||
2023 | |||
Less: Interest | ( | ) | |
Total | $ | ||
Indemnifications
In the normal course of business, we provide indemnifications to our customers with regard to certain products and enter into contracts and agreements that may contain representations and warranties and provide for general indemnifications. Our maximum exposure under many of these agreements is not quantifiable as we have a limited history of prior indemnification claims and payments. Payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, we could incur costs in the future as a result of indemnification obligations.
Litigation
Since the announcement of the Merger, five putative class action complaints have been filed by and purportedly on behalf of alleged Company stockholders: Gray v. Wesco Aircraft Holdings, Inc., et al., No. 1:19-cv-08528 filed September 13, 2019 in the United States District Court for the Southern District of New York, Stein v. Wesco Aircraft Holdings, Inc., et al., No. 2:19-cv-08053 filed September 17, 2019 in the United States District Court for the Central District of California, Kent v. Wesco Aircraft Holdings, Inc., et al., No. 1:19-cv-01750 filed September 17, 2019 in the United States District Court for the District of Delaware, Sweeney v. Wesco Aircraft Holdings, Inc., et al., No. 19STCV33392 filed September 19, 2019 in the Superior Court of the State of California County of Los Angeles, and Bushansky v. Wesco Aircraft Holdings, Inc., et al., No. 2:19-cv-08274 filed September 24, 2019 in the United States District Court for the Central District of California (together, the Actions).
The Actions name as defendants the Company and the members of the Company’s Board of Directors. The Actions allege, among other things, that the definitive proxy statement on Schedule 14A filed by the Company on September 13, 2019 omits certain information regarding the confidentiality agreements between the Company and the potentially interested parties, the Company’s updated projections, the analysis performed by the financial advisors, and services the financial advisors previously provided to certain parties. The Actions seek, among other things, damages, attorneys’ fees and injunctive relief to prevent the Merger from closing. The Stein, Kent, Sweeney and Bushansky actions have been voluntarily dismissed.
Note 5. Inventory
Our inventory is comprised solely of finished goods. We record provisions to write down E&O inventory to estimated net realizable value.
During the years ended September 30, 2019, 2018 and 2017, net adjustments to cost of sales related to E&O inventory related activities were $2.7 million, $16.8 million and $12.9 million, respectively. The net adjustments for the years ended September 30, 2019, 2018 and 2017 reflect a combination of additional expense for E&O related provisions ($28.0 million, $40.0 million and $33.2 million, respectively) offset by sales and disposals ($25.3 million, $23.2 million and $20.3 million, respectively) of inventory for which an E&O provision was provided previously through expense recognized in prior periods. Our inventory also is impacted by shrinkage and spoilage cost, which was $24.2 million, $7.9 million and $15.6 million for the
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years ended September 30, 2019. 2018 and 2017, respectively. Inventory shrinkage and spoilage typically is incurred as a normal part of our business. We will provide for shrinkage and spoilage on a periodic basis along with making provisions as required based upon operational activity. We believe that these amounts appropriately write-down our inventory to its net realizable value.
Note 6. Related Party Transactions
We entered into a management agreement with The Carlyle Group to provide certain financial, strategic advisory and consultancy services. Under this management agreement, we are obligated to pay The Carlyle Group, or a designee thereof, an annual management fee of $1.0 million (paid quarterly) plus fees and expenses associated with company-related meetings. The management fee was waived by an entity affiliated with The Carlyle Group for fiscal years 2019 and 2018 and for the third and fourth quarters of fiscal year 2017. We incurred expense of $0.1 million, $0.1 million and $0.6 million for the years ended September 30, 2019, 2018 and 2017, respectively, related to this management agreement. These amounts were paid to The Carlyle Group during the years ended September 30, 2019, 2018 and 2017.
We lease several office and warehouse facilities under operating lease agreements from entities controlled by our former chief executive officer, who is also our Chairman of the Board. Rent expense on these facilities was $1.8 million, $1.9 million and $1.6 million for the years ended September 30, 2019, 2018 and 2017, respectively (see Note 4).
Note 7. Property and Equipment, net
Property and equipment, net, consists of the following at September 30 (in thousands):
2019 | 2018 | ||||||
Land, buildings and improvements | $ | $ | |||||
Machinery and equipment | |||||||
Furniture and fixtures | |||||||
Vehicles | |||||||
Computer hardware | |||||||
Computer software | |||||||
Construction in progress | |||||||
Less: accumulated depreciation | ( | ) | ( | ) | |||
Property and equipment, net | $ | $ | |||||
At September 30, 2019 and 2018, property and equipment included assets of $17.9 million and $18.4 million, respectively, acquired under capital lease arrangements. Accumulated amortization of assets acquired under capital leases was $14.7 million and $11.3 million as of September 30, 2019 and 2018, respectively.
Depreciation and amortization expense for property and equipment was $14.4 million, $14.4 million and $13.4 million during the years ended September 30, 2019, 2018 and 2017, respectively (including amortization expense of $4.3 million, $3.4 million and $2.5 million on assets acquired under capital leases for the years ended September 30, 2019, 2018 and 2017, respectively).
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Note 8. Goodwill and Intangible Assets, net
Goodwill
A reconciliation of our goodwill balance is as follows (in thousands):
Americas September 30, | EMEA September 30, | APAC September 30, | Consolidated September 30, | ||||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||
Beginning balance, gross | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||
Accumulated impairment | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||
Beginning balance, net | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||
Ending balance, gross | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||
Accumulated impairment | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||
Ending balance, net | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||
We performed our annual Step 1 goodwill impairment tests on July 1, 2019 and 2018. The results of these tests indicated that the estimated fair values of our reporting units exceeded their carrying values.
Intangible Assets
As of September 30, 2019 and 2018, the gross amounts and accumulated amortization of intangible assets is as follows (in thousands):
2019 | 2018 | ||||||||||||||||||||
Gross Amount | Accumulated Amortization | Net Amount | Gross Amount | Accumulated Amortization | Net Amount | ||||||||||||||||
Customer relationships (12 to 20 year life) | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||
Trademarks (5 years to indefinite life) | ( | ) | ( | ) | |||||||||||||||||
Backlog (2 year life) | ( | ) | ( | ) | |||||||||||||||||
Non-compete agreements (3 to 4 year life) | ( | ) | ( | ) | |||||||||||||||||
Technology (10 year life) | ( | ) | ( | ) | |||||||||||||||||
Total intangible assets | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||
Estimated future intangible amortization expense as of September 30, 2019 is as follows (in thousands):
2020 | $ | ||
2021 | |||
2022 | |||
2023 | |||
2024 | |||
Thereafter | |||
$ | |||
Amortization expense included in the statements of comprehensive income (loss) for the years ended September 30, 2019, 2018 and 2017 was $14.9 million, $14.9 million and $14.9 million, respectively. In addition to amortizing intangibles, we assigned an indefinite life to the Wesco Aircraft trademark. As of September 30, 2019 and 2018, the trademark had a carrying value of $37.8 million.
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Note 9. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following (in thousands):
September 30, | |||||||
2019 | 2018 | ||||||
Accrued compensation and related expenses | $ | $ | |||||
Accrued customer rebates | |||||||
Accrued Merger related expenses | |||||||
Interest rate swap | |||||||
Accrued construction in progress costs | |||||||
Accrued professional fees | |||||||
Accrued taxes (property, sales and use) | |||||||
Accrued severance and other expenses | |||||||
Deferred revenue | |||||||
Other accruals | |||||||
Accrued expenses and other current liabilities | $ | $ | |||||
Note 10. Fair Value of Financial Instruments
Our financial instruments include cash and cash equivalents, accounts receivable and payable, other current liabilities and a revolving facility. The carrying amounts of these instruments approximate fair value because of their short-term maturities. The fair value of interest rate swap instruments is determined using pricing models that use observable market inputs as of the balance sheet date, a Level 2 measurement. The fair value of the long-term debt instruments is determined using current applicable rates for similar instruments as of the balance sheet date, a Level 2 measurement.
The carrying amounts and fair values of the debt instruments and interest rate swap hedge instruments were as follows (in thousands):
September 30, 2019 | September 30, 2018 | ||||||||||||||
Principal Amount | Fair Value | Principal Amount | Fair Value | ||||||||||||
Term loan A | $ | $ | $ | $ | |||||||||||
Term loan B | |||||||||||||||
Revolving facility | |||||||||||||||
Interest rate swap hedge assets (liabilities), net | ( | ) | ( | ) | |||||||||||
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Note 11. Long-Term Debt
Long-term debt consists of the following (in thousands):
September 30, 2019 | September 30, 2018 | |||||||||||||||||||||||
Principal Amount | Deferred Debt Issuance Costs | Carrying Amount | Principal Amount | Deferred Debt Issuance Costs | Carrying Amount | |||||||||||||||||||
Term loan A facility | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | ||||||||||||||
Term loan B facility | ( | ) | ( | ) | ||||||||||||||||||||
Revolving facility | ||||||||||||||||||||||||
( | ) | ( | ) | |||||||||||||||||||||
Less: current portion | — | — | ||||||||||||||||||||||
Non-current portion | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | ||||||||||||||
Aggregate maturities of long-term debt as of September 30, 2019 are as follows (in thousands):
Years Ended September 30, | |||
2020 | $ | ||
2021 | |||
$ | |||
Senior Secured Credit Facilities
The credit agreement, dated as of December 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 term loan A facility, the revolving facility and the term loan B facility, together, as the “Credit Facilities.”
As of September 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) $6.0 million of indebtedness under the revolving facility, and (3) $440.6 million of indebtedness under the term loan B facility. As of September 30, 2019, a $1.0 million letter of credit was outstanding and $173.0 million was available for borrowing under the revolving facility to fund our operating and investing activities without breaching any covenants contained in the Credit Agreement.
During the year ended September 30, 2019, we borrowed $95.0 million under the revolving facility, and made our required payments of $20.0 million under the term loan A facility and voluntary prepayments totaling $143.0 million on our borrowings under the revolving facility.
The interest rate for the term loan A facility is based on our Consolidated Total Leverage Ratio (as such term is defined in the Credit Agreement) as determined in the most recently delivered financial statements, with the respective margins ranging from 2.00 % to 3.00 % for Eurocurrency loans and 1.00 % to 2.00 % for ABR loans. 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. As of September 30, 2019 and 2018, the interest rate for borrowings under the term loan A facility was 5.05 % and 5.25 %, respectively, which approximated the effective interest rate.
The interest rate for the term loan B facility has a margin of 2.50 % per annum for Eurocurrency loans (subject to a minimum Eurocurrency rate floor of 0.75 % per annum) or 1.50 % per annum for ABR loans (subject to a minimum ABR floor of 1.75 % per annum). 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 on February 28, 2021. We have paid in advance all the required quarterly installments until the term loan B reaches its maturity. As of September 30, 2019 and 2018, the interest rate for borrowings under the term loan B facility was 4.55 % and 4.75 %, respectively, which approximated the effective interest rate. We have two interest rate swap agreements relating to this indebtedness, which are described in greater detail in Note 12.
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The interest rate for the revolving facility is based on our Consolidated Total Leverage Ratio as determined in the most recently delivered financial statements, with the respective margins ranging from 2.00 % to 3.00 % for Eurocurrency loans and 1.00 % to 2.00 % for ABR loans. 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. As of September 30, 2019 and 2018, the weighted-average interest rate for borrowings under the revolving facility was 5.04 % and 5.15 %, respectively.
Our borrowings under the Credit Facilities are guaranteed by us and all of our direct and indirect, wholly-owned, domestic restricted subsidiaries (subject to certain exceptions) and secured by a first lien on substantially all of our assets and the assets of our guarantor subsidiaries, including capital stock of the subsidiaries (in each case, subject to certain exceptions).
The Credit Agreement 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. 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 ending September 30, 2019. As of September 30, 2019, we were in compliance with all of the foregoing covenants, and our Consolidated Total Leverage Ratio was 3.86 . The Consolidated Total Leverage Ratio requirement for the financial covenant is scheduled to step-down to 4.00 for the quarters ending June 30, 2020, September 30, 2020, December 31, 2020 and March 31, 2021; and 3.00 for the quarter ending June 30, 2021 and thereafter. Based on our current covenants and forecasts, we expect to be in compliance for the one-year period after November 25, 2019.
The Credit Agreement also includes an Excess Cash Flow Percentage (as such term is defined in the Credit Agreement), which is currently set at 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 ended September 30, 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 by February 24, 2020. In accordance with the terms of the Credit Agreement, we will make a final determination of the Excess Cash Flow payment by February 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 for further discussion about the Merger.
The following table summarizes the total deferred debt issuance costs for the term loan A facility, the term loan B facility and the revolving facility as of September 30, 2019 and 2018 (dollars in thousands). The remaining deferred debt issuance costs as of September 30, 2019 will be amortized over their remaining terms.
Term Loan A Facility | Term Loan B Facility | Revolving Facility | Total | |||||||||||||
Deferred debt issuance costs as of September 30, 2018 | $ | $ | $ | $ | ||||||||||||
Amortization of deferred debt issuance costs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Deferred debt issuance costs as of September 30, 2019 | $ | $ | $ | $ | ||||||||||||
UK Line of Credit
Our subsidiary, Wesco Aircraft EMEA, has a £5.0 million ($6.1 million based on the September 30, 2019 exchange rate) line of credit that automatically renews annually on November 1. The line of credit bears interest based on the base rate plus an applicable margin of 1.65 %. As of September 30, 2019, the full £5.0 million was available for borrowing under the UK line of credit without breaching any covenants contained in the agreements governing our indebtedness.
Note 12. Derivative Financial Instruments
Our primary objective in using financial derivatives is to reduce the volatility of earnings and cash flows associated with fluctuations in foreign exchange rates and changes in interest rates. Our use of financial derivatives exposes us to credit risk to the extent that associated counterparties may be unable to meet the terms of the derivatives. We, however, seek to mitigate such risks by limiting our counterparties to major financial institutions. In addition, the potential risk of loss with any
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one counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.
Cash Flow Hedges of Interest Rate Risk
Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish these objectives, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for our making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. We have two interest rate swap agreements outstanding (the Swap Agreements) that we have designated as a cash flow hedge in order to reduce our exposure to variability in cash flows related to interest payments on a portion of our outstanding debt. The Swap Agreements were entered into on May 14, 2018, had a total notional amount of $380.8 million as of September 30, 2019, and mature on February 26, 2021. The Swap Agreements give us the contractual right to pay a fixed interest rate of 2.79 % plus the applicable margin under the term loan B facility (see Note 11 for the applicable margin).
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (loss) (AOCI) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the year ended September 30, 2019, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. No portion of our interest rate swap agreements is excluded from the assessment of hedge effectiveness.
Amounts reported in AOCI related to derivatives and the related deferred tax are reclassified to interest expense as interest payments are made on our variable-rate debt. As of September 30, 2019, we expected to reclassify approximately $2.8 million from accumulated other comprehensive loss to earnings as an increase to interest expense over the next 12 months when the underlying hedged item impacts earnings. However, upon the closing of the Merger or termination of the existing Credit Agreement for any other reason, the interest rate swap agreements will be terminated (see Note 1 for further discussion about the Merger). The amount of fees would vary depending on actual timing of the termination.
Non-Designated Derivatives
From time to time, we enter into foreign currency forward contracts to partially reduce our exposure to foreign currency fluctuations for a subsidiary's net monetary assets, which are denominated in a foreign currency. The derivatives are not designated as a hedging instrument. The change in their fair value is recognized as periodic gain or loss in the other (expense) income, net line of our consolidated statements of comprehensive income (loss). We did not have foreign currency forward contracts as of September 30, 2019 and 2018.
The following table summarizes the notional principal amounts at September 30, 2019 and 2018 of our outstanding interest rate swap agreements discussed above (in thousands).
Derivative Notional | |||||||||
September 30, 2019 | September 30, 2018 | ||||||||
Instruments designated as accounting hedges: | |||||||||
Interest rate contracts | $ | $ | |||||||
The following table provides the location and fair value amounts of our hedge instruments, which are reported in our consolidated balance sheets as of September 30, 2019 and 2018 (in thousands).
Fair Value as of September 30, | |||||||||
Liability Derivatives | Balance Sheet Locations | 2019 | 2018 | ||||||
Instruments designated as accounting hedges: | |||||||||
Interest rate swap contracts | Other current assets | $ | $ | ||||||
Interest rate swap contracts | Other assets | ||||||||
Interest rate swap contracts | Accrued expenses | ||||||||
Interest rate swap contracts | Other liabilities | ||||||||
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Location in Consolidated Statement | Years Ended September 30, | ||||||||||||
Cash Flow Derivatives | Of Comprehensive Income (Loss) | 2019 | 2018 | 2017 | |||||||||
Interest rate swap contracts | Interest expense, net | $ | $ | $ | |||||||||
Total interest expense, net presented in the consolidated statements of comprehensive income (loss) in which the above effects of cash flow hedges are recorded | $ | $ | $ | ||||||||||
The following table provides the effective portion of the (loss) income of our cash flow hedge instruments which is recognized (net of income taxes) in other comprehensive income (loss) for the years ended September 30, 2019, 2018 and 2017 (in thousands).
Years Ended September 30, | ||||||||||||
Cash Flow Derivatives | 2019 | 2018 | 2017 | |||||||||
Interest rate swap contracts | $ | ( | ) | $ | $ | |||||||
The following table provides a summary of changes to our accumulated other comprehensive income (loss) related to our cash flow hedging instruments (net of income taxes) during the years ended September 30, 2019 and 2018.
Years Ended September 30, | |||||||||
AOCI - Unrealized Gain (Loss) on Hedging Instruments | 2019 | 2018 | |||||||
Balance at beginning of period | $ | $ | ( | ) | |||||
Change in fair value of hedging instruments | ( | ) | |||||||
Amounts reclassified to earnings | |||||||||
Net current period other comprehensive income | ( | ) | |||||||
Effect of adoption of accounting standard | $ | $ | ( | ) | |||||
Balance at end of period | $ | ( | ) | $ | |||||
The following table provides the pretax effect of our derivative instruments not designated as hedging instruments on our consolidated comprehensive income (loss) for the years ended September 30, 2019, 2018 and 2017 (in thousands).
Instruments Not Designated as Hedging Instruments | Location in Consolidated Statement of Comprehensive Income (Loss) | Years Ended September 30, | ||||||||||||
2019 | 2018 | 2017 | ||||||||||||
Foreign exchange contract | Other (expense) income, net | $ | $ | $ | ( | ) | ||||||||
Note 13. Other Comprehensive Income (Loss)
The components of other comprehensive (loss) income and related tax effects for each period were as follows (dollars in thousands):
Year Ended September 30, 2019 | Year Ended September 30, 2018 | Year Ended September 30, 2017 | |||||||||||||||||||||||||||||||||
Before Tax | Tax | After Tax | Before Tax | Tax | After Tax | Before Tax | Tax | After Tax | |||||||||||||||||||||||||||
Change in unrealized holding losses on derivatives | $ | ( | ) | $ | $ | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
Less: adjustment for losses on derivatives included in net income | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||||||||||
Change in net foreign currency translation adjustment | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Other comprehensive income (loss) | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||||||||||||
See Note 12 for the amounts of losses on derivatives reclassified out of accumulated other comprehensive loss into the consolidated statements of income, with presentation location, for each period.
The changes in accumulated other comprehensive income (loss) by component and related tax effects for each period were as follows (in thousands):
Foreign Currency Translation Adjustments | Unrealized (Loss) income on Derivative Instruments | Total | |||||||||
Balance at September 30, 2016 | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||
Other comprehensive (loss) income before reclassifications | ( | ) | ( | ) | |||||||
Amounts reclassified out of accumulated other loss | |||||||||||
Tax effect | ( | ) | ( | ) | ( | ) | |||||
Other comprehensive (loss) income | ( | ) | ( | ) | |||||||
Balance at September 30, 2017 | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||
Other comprehensive (loss) income before reclassifications | ( | ) | |||||||||
Amounts reclassified out of accumulated other comprehensive loss | |||||||||||
Tax effect | ( | ) | ( | ) | |||||||
Effect of adoption of accounting standard | ( | ) | ( | ) | |||||||
Other comprehensive (loss) income | ( | ) | |||||||||
Balance at September 30, 2018 | ( | ) | ( | ) | |||||||
Other comprehensive loss before reclassifications | ( | ) | ( | ) | ( | ) | |||||
Amounts reclassified out of accumulated other comprehensive loss | |||||||||||
Tax effect | |||||||||||
Other comprehensive (loss) income | ( | ) | ( | ) | ( | ) | |||||
Balance at September 30, 2019 | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||
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Note 14. Net Income (Loss) Per Share
The following table presents net income (loss) per share and related information (dollars in thousands):
Years Ended September 30, | |||||||||||
2019 | 2018 | 2017 | |||||||||
Net income (loss) | $ | $ | $ | ( | ) | ||||||
Basic weighted average shares outstanding | |||||||||||
Dilutive effect of stock options and restricted shares | |||||||||||
Dilutive weighted average shares outstanding | |||||||||||
Basic net income (loss) per share | $ | $ | $ | ( | ) | ||||||
Diluted net income (loss) per share | $ | $ | $ | ( | ) | ||||||
Note 15. Income Taxes
Income (loss) before benefit or provision for income taxes for the years ended September 30, 2019, 2018 and 2017 was as follows (in thousands):
2019 | 2018 | 2017 | |||||||||
U.S. income (loss) | $ | $ | $ | ( | ) | ||||||
Foreign income | |||||||||||
Total | $ | $ | $ | ( | ) | ||||||
The components of our income tax provision (benefit) for the years ended September 30, 2019, 2018 and 2017 were as follows (in thousands):
2019 | 2018 | 2017 | |||||||||
Current provision | |||||||||||
Federal | $ | ( | ) | $ | $ | ( | ) | ||||
State and local | ( | ) | |||||||||
Foreign | |||||||||||
Subtotal | ( | ) | |||||||||
Deferred (benefit) provision | |||||||||||
Federal | ( | ) | |||||||||
State and local | ( | ) | ( | ) | ( | ) | |||||
Foreign | ( | ) | ( | ) | |||||||
Subtotal | ( | ) | |||||||||
Provision (benefit)for income taxes | $ | $ | $ | ( | ) | ||||||
The tax impact associated with the exercise of employee stock options and vesting of restricted stock units for the year ended September 30, 2019 will be recognized in the current tax return. For the year ended September 30, 2019, $0.2 million of tax benefit was recorded as a decrease to our provision for income tax due to the adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, as discussed in Note 3. For the years ended September 30, 2018 and 2017, $0.1 million and $0.9 million of tax benefit, respectively, was recorded as a decrease to our provision for income tax.
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A reconciliation of our (benefit) provision for income taxes to the U.S. federal statutory rate is as follows for the years ended September 30, 2019, 2018 and 2017 (in thousands):
2019 | 2018 | 2017 | ||||||||||||||||||
Provision (benefit) for income taxes at statutory rate | $ | % | $ | % | $ | ( | ) | % | ||||||||||||
State taxes, net of tax benefit | ( | ) | ( | )% | % | ( | ) | % | ||||||||||||
Deemed foreign dividends | % | % | ( | )% | ||||||||||||||||
Nondeductible items | % | % | ( | )% | ||||||||||||||||
Impact of foreign operations | % | ( | ) | ( | )% | ( | ) | % | ||||||||||||
Impact of Tax Act | ( | ) | ( | )% | % | % | ||||||||||||||
Foreign tax credit | ( | ) | ( | )% | ( | ) | ( | )% | ( | ) | % | |||||||||
Valuation allowance | % | % | ( | )% | ||||||||||||||||
Non-deductible goodwill impairment | % | % | ( | )% | ||||||||||||||||
Unremitted earnings of foreign subsidiaries | % | % | ( | )% | ||||||||||||||||
Tax contingencies | ( | ) | ( | )% | % | ( | )% | |||||||||||||
Other | % | % | ( | )% | ||||||||||||||||
Actual provision (benefit) for income taxes | $ | % | $ | % | $ | ( | ) | % | ||||||||||||
During the year ended September 30, 2019, the Company reassessed the potential need to repatriate foreign earnings and determined it was likely that we would, in the future, repatriate certain unremitted foreign earnings. Following the enactment of the Tax Act, no federal taxes would be imposed upon the repatriation of these foreign earnings. The Company intends to permanently reinvest $38.9 million of foreign earnings for which no state, local or foreign withholding taxes have been provided and the state, local and foreign withholding taxes associated with the repatriation of such earnings would be between $1.0 million and $1.5 million.
For the year ended September 30, 2018, the Company recorded a provisional $9.3 million charge to tax expense related to the one-time tax imposed on accumulated earnings and profits of foreign operations (the Transition Tax). For the three months ended December 31, 2018, the Company recorded a $0.1 million tax benefit to the Transition Tax resulting in a $9.2 million final Transition Tax under SAB 118. The completion of our calculations for the fiscal year 2018 U.S. federal tax return during the three months ended June 30, 2019 resulted in both a decrease of $9.2 million of foreign tax credits generated related to the Transition Tax as well as an additional utilization of $9.2 million of foreign tax credits due to a change in the calculation method, both of which reduced the balance of the foreign tax credit carryforward. The additional $9.2 million of foreign tax credits utilized also resulted in a tax benefit fully reversing the cumulative Transition Tax which had previously been accrued as of December 31, 2018. Our tax return calculation of the Transition Tax complies with the Tax Act as enacted into law on December 22, 2017, which is inconsistent with final regulations issued by the U.S. Treasury Department on June 21, 2019 and proposed regulations which were previously issued on November 28, 2018. Based on the final regulations, we would incur an additional Transition Tax liability of $7.1 million but also release the valuation allowance on, an additional $7.1 million of foreign tax credits fully offsetting the additional Transition Tax liability and resulting in no Transition Tax payment being required. We therefore recorded an uncertain tax position expense of $7.1 million for the potential Transaction Tax liability, by reducing our foreign tax credits by $7.1 million, which in turn resulted in an offsetting tax benefit through the release of a $7.1 million valuation allowance against the foreign tax credits. As described above, and specifically based on
the $9.2 million decrease of foreign tax credits generated and the additional foreign tax credit utilization of $9.2 million to reverse the Transition Tax and $7.1 million for the Transition Tax liability related to the final tax regulations, the foreign tax credit carryforward as of September 30, 2019 was $11.1 million. The Company continues to record a full valuation allowance on foreign tax credits for U.S. federal income tax purposes.
The Company also recorded a $1.1 million tax benefit related to an impairment loss for an equity method investment, which is included in the Company’s provision for income taxes.
In May 2019 we received a letter from the Canada Revenue Agency for the 2014 fiscal year. The letter addressed the purchase price paid by our Canadian subsidiary to our U.K. subsidiary in September 2014 for the transfer of the Canadian portion of the Interfast business which our U.K. subsidiary had previously acquired from a third party in July 2012. The letter does not represent an assessment of tax from the Canada Revenue Agency, nor has any assessment been received as of the date of this filing. Based on limited information received at this time we believe that we have been, and continue to be, in
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compliance with Canadian tax law. As a result, we have not recorded a contingent liability for an uncertain tax position in connection with the letter. If an assessment of tax were to occur, an unfavorable resolution of this matter could have a material effect on our results of operations or cash flows in the period or periods in which an adjustment is recorded or the tax is due or paid. In the event of a Canadian tax assessment, the Company may seek corresponding U.K. tax relief through administrative proceedings in the U.K. but it is uncertain whether any tax relief would be granted.
As of September 30, 2019 and 2018, the components of deferred income tax assets (liabilities) were as follows (in thousands):
2019 | 2018 | ||||||
Deferred tax assets | |||||||
Inventories | $ | $ | |||||
Reserves and other accruals | |||||||
Compensation accruals | |||||||
Goodwill and intangible assets | |||||||
Stock options | |||||||
Net operating losses and tax credits | |||||||
Other | |||||||
Total deferred tax assets | |||||||
Deferred tax liabilities | |||||||
Property and equipment | ( | ) | ( | ) | |||
Unremitted earnings of foreign subsidiaries | ( | ) | ( | ) | |||
Goodwill and intangible assets | ( | ) | |||||
Other | ( | ) | ( | ) | |||
Total deferred tax liabilities | ( | ) | ( | ) | |||
Valuation allowance | ( | ) | ( | ) | |||
Net deferred tax assets | $ | $ | |||||
As of September 30, 2019, we had state net operating loss carryforwards of $20.5 million, which will begin to expire in 2022, and foreign net operating loss carryforwards of $10.6 million which will begin to expire in 2021. As of September 30, 2019, we had U.S. foreign tax credit carryforwards of $11.1 million which will begin to expire in 2021.
We are subject to U.S. federal income tax as well as income taxes in various state and foreign jurisdictions. The earliest tax year still subject to examination by a significant taxing jurisdiction is September 30, 2013.
We determine whether it is more likely than not that a tax position will be sustained upon examination. If a tax position meets the more-likely-than-not recognition threshold, it is then measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. We classify gross interest and penalties and unrecognized tax benefits as non-current liabilities in the consolidated balance sheets. As of September 30, 2019, the total amount of gross unrecognized tax benefits was $4.8 million, including $0.6 million of interest and $0.1 million of penalties, all of which would impact the effective tax rate if recognized. It is reasonably possible that within the next twelve months, $0.1 million of benefit may be recognized as a result of the lapsing of the statute of limitations.
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The unrecognized tax benefits, which exclude interest and penalties, for the years ended September 30, 2019, 2018 and 2017 are as follows (in thousands):
2019 | 2018 | 2017 | |||||||||
Beginning balance | $ | $ | $ | ||||||||
Increases related to tax positions taken during a prior year | |||||||||||
Decreases related to tax positions taken during a prior year | |||||||||||
Increases related to tax positions taken during the current year | |||||||||||
Decreases related to settlements with taxing authorities | ( | ) | |||||||||
Decreases related to expiration of statute of limitations | ( | ) | ( | ) | ( | ) | |||||
Changes due to translation of foreign currencies | ( | ) | |||||||||
Ending balance | $ | $ | $ | ||||||||
We determine whether it is more likely than not that some or all of our deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends upon the generation of future 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. Based upon the level of historical income and projections for future taxable income, we believe it is more likely than not that we will not realize the benefits of the temporary differences related to foreign tax credits and foreign net operating losses. Therefore, a valuation allowance has been recorded against these deferred tax assets (in thousands).
Beginning Balance | Valuation Allowance Recorded/ (Released) During The Period | Ending Balance | |||||||||
Valuation allowance for deferred tax assets: | |||||||||||
Year ended September 30, 2019 | $ | $ | ( | ) | $ | ||||||
Year ended September 30, 2018 | |||||||||||
Year ended September 30, 2017 | |||||||||||
The $0.5 million increase in valuation allowance for the fiscal year ended September 30, 2019 as shown in our reconciliation of (benefit) provision for income taxes to the U.S. federal statutory rate (the Rate Reconciliation) differs from the $24.6 million decrease in valuation allowance included in the rollforward of valuation allowance for deferred tax assets shown immediately above. The difference is related to items which impact the valuation allowance balance but are reported in line items other than the valuation allowance in the Rate Reconciliation. As also described above for the fiscal year ended September 30, 2018, the items decreasing the valuation allowance balance primarily include the $9.2 million decrease of foreign tax credits generated, the $9.2 million of additional foreign tax credits utilized against the Transition Tax and the $7.1 million of foreign tax credits which would be used to offset the uncertain tax position related to the Transition Tax.
Note 16. Stock-Based and Other Compensation Arrangements
On January 24, 2019 our stockholders approved the Amendment to our 2014 Plan, which amended and restated our plan and authorized the issuance of a total of 12,000,819 shares from and after September 30, 2019. As of September 30, 2019, there were 6,731,517 shares remaining available for issuance under the 2014 Plan.
Stock Options
Our stock options are eligible to vest over three years in three equal annual installments, subject to continued employment on each vesting date. Vested options are exercisable at any time until 10 years from the date of the option grant, subject to earlier expirations under certain terminations of service and other conditions. The stock options granted have an exercise price equal to the closing stock price of our common stock on the grant date.
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Continuous Employment Conditions
At September 30, 2019, we have outstanding 363,299 unvested time-based stock options under the 2014 Plan or our prior equity incentive plans (collectively, the Plans), which will vest on the basis of continuous employment. All of the time-based options vest ratably during the period of service.
The following table sets forth the summary of options activity under the Plans (dollars in thousands except per share data):
Number of Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (in years) | Aggregate Intrinsic Value(1) | |||||||||
Options outstanding at September 30, 2018 | $ | $ | ||||||||||
Granted | ||||||||||||
Exercised | ( | ) | ||||||||||
Forfeited options | ( | ) | ||||||||||
Options outstanding at September 30, 2019 | $ | $ | ||||||||||
Options exercisable at September 30, 2019 | $ | $ | ||||||||||
(1) | Aggregate intrinsic value is calculated based on the difference between our closing stock price at year end and the exercise price, multiplied by the number of in-the-money options and represents the pre-tax amount that would have been received by the option holders, had they all exercised all their options on the fiscal year end date. |
The total intrinsic value of options exercised during the years ended September 30, 2019, 2018 and 2017 was $2.6 thousand, $0.1 million and $6.0 million, respectively. For the years ended September 30, 2019, 2018 and 2017, we recorded $1.4 million, $1.4 million and $2.6 million, respectively, of stock-based compensation expense related to these options that is included within selling, general and administrative expenses. At September 30, 2019, the unrecognized stock-based compensation related to these options was $1.1 million and is expected to be recognized over a weighted-average period of 1.7 years. However, upon completion of the Merger, $0.4 million of the $1.1 million unrecognized stock-based compensation expense will be recognized immediately prior to the effective time of the Merger and the remaining $0.7 million of unrecognized expense will not be recognized (see Note 1 for further discussion about the Merger). Cash received from the exercise of stock options by us during the years ended September 30, 2019, 2018 and 2017 was $37.1 thousand, $0.1 million and $2.7 million, respectively.
Restricted Stock Units and Restricted Stock
In the year ended September 30, 2019, we granted 716,512 shares of restricted common stock to employees. These shares are eligible to vest over three years in three equal annual installments, subject to continued employment on each vesting date. During the years ended September 30, 2019, 2018 and 2017, we granted 67,012 , 104,663 and 68,493 , respectively, restricted common shares to our directors. During fiscal year 2019, we also granted performance-related restricted stock units (PSUs) to certain executives. The PSUs vest after three years based on the achievement of certain predetermined goals and are payable in shares of our common stock. One of the goals is based on our achieving a certain level of return on invested capital (ROIC) and the other goal is based on our total shareholder return (TSR) relative to certain peer companies over the three-year performance period. The actual number of shares to be issued for these PSUs is subject to final achievement of these goals and can range from 0 % to 200 % of the target shares set at the time of grant. Stock-based compensation expense for the PSUs is recognized on a straight-line basis over the performance period based upon the value determined using the intrinsic value method for the ROIC portion of the PSUs and using the Monte Carlo valuation method for the TSR portion of the PSUs. Stock-based compensation expense for the ROIC portion of the PSUs is cumulatively adjusted based upon the expected achievement of ROIC, which is assessed by management quarterly until vesting. Stock-based compensation expense for the TSR portion of the PSUs is recognized over the performance period regardless of the TSR performance.
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For the years ended September 30, 2019, 2018 and 2017, we recorded $7.9 million, $7.8 million and $3.8 million, respectively, of stock-based compensation expense related to restricted stock that is included within selling, general and administrative expenses. The restricted stock awards do not contain any redemption provisions that are not within our control. Accordingly, these restricted stock awards have been accounted for as our stockholders’ equity. At September 30, 2019, the unrecognized stock-based compensation related to restricted stock awards was $6.7 million and is expected to be recognized over a weighted-average period of 1.6 years.
Restricted share activity during the year ended September 30, 2019 was as follows:
Shares | Weighted Average Fair Value | |||||
Outstanding at September 30, 2018 | $ | |||||
Granted(1) | ||||||
Vested(2) | ( | ) | ||||
Forfeited | ( | ) | ||||
Outstanding at September 30, 2019 | $ | |||||
(1) | Under the terms of their respective restricted stock award agreements, holders of restricted stock have the same voting rights as common stock shareholders; such rights exist even if the shares of restricted stock have not vested. |
(2) | The majority of vested shares were net share settled such that the Company withheld shares with a value equivalent to the employees’ obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld for the year were |
Fair value of our restricted shares is based on our closing stock price on the date of grant. The fair value of shares that were vested during the years ended September 30, 2019, 2018 and 2017 was $7.3 million, $5.7 million and $5.3 million, respectively. The fair value of shares that were granted during the years ended September 30, 2019, 2018 and 2017 was $7.1 million, $11.4 million and $11.1 million, respectively. The weighted average fair value at the grant date for restricted shares issued during the years ended September 30, 2019, 2018 and 2017 was $9.16 , $8.10 and $12.63 , respectively.
Due to tax deductions associated with option exercises and restricted share activities, we realized tax benefits of $0.2 million, $0.1 million and $0.9 million for the years ended September 30, 2019, 2018 and 2017, respectively. The realized 2019, 2018 and 2017 tax benefits were recorded as a reduction to our provision for income tax.
Stock-Based Compensation
We use the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, risk-free interest rate and expected dividends.
We estimated expected volatility based on historical data of the price of our common stock over the expected term of the options. The expected term, which represents the period of time that options granted are expected to be outstanding, is estimated based on guidelines provided in U.S. SEC Staff Accounting Bulletin No. 110 and represents the average of the vesting tranches and contractual terms. The risk-free rate assumed in valuing the options is based on the U.S. Treasury rate in effect at the time of grant for the expected term of the option. We do not anticipate paying any cash dividends in the foreseeable future and, therefore, used an expected dividend yield of zero in the option pricing model. Compensation expense is recognized only for those options expected to vest with forfeitures estimated based on our historical experience and future expectations. Stock-based compensation awards are amortized on a straight-line basis over a three-year period.
The weighted average assumptions used to value the option grants are as follows:
2019 | 2018 | 2017 | ||||||
Expected life (in years) | ||||||||
Volatility | % | % | % | |||||
Risk free interest rate | % | % | % | |||||
Dividend yield | ||||||||
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The weighted average fair value per option at the grant date for options issued during the years ended September 30, 2019, 2018, and 2017 was $4.31 , $3.46 and $4.37 , respectively.
Note 17. Employee Benefit Plan
We maintain a 401(k) defined contribution plan and a retirement saving plan for the benefit of our eligible employees. All U.S. full-time employees who have completed at least one full month of service and are at least 20 years of age are eligible to participate in the plans. Eligible employees may elect to contribute up to 60 % of their eligible compensation. We made contributions of $2.8 million, $2.4 million and $2.4 million to this plan during the years ended September 30, 2019, 2018 and 2017, respectively. Certain non-US employees of the Company participate in other defined contribution retirement plans with varying vesting and contribution provisions.
Note 18. Supplemental Cash Flow Information
Years Ended September 30, | |||||||||||
2019 | 2018 | 2017 | |||||||||
(in thousands) | |||||||||||
Cash payments for: | |||||||||||
Interest | $ | $ | $ | ||||||||
Income taxes | |||||||||||
Schedule of non-cash investing and financing activities: | |||||||||||
Property and equipment acquired pursuant to capital leases | $ | $ | $ | ||||||||
Note 19. Quarterly Financial Data (unaudited)
Summarized unaudited quarterly financial data for quarters ended December 31, 2017 through September 30, 2019 is as follows (in thousands except per share data):
Quarters Ended: | September 30, 2019 | June 30, 2019 | March 31, 2019 | December 31, 2018 | |||||||||||
Net sales | $ | $ | $ | $ | |||||||||||
Gross profit | |||||||||||||||
Net (loss) income | ( | ) | |||||||||||||
Basic net (loss) income per share (1) | $ | ( | ) | $ | $ | $ | |||||||||
Diluted net (loss) income per share (1) | $ | ( | ) | $ | $ | $ | |||||||||
Quarters Ended: | September 30, 2018 | June 30, 2018 | March 31, 2018 | December 31, 2017 | |||||||||||
Net sales | $ | $ | $ | $ | |||||||||||
Gross profit | |||||||||||||||
Net income (loss) | ( | ) | |||||||||||||
Basic net income (loss) per share (1) | $ | $ | $ | $ | |||||||||||
Diluted net income (loss) per share (1) | $ | $ | $ | $ | |||||||||||
1. | Net income (loss) per share calculations for each quarter are based on the weighted average basic and diluted shares outstanding for that quarter and may not total to the full year amount. |
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Note 20. Segment Reporting
We evaluate segment performance based on segment income or loss from operations. Each segment reports its results of operations and makes requests for capital expenditures and acquisition funding to our chief operating decision-maker (CODM). Our chief executive officer serves as our CODM.
We organize our businesses under three geographic-based segments: the Americas, EMEA and APAC. Our CODM reviews segment results on this basis for purposes of allocating resources and assessing performance. Each segment’s results reflect the results of our subsidiaries within that geographic region. Revenues reported by a segment reflect the customer contracts held by that segment, regardless of the geographic location of that customer. Some segments incur expenses for the benefit of the group or other segments; however, these expenses are not allocated. We present corporate expenses related to public company reporting costs and other costs that would not be required by the segments if they were operating on a standalone basis as unallocated corporate costs.
The following table presents net sales and other financial information by business segment (in thousands):
Year Ended September 30, 2019 | |||||||||||||||||||
Americas | EMEA | APAC | Unallocated Corporate Costs | Consolidated | |||||||||||||||
Net sales (1) | $ | $ | $ | $ | $ | ||||||||||||||
Income (loss) from operations (2) | ( | ) | |||||||||||||||||
Interest expense, net | |||||||||||||||||||
Capital expenditures | |||||||||||||||||||
Depreciation and amortization | |||||||||||||||||||
(1) | For fiscal 2019, approximately |
(2) | Unallocated corporate costs for fiscal 2019 consisted of payroll and personnel costs of $ |
Year Ended September 30, 2018 | |||||||||||||||||||
Americas | EMEA | APAC | Unallocated Corporate Costs | Consolidated | |||||||||||||||
Net sales (1) | $ | $ | $ | $ | $ | ||||||||||||||
Income (loss) from operations (2) | ( | ) | |||||||||||||||||
Interest expense, net | |||||||||||||||||||
Capital expenditures | |||||||||||||||||||
Depreciation and amortization | |||||||||||||||||||
(1) | For fiscal 2018, approximately |
(2) | Unallocated corporate costs for fiscal 2018 consisted of payroll and personnel costs of $ |
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Year Ended September 30, 2017 | |||||||||||||||||||
Americas | EMEA | APAC | Unallocated Corporate Costs | Consolidated | |||||||||||||||
Net sales (1) | $ | $ | $ | $ | $ | ||||||||||||||
Income (loss) from operations (2) (3) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||
Interest expense, net | |||||||||||||||||||
Capital expenditures | |||||||||||||||||||
Depreciation and amortization | |||||||||||||||||||
(1) | For fiscal 2017, nearly |
(2) | Unallocated corporate costs for fiscal 2017 consisted of payroll and personnel costs of $ |
(3) | Changes in the goodwill balance for fiscal 2017 included a non-cash impairment charge of $ |
As of September 30, 2019 | |||||||||||||||
Americas | EMEA | APAC | Consolidated | ||||||||||||
Total assets | $ | $ | $ | $ | |||||||||||
Goodwill | |||||||||||||||
As of September 30, 2018 | |||||||||||||||
Americas | EMEA | APAC | Consolidated | ||||||||||||
Total assets | $ | $ | $ | $ | |||||||||||
Goodwill | |||||||||||||||
Geographic Information
We operated principally in the United States, United Kingdom and other foreign geographic areas in Americas, Europe and emerging markets, such as Asia, Pacific Rim and the Middle East.
Net sales by geographic area, for the years ended September 30, 2019, 2018, and 2017, were as follows (dollars in thousands):
Years Ended September 30, | ||||||||||||||||||||
2019 | 2018 | 2017 | ||||||||||||||||||
Sales | % of Total Sales | Sales | % of Total Sales | Sales | % of Total Sales | |||||||||||||||
United States of America | $ | % | $ | % | $ | % | ||||||||||||||
United Kingdom | % | % | % | |||||||||||||||||
Other foreign countries | % | % | % | |||||||||||||||||
All foreign countries | % | % | % | |||||||||||||||||
Total | $ | % | $ | % | $ | % | ||||||||||||||
We determine the geographic area based on the origin of the sale.
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Our long-lived assets consist of property and equipment, net, intangible assets, net and investment in joint ventures. Long-lived assets by geographic area, for the years ended September 30, 2019 and 2018, were as follows (in thousands):
Years Ended September 30, | ||||||||
2019 | 2018 | |||||||
United States of America | $ | $ | ||||||
All foreign countries | ||||||||
$ | $ | |||||||
Product and Services Information
Net sales by product categories, for the years ended September 30, 2019, 2018 and 2017 were as follows (dollars in thousands):
Year Ended September 30, 2019 | |||||||||||||||||||||||||||
Americas | EMEA | APAC | Consolidated | ||||||||||||||||||||||||
Sales | % of Total | Sales | % of Total | Sales | % of Total | Sales | % of Total | ||||||||||||||||||||
Hardware | $ | % | $ | % | $ | % | $ | % | |||||||||||||||||||
Chemicals (1) | % | % | % | % | |||||||||||||||||||||||
Electronic components | % | % | % | % | |||||||||||||||||||||||
Bearings | % | % | % | % | |||||||||||||||||||||||
Machined parts and other | % | % | % | % | |||||||||||||||||||||||
Total | $ | % | $ | % | $ | % | $ | % | |||||||||||||||||||
(1) Includes CMS contracts
Year Ended September 30, 2018 | |||||||||||||||||||||||||||
Americas | EMEA | APAC | Consolidated | ||||||||||||||||||||||||
Sales | % of Total | Sales | % of Total | Sales | % of Total | Sales | % of Total | ||||||||||||||||||||
Hardware | $ | % | $ | % | $ | % | $ | % | |||||||||||||||||||
Chemicals (1) | % | % | % | % | |||||||||||||||||||||||
Electronic components | % | % | % | % | |||||||||||||||||||||||
Bearings | % | % | % | % | |||||||||||||||||||||||
Machined parts and other | % | % | % | % | |||||||||||||||||||||||
Total | $ | % | $ | % | $ | % | $ | % | |||||||||||||||||||
(1) Includes CMS contracts
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Year Ended September 30, 2017 | |||||||||||||||||||||||||||
Americas | EMEA | APAC | Consolidated | ||||||||||||||||||||||||
Sales | % of Total | Sales | % of Total | Sales | % of Total | Sales | % of Total | ||||||||||||||||||||
Hardware | $ | % | $ | % | $ | % | $ | % | |||||||||||||||||||
Chemicals (1) | % | % | % | % | |||||||||||||||||||||||
Electronic components | % | % | % | % | |||||||||||||||||||||||
Bearings | % | % | % | % | |||||||||||||||||||||||
Machined parts and other | % | % | % | % | |||||||||||||||||||||||
Total | $ | % | $ | % | $ | % | $ | % | |||||||||||||||||||
(1) Includes CMS contracts
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined in Rule 13a‑15(e) under the Exchange Act as of the end of the period covered by this Annual Report on Form 10-K. Based upon their evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2019.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our financial statements; and providing reasonable assurance regarding the prevention or timely detection of the unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
Under the supervision and with the participation of our chief executive officer and chief financial officer, management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was effective at the reasonable assurance level as of September 30, 2019.
The effectiveness of our internal control over financial reporting has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their attestation report which expresses an unqualified opinion on the effectiveness of our internal control over financial reporting as of September 30, 2019.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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ITEM 9B. OTHER INFORMATION
None.
PART III
In accordance with General Instruction G.(3) of Form 10-K certain information required by this Part III will either be incorporated into this Annual Report on Form 10-K by reference to our definitive proxy statement filed within 120 days after September 30, 2019 or will be included in an amendment to this Annual Report on Form 10-K filed within 120 days after September 30, 2019.
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We will provide information that is responsive to this Item 10 in our definitive proxy statement or in an amendment to this Annual Report on Form 10-K not later than 120 days after September 30, 2019. Such information is incorporated into this Item 10 by reference.
ITEM 11. EXECUTIVE COMPENSATION
We will provide information that is responsive to this Item 11 in our definitive proxy statement or in an amendment to this Annual Report on Form 10-K not later than 120 days after September 30, 2019. Such information is incorporated into this Item 11 by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
We will provide information that is responsive to this Item 12 in our definitive proxy statement or in an amendment to this Annual Report on Form 10-K not later than 120 days after September 30, 2019. Such information is incorporated into this Item 12 by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
We will provide information that is responsive to this Item 13 in our definitive proxy statement or in an amendment to this Annual Report on Form 10-K not later than 120 days after September 30, 2019. Such information is incorporated into this Item 13 by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
We will provide information that is responsive to this Item 14 in our definitive proxy statement or in an amendment to this Annual Report on Form 10-K not later than 120 days after September 30, 2019. Such information is incorporated into this Item 14 by reference.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) | The following documents are filed as part of this Annual Report on Form 10-K: |
(1) | Financial Statements. The financial statements listed in the “Index to Consolidated Financial Statements” under Part II, Item 8. “Financial Statements and Supplementary Data,” which index is incorporated herein by reference. |
(2) | Financial Statement Schedules. Financial statement schedules have been omitted because either they are not applicable, not required or the information is included in the financial statements or the notes thereto. |
(3) | Exhibits. The attached list of exhibits in the “Exhibit Index” immediately preceding the exhibits to this Annual Report on Form 10-K, which index is incorporated herein by reference. |
ITEM 16. FORM 10-K SUMMARY
None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WESCO AIRCRAFT HOLDINGS, INC. | |||
Date: | November 25, 2019 | By: | /s/ Todd S. Renehan |
Todd S. Renehan Chief Executive Officer | |||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE | TITLE | DATE | ||
/s/ TODD S. RENEHAN | Chief Executive Officer and Director | |||
Todd S. Renehan | (principal executive officer) | November 25, 2019 | ||
/s/ KERRY A. SHIBA | Executive Vice President and Chief Financial | |||
Kerry A. Shiba | Officer (principal financial officer) | November 25, 2019 | ||
/s/ HOWARD D. ROSEN | Vice President and Corporate Controller | |||
Howard D. Rosen | (principal accounting officer) | November 25, 2019 | ||
/s/ RANDY J. SNYDER | ||||
Randy J. Snyder | Chairman of the Board of Directors | November 25, 2019 | ||
/s/ DAYNE A. BAIRD | ||||
Dayne A. Baird | Director | November 25, 2019 | ||
/s/ THOMAS M. BANCROFT | ||||
Thomas M. Bancroft | Director | November 25, 2019 | ||
/s/ PAUL E. FULCHINO | ||||
Paul E. Fulchino | Director | November 25, 2019 | ||
/s/ JAY L. HABERLAND | ||||
Jay L. Haberland | Director | November 25, 2019 | ||
/s/ SCOTT E. KUECHLE | ||||
Scott E. Kuechle | Director | November 25, 2019 | ||
/s/ ADAM J. PALMER | ||||
Adam J. Palmer | Director | November 25, 2019 | ||
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/s/ ROBERT D. PAULSON | ||||
Robert D. Paulson | Director | November 25, 2019 | ||
/s/ JENNIFER M. POLLINO | ||||
Jennifer M. Pollino | Director | November 25, 2019 | ||
/s/ NORTON A. SCHWARTZ | ||||
Norton A. Schwartz | Director | November 25, 2019 | ||
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Exhibit Index
Exhibit Number | Description | ||
2.1 | |||
3.2 | |||
4.1 | |||
4.2 | |||
10.1 | |||
10.2 | |||
10.3 | |||
10.4 | |||
10.5 | |||
10.6 | |||
10.7 | |||
10.8 | |||
10.9 | |||
10.10 | |||
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Exhibit Number | Description | ||
10.11 | |||
10.12 | |||
10.13 | |||
10.14 | |||
10.15 | |||
10.16 | |||
10.17 | |||
10.18 | |||
10.19 | |||
10.20 | |||
10.21 | |||
10.22 | |||
10.23 | |||
10.24 | |||
10.25 | |||
10.26 | |||
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Exhibit Number | Description | ||
10.27 | |||
10.28 | |||
10.29 | |||
10.30 | |||
10.31 | |||
21.1 | |||
23.1 | |||
31.1 | |||
31.2 | |||
32.1 | |||
101.INS | XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document | ||
101.SCH | XBRL Taxonomy Extension Schema Document | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | ||
104 | Cover Page Interactive Data File (the cover page XBRL tags are embedded within the Inline XBRL document) | ||
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