United States

Securities and Exchange Commission

Washington, DC 20549

 

FORM 10-K

 

(Mark One)

For the fiscal year ended December 31, 2015

or

For the transition period from                      to                     

Commission file number: 0-10653

 

ESSENDANT INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

One Parkway North Boulevard

Suite 100

Deerfield, Illinois 60015-2559

(847) 627-7000

(Address, Including Zip Code and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Securities registered pursuant to Section 12(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   x    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   x

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   x    No   ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 and Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes   x    No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes  ¨     No   x

The aggregate market value of the common stock of Essendant Inc. held by non-affiliates as of June 30, 2015 was approximately $1.426 billion.

On February 12, 2016, Essendant Inc. had 37,286,573 shares of common stock outstanding.

Documents Incorporated by Reference:

Certain portions of Essendant Inc.’s definitive Proxy Statement relating to its 2016 Annual Meeting of Stockholders, to be filed within 120 days after the end of Essendant Inc.’s fiscal year, are incorporated by reference into Part III.

 

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ESSENDANT INC.

FORM 10-K

For The Year Ended December 31, 2015

TABLE OF CONTENTS

 

 

 

 

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PART I

 

 

General

Essendant Inc. (formerly known as United Stationers Inc.) is a leading national wholesale distributor of workplace items including traditional office products and office furniture, janitorial, sanitation and breakroom supplies, technology products, industrial supplies, and automotive aftermarket tools and equipment. Except where otherwise noted, the terms “Essendant” and “the Company” refer to Essendant Inc. and its consolidated subsidiaries. The parent holding company, Essendant Inc. (ESND), was incorporated in 1981 in Delaware. ESND’s only direct wholly owned subsidiary and principal operating company is Essendant Co. (ECO) incorporated in 1922 in Illinois.

Essendant’s goal is to be the fastest, most convenient solution for workplace essentials. To achieve this goal, Essendant leverages its nationwide network of distribution centers, a comprehensive portfolio of products, speed and expertise in distribution, and accessible customer care.

During 2015, Essendant continued to focus on three strategic pillars to further reach its goal:

Essendant will focus on the following five key objectives over the next two years:

Products

Essendant stocks over 180,000 products and is a leading national wholesale distributor in the following categories:

Janitorial and Breakroom Supplies. The Company stocks approximately 26,000 items in these lines: janitorial supplies (cleaners and cleaning accessories), breakroom items (food and beverage products), foodservice consumables (such as disposable cups, plates and utensils), safety and security items, and paper and packaging supplies. This product category provided 27.1% of 2015’s net sales.

Technology Products. The Company stocks over 11,000 items, including imaging supplies, data storage, digital cameras, computer accessories and computer hardware items such as printers and other peripherals. Essendant provides these products to value-added computer resellers, office products dealers, drug stores, grocery chains and online merchants. Technology products generated 25.5% of the Company’s 2015 consolidated net sales.

Traditional Office Products. The Company stocks a broad range of office supplies. It carries over 22,000 brand-name and private label products, such as filing and record storage products, business machines, presentation products, writing instruments, paper products, shipping and mailing supplies, calendars and general office accessories. These products contributed 22.5% of net sales during 2015.

Industrial Supplies. Essendant stocks over 117,000 items including hand and power tools, safety and security supplies, janitorial equipment and supplies, other various industrial MRO (maintenance, repair and operations) items, oil field and welding supplies, and automotive aftermarket tools and equipment. In 2015, the industrial category accounted for 16.2% of the Company’s net sales.

Office Furniture. Essendant stocks approximately 4,000 products including desks, filing and storage solutions, seating and systems furniture, along with a variety of products for niche markets such as education, government, healthcare and professional services. This product category represented 5.9% of net sales for the year.

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

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Essendant offers private brand products within each of its product categories to help resellers provide quality value-priced items to their customers. These include Innovera^® technology products, Universal^® office products, Windsoft^® paper products, Boardwalk^® janitorial and sanitation products, Alera^® office furniture, and Anchor Brand^® and Best Welds^® welding, industrial, safety and oil field pipeline products. Essendant also offers the following automotive brand products: Advanced Tool Design (ATD), Finish Pro, Painters Pride, Quipall, Nesco, Performance One, and AIM.

During 2015, private brand products accounted for approximately 13.9% of Essendant’s net sales.

Customers

Essendant serves a diverse group of approximately 30,000 reseller customers. They include independent office products dealers, janitorial and sanitation distributors, office products superstores, online retailers, computer products resellers, office furniture dealers, mass merchandisers, mail order companies, sanitary supply, paper and foodservice distributors, drug and grocery store chains, healthcare distributors, oil field, welding supply and industrial/MRO distributors, automotive aftermarket dealers and wholesalers, and other independent distributors.

To help its reseller-customers unlock their full potential, Essendant leverages its common platform which comprises an extensive national distribution and logistics network, enhanced digital solutions, print marketing tools, broad product portfolio, and the Company’s long-standing industry expertise and dedicated support team with intimate knowledge of what customers need and how the industry works. Many of the Company’s resellers have online capabilities. The Company also operates CPO Commerce which sells tools and do-it-yourself equipment online to the consumer market.

During 2015 the Company’s net sales were comprised of independent resellers contributing 78% of consolidated net sales, national accounts 10% and online retailers (“eTailers”) 12%.  One customer, W.B. Mason Co., Inc., accounted for approximately 12% of its 2015 consolidated net sales. No other single customer accounted for more than 10% of 2015 consolidated net sales.

Marketing and Customer Support

Essendant’s marketing and customer care capabilities are key to its position as a high value-add distributor. Essendant provides its resellers a variety of digital tools to enhance their ability to compete online.  These tools include digitized product content, website development, digital analytics, marketing and merchandising tools to drive the performance of their reseller’s websites.  An important component of the value proposition is that the company produces print and digital tools in return for a deeper commercial relationship with their resellers.

Essendant also provides specific services that enable resellers to improve their operating and strategic business models. These services include primary research efforts, brand strategy and development, campaign development, customer segmentation and cost management, and training programs designed to help resellers improve their sales and marketing techniques.

Distribution

Essendant’s distribution network enables the Company to ship most products on an overnight basis to more than 90% of the U.S. with an average line fill rate of approximately 97%. Essendant’s domestic operations generated approximately $5.3 billion of its approximate $5.4 billion in 2015 consolidated net sales, with its international operations contributing another $0.1 billion to 2015 net sales.

The Company’s network of 74 distribution centers are spread across the nation to facilitate delivery. Essendant has a dedicated fleet of approximately 480 trucks. This enables Essendant to make direct deliveries to resellers from regional distribution centers and local distribution points.

In addition to providing a broad product selection that allows resellers to offer products to their customers that they do not physically stock, the company also offers the “Wrap and Label” program. “Wrap and Label” gives resellers the option to receive individually packaged orders ready to be delivered to their end consumers. For example, when a reseller places orders for several individual consumers, Essendant can pick and pack the items separately, placing a label on each package with the consumer’s name, ready for delivery to the end consumer by the reseller. Resellers benefit from the “Wrap and Label” program because it eliminates the need to break down bulk shipments and repackage orders before delivering them to consumers.

In addition to providing value-adding programs for resellers, Essendant also remains committed to reducing its operating costs. These activities include process improvement and work simplification activities that help increase efficiency throughout the business and improve customer satisfaction. As a high value-add distributor, the company makes an effort to reduce its operating costs each year in order to remain competitive on price in the marketplace, re-invest savings into its business, and return value to shareholders.

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Purchasing and Merchandising

As a leading wholesale distributor of workplace essentials, Essendant leverages its broad product selection as a key merchandising strategy. Based on Essendant’s purchasing volume it receives substantial supplier allowances and can realize significant economies of scale in its logistics and distribution activities. In 2015, the Company’s largest supplier was Hewlett-Packard Company, which represented approximately 14% of the Company’s total purchases.

The Company’s merchandising department is responsible for selecting merchandise and for managing the entire supplier relationship. Product selection is based on three factors: end-consumer acceptance; anticipated demand for the product; and the manufacturer’s total service, price and product quality.

Competition

The markets in which the Company participates are highly competitive. The Company competes with other wholesale distributors and with the manufacturers of the products the Company sells. In addition, the Company competes with warehouse clubs and the business-to-business sales divisions of national business products resellers. Essendant competes primarily on the basis of breadth of product lines, availability of products, speed of delivery, order fill rates, net pricing to customers, and the quality of marketing and other value-added services.

Employees

As of February 12, 2016, Essendant employed approximately 6,400 associates.

Approximately 625 of the shipping, warehouse and maintenance associates at certain of the Company’s Baltimore, Los Angeles and New Jersey distribution centers are covered by collective bargaining agreements. The bargaining agreements in the Los Angeles and New Jersey distribution centers were renegotiated in 2014. The bargaining agreement in Baltimore was renegotiated in August 2015.

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Executive Officers Of The Registrant

The executive officers of the Company are as follows:

 

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Executive officers are elected by the Board of Directors. Except as required by individual employment agreements between executive officers and the Company, there exists no arrangement or understanding between any executive officer and any other person pursuant to which such executive officer was elected. Each executive officer serves until his or her successor is appointed and qualified or until his or her earlier removal or resignation.

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Availability of the Company’s Reports

The Company’s principal Website address is www.Essendant.com. This site provides Essendant’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as amendments and exhibits to those reports filed or furnished under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) for free as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (SEC). In addition, copies of these filings (excluding exhibits) may be requested at no cost by contacting the Investor Relations Department:

Essendant Inc.

Attn: Investor Relations Department

One Parkway North Boulevard

Suite 100

Deerfield, IL 60015-2559

Telephone: (847) 627-7000

E-mail: IR@essendant.com

 

 

 

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Any of the risks described below could have a material adverse effect on the Company’s business, financial condition or results of operations. These risks are not the only risks facing Essendant; the Company’s business operations could also be materially adversely affected by risks and uncertainties that are not presently known to Essendant or that Essendant currently deems immaterial.

The loss of one or more significant customers could significantly reduce Essendant’s revenues and profitability.

In 2015, Essendant’s largest customer accounted for approximately 12% of net sales and Essendant’s top five customers accounted for approximately 28.9% of net sales. Several of Essendant’s current and potential customers were involved in business combinations in 2015 and the Company expects increased customer consolidation in the future. In February 2015, two of Essendant’s five largest customers announced they intend to merge. Following business combinations, the surviving companies often review their supply chain and sourcing options, which can result in the companies altering their sourcing relationships. Increasing direct purchases by major customers from manufacturers, as well as the loss of one or more key customers, changes in the sales mix or sales volume to key customers, or a significant downturn in the business or financial condition of any of them could significantly reduce Essendant’s sales and profitability.

Demand for office products may continue to decline.

The overall demand for certain office products may continue to weaken as consumers increasingly create, share, and store documents electronically, without printing or filing them. If demand continues to decline and Essendant is unable to offset lower aggregate demand by increasing market share for these products, finding new markets for these products, increasing sales of products in other categories, and reducing expenses, the Company’s results of operations and financial condition may be adversely affected.

Essendant relies on independent resellers for a significant percentage of its net sales.

Sales to independent resellers account for a significant portion of Essendant’s net sales. Independent resellers compete with national distributors and retailers that have substantially greater financial resources and technical and marketing capabilities. Financial, technical, and commercial constraints are increasingly challenging as business increasingly shifts online. Over the years, several of the Company’s independent reseller customers have been acquired by competitors or have ceased operation. If Essendant’s customer base of independent resellers declines, the Company’s business and results of operations may be adversely affected.

 

Essendant’s Industrial business may experience financial cycles related to economic factors that are different than the office products market segment.

 

Sales of Essendant’s industrial and automotive products are affected by oil prices, oil rig count, and broader industrial market pressures, that are subject to cyclical fluctuations and that in some cases differ from the factors impacting sales in other Essendant product categories.  As the Company’s presence grows in the industrial marketplace, these impacts and cycles may become more apparent.  Thus, a significant or prolonged slowdown in the energy, automotive or industrial sectors could negatively impact Essendant’s sales growth and results of operations.

Essendant’s operating results depend on the strength of the market segments the Company serves.  

The customers that Essendant serves are affected by changes in economic conditions outside the Company’s control, including national, regional, and local slowdowns in general economic activity, job markets, and market segments the Company serves. Demand for the products and services the Company offers, particularly in the office product, technology, and furniture categories, is affected by the number of white collar and other workers employed by the businesses Essendant’s customers serve. If employment rates decline, do not grow, or continue to grow at a slow rate, demand for the products the Company sells could be adversely affected.

The Company relies heavily on the ability to recruit, retain, and develop high-performing managers and the lack of execution in these areas could harm the Company’s ability to carry out its business strategy.

Essendant’s ability to implement its business strategy depends largely on the efforts, skills, abilities, and judgment of the Company’s executive management team. Essendant’s success also depends to a significant degree on its ability to recruit and retain sales and marketing, operations, and other senior managers. The Company may not be successful in attracting and retaining these employees, which may in turn have an adverse effect on the Company’s results of operations and financial condition.

 

 

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A significant disruption or failure of the Company’s information technology systems could disrupt Essendant’s business, result in increased costs and decreased revenues, harm the Company’s reputation, and expose the Company to liability.

The Company relies on information technology in all aspects of its business, including managing and replenishing inventory, filling and shipping customer orders, and coordinating sales and marketing activities. Several of the Company’s software applications are legacy systems which the Company must periodically update, enhance, and replace. A significant disruption or failure of the Company’s existing information technology systems or in the Company’s development and implementation of new systems could put it at a competitive disadvantage and could adversely affect its results of operations.

Price transparency, customer consolidation, and changes in product sales mix may result in lower margins.

The Company faces price and margin pressure due to a number of factors, including:

If Essendant is unable to reduce expenses, grow sales to existing and new customers, and increase sales of higher margin products as a percentage of total sales, the Company’s results of operations and financial condition may be adversely affected.

A breach of the Company’s information technology systems could result in costly enforcement actions and litigation and could harm the Company’s reputation and relationships.

Through Essendant’s sales, marketing, and e-commerce activities, the Company collects and stores personally identifiable information and credit card data that customers provide when they buy products or services, enroll in promotional programs, or otherwise communicate with Essendant. Essendant also gathers and retains information about its employees in the normal course of business. Essendant uses vendors to assist with certain aspects of Essendant’s business and, to enable the vendors to perform services for Essendant, the Company shares some of the information provided by customers and employees. Similarly, to enable Essendant to provide goods and services to its customers, Essendant’s customers share with Essendant information their customers provide to them. Essendant has, from time to time, experienced attempts to breach its systems, and these attempts are expected to continue. Any loss, unauthorized access to or misuse of our information technology systems  could disrupt the Company’s operations, expose Essendant to claims from customers, financial institutions, regulators, payment card associations, and other persons, and damage the Company’s reputation. In addition, compliance with more stringent privacy and information security laws and standards may result in significant expense due to increased investment in technology and the development of new operational processes.  

Combining Essendant’s businesses on a common platform may result in disruptions with suppliers and customers.

Essendant is in the process of combining its businesses onto a common platform with common systems and processes. These activities could disrupt Essendant’s relationships with customers and suppliers or could impair the Company’s ability to timely and accurately record transactions, which could adversely affect the Company’s results of operations and financial condition.

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

Supplier allowances and promotional incentives that are often based on volume contribute significantly to Essendant’s profitability. If Essendant does not comply with suppliers’ terms and conditions, or does not make requisite purchases to achieve certain volume hurdles, Essendant may not earn certain allowances and promotional incentives. Additionally, suppliers may reduce the allowances they pay Essendant if they conclude the value Essendant creates does not justify the allowances. If Essendant’s suppliers reduce or otherwise alter their allowances or promotional incentives, Essendant’s profit margin for the sale of the products it purchases from those suppliers may decline. The loss or diminution of supplier allowances and promotional support could have an adverse effect on the Company’s results of operations.

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Essendant is exposed to the credit risk of its customers.

Essendant extends credit to its customers. The failure of a significant customer or a significant group of customers to timely pay all amounts due Essendant could have a material adverse effect on the Company’s financial condition and results of operations. The Company’s trade receivables are generally unsecured or subordinated to other lenders, and many of the Company’s customers are highly leveraged. The extension of credit involves considerable judgment and is based on management’s evaluation of a variety of factors, including customers’ financial condition and payment history, the availability of collateral to secure customers’ receivables, and customers’ prospects for maintaining or increasing their sales revenues. There can be no assurance that Essendant has assessed and will continue to assess the creditworthiness of its existing or future customers accurately.

Essendant operates in a competitive environment.

The Company operates in a competitive environment. The Company competes with other wholesale distributors and with the manufacturers of the products the Company sells. In addition, the Company competes with warehouse clubs and the business-to-business sales divisions of national business products resellers. Competition is based largely upon service capabilities and price, as the Company’s competitors generally offer products that are the same as or similar to the products the Company offers to the same customers or potential customers. These competitive pressures are exacerbated by the ongoing decline in the overall demand for office products. The competitive arena is also increasingly shifting online. The Company’s financial condition and results of operations depend on its ability to compete effectively on price, product selection and availability, marketing support, logistics, and other ancillary services; diversify its product offering; and provide services and capabilities that enable its customers to succeed online.

Supply chain disruptions or changes in key suppliers’ distribution strategies could decrease Essendant’s revenues and profitability.

Essendant believes its ability to offer a combination of well-known brand name products, competitively priced private brand products, and support services is an important factor in attracting and retaining customers. The Company’s ability to offer a wide range of products and services is dependent on obtaining adequate product supply and services from manufacturers or other suppliers. Essendant’s agreements with its suppliers are generally terminable by either party on limited notice. The loss of, or a substantial decrease in the availability of products or services from key suppliers at competitive prices could cause the Company’s revenues and profitability to decrease. In addition, supply interruptions could arise due to transportation disruptions, labor disputes or other factors beyond Essendant’s control. Disruptions in Essendant’s supply chain could result in a decrease in revenues and profitability.

Some manufacturers refuse to sell their products to wholesalers like Essendant. Other manufacturers only allow Essendant to sell their products to specified customers. If changes in key suppliers’ distribution strategies or practices reduce the breadth of products the Company is able to purchase or the number of customers to whom Essendant can sell key products, the Company’s results of operations and financial condition could be adversely affected.

Many of the Company’s independent resellers use third party technology vendors (“3PVs”) to automate their business operations. The 3PVs play an important role in the independent dealer channel, as most purchase orders, order confirmations, stock availability checks, invoices, and advanced shipping notices are exchanged between Essendant and its independent resellers over 3PV networks. The 3PVs also provide e-commerce portals that Essendant’s customers use to transact online business with their customers. If Essendant is unable to transact business with its customers through one or more 3PVs on terms that are acceptable to Essendant, or if a 3PV fails to provide quality services to Essendant’s customers, Essendant’s business, financial condition, and results of operations could be adversely affected.

Essendant must manage inventory effectively while minimizing excess and obsolete inventory.

To maximize supplier allowances and minimize excess and obsolete inventory, Essendant must project end-consumer demand for over 180,000 items in stock. If Essendant underestimates demand for a particular manufacturer’s products, the Company will lose sales, reduce customer satisfaction, and earn a lower level of allowances from that manufacturer. If Essendant overestimates demand, it may have to liquidate excess or obsolete inventory at a price that would produce a lower margin, no margin, or a loss.

Essendant is focusing on increasing its sales of private brand products. These products can present unique inventory challenges. Essendant sources some of its private brand products overseas, resulting in longer order-lead times than for comparable products sourced domestically. These longer lead-times make it more difficult to forecast demand accurately and require larger inventory investments to support high service levels.

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Essendant may not be successful in identifying, consummating, and integrating future acquisitions.

 

Historically, part of Essendant’s growth and expansion into new product categories or markets has come from targeted acquisitions. Essendant may not be able to identify attractive acquisition candidates or complete the acquisition of any identified candidates at favorable prices and upon advantageous terms. Furthermore, competition for attractive acquisition candidates may limit the number of acquisition candidates or increase the overall costs of making acquisitions. Acquisitions involve significant risks and uncertainties, including difficulties integrating acquired business systems and personnel with Essendant’s business; the potential loss of key employees, customers or suppliers; the assumption of liabilities and exposure to unforeseen liabilities of acquired companies; the difficulties in achieving target synergies; and the diversion of management attention and resources from existing operations. Difficulties in identifying, completing or integrating acquisitions could impede Essendant’s revenues, profitability, and net worth. In addition, some of the Company’s acquisitions have included foreign operations, and future acquisitions may increase Essendant’s international presence. International operations present a variety of unique risks, including the costs and difficulties of managing foreign enterprises, limitations on the repatriation and investment of funds, currency fluctuations, cultural differences that affect customer preferences and business practices, and unstable political or economic conditions.

The Company is subject to costs and risks associated with laws, regulations, and industry standards affecting Essendant’s business.

Essendant is subject to a wide range of state, federal, and foreign laws and industry standards, including laws and standards regarding labor and employment, government contracting, product liability, the storage and transportation of hazardous materials, privacy and data security, imports and exports, tax, and intellectual property, as well as laws relating to the Company’s international operations, including the Foreign Corrupt Practices Act and foreign tax laws. These laws, regulations, and standards may change, sometimes significantly, as a result of political or economic events. The complex legal and regulatory environment exposes Essendant to compliance and litigation costs and risks that could materially affect Essendant’s operations and financial results. See “Legal Proceedings” included below under Item 3.

Essendant’s financial condition and results of operations depend on the availability of financing sources to meet its business needs.

The Company depends on various external financing sources to fund its operating, investing, and financing activities. The Company’s financing agreements include covenants by the Company to maintain certain financial ratios and comply with other obligations. If the Company violates a covenant or otherwise defaults on its obligations under a financing agreement, the Company’s lenders may refuse to extend additional credit, demand repayment of outstanding indebtedness, and terminate the financing agreements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” included below under Item 7.

The Company’s primary external financing sources terminate or mature in 2017 and 2021 years. If the Company defaults on its obligations under a financing agreement or is unable to obtain or renew financing sources on commercially reasonable terms, its business and financial condition could be materially adversely affected.

Unexpected events could disrupt normal business operations, which might result in increased costs and decreased revenues.

Unexpected events, such as hurricanes, fire, war, terrorism, and other natural or man-made disruptions, may adversely impact Essendant’s ability to serve its customers and increase the cost of doing business or otherwise impact Essendant’s financial performance. In addition, damage to or loss of use of significant aspects of the Company’s infrastructure due to such events could have an adverse effect on the Company’s operating results and financial condition.

 

None.

 

 

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The Company considers its properties to be suitable with adequate capacity for their intended uses. The Company evaluates its properties on an ongoing basis to improve efficiency and customer service and leverage potential economies of scale. As of December 31, 2015, the Company’s properties consisted of the following:

Offices. The Company leases approximately 200,000 square feet for its corporate headquarters in Deerfield, Illinois. Additionally the Company owns 49,000 square feet of office space in Orchard Park, New York; leases 38,000 square feet of office space in Tulsa, Oklahoma; leases 10,000 square feet in Pasadena, California; and leases 11,000 square feet in Atlanta, Georgia.

Distribution Centers. The Company utilizes 74 distribution centers totaling approximately 12.9 million square feet of warehouse space, of which 2.2 million square feet are owned and 10.7 million square feet are leased.

 

 

The Company has been named as a defendant in two lawsuits alleging that the Company sent unsolicited fax advertisements to the named plaintiffs, as well as other persons and entities, in violation of the Telephone Consumer Protection Act of 1991, as amended by the Junk Fax Prevention Act of 2005 ("TCPA"). One lawsuit was filed in the United States District Court for the Central District of California on May 1, 2015.  The case is presently stayed.  The other lawsuit was filed in the United States District Court for the Northern District of Illinois on January 14, 2016.  In both lawsuits the plaintiffs filed a motion asking the Court to certify a class of plaintiffs comprised of persons and entities who allegedly received fax advertisements from the Company.  Under the TCPA, recipients of unsolicited fax advertisements can seek damages of $500 per fax for inadvertent violations and up to $1,500 per fax for knowing and willful violations.   Other reported TCPA lawsuits have resulted in a broad range of outcomes, with each case being dependent on its own unique set of facts and circumstances.  In each lawsuit, the Company is vigorously contesting class certification and denies that any violations occurred.  Litigation of this kind, however, is likely to lead to settlement negotiations, including negotiations prompted by pre-trial civil court procedures.  Regardless of whether the lawsuits are resolved at trial or through settlement, the Company believes that a loss associated with resolution of pending claims is probable.  However, the amount of any such loss, which could be material, cannot be reasonably estimated because the Company is continuing to evaluate its defenses based on its internal review and investigation of prior events, new information and future circumstances.

The Company is also involved in other legal proceedings arising in the ordinary course of or incidental to its business. The Company has established reserves, which are not material, for potential losses that are probable and reasonably estimable that may result from those proceedings. In many cases, however, it is difficult to determine whether a loss is probable or even possible or to estimate the amount or range of potential loss, particularly where proceedings may be in relatively early stages or where plaintiffs are seeking substantial or indeterminate damages. Matters frequently need to be more developed before a loss or range of loss can reasonably be estimated. The Company believes that such ordinary course legal proceedings will be resolved with no material adverse effect upon its financial condition or results of operations.  

 

 

 

Not applicable.

 

 

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PART II

 

 

Common Stock Information

ESND’s common stock is quoted through the NASDAQ Global Select Market (“NASDAQ”) under the symbol ESND. The following table shows the high and low closing sale prices per share for ESND’s common stock as reported by NASDAQ:

 

On February 12, 2016, the closing sale price of Company’s common stock as reported by NASDAQ was $28.09 per share. On February 12, 2016, there were approximately 670 holders of record of common stock. A greater number of holders of ESND common stock are “street name” or beneficial holders, whose shares are held of record by banks, brokers and other financial institutions.

Stock Performance Graph

The following graph compares the performance of the Company’s common stock over a five-year period with the cumulative total returns of (1) Russell 2000 Index and (2) a group of companies included within Value Line’s Office Equipment Industry Index. The graph assumes $100 was invested on December 31, 2010 in the Company’s common stock and in each of the indices and assumes reinvestment of all dividends (if any) at the date of payment. The following stock price performance graph is presented pursuant to SEC rules and is not meant to be an indication of future performance.

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Common Stock Repurchases

During 2015, the Company repurchased 1.8 million shares of common stock at an aggregate cost of $67.4 million. During 2014, the Company repurchased 1.3 million shares of common stock at an aggregate cost of $50.6 million. As of February 12, 2016, the Company had approximately $75.0 million remaining under share repurchase authorizations from its Board of Directors.

Purchases may be made from time to time in the open market or in privately negotiated transactions. Depending on market and business conditions and other factors, the Company may continue or suspend purchasing its common stock at any time without notice.

Acquired shares are included in the issued shares of the Company and treasury stock, but are not included in average shares outstanding when calculating earnings per share data.

The following table reports purchases of equity securities during the fourth quarter of fiscal year 2015 by the Company and any affiliated purchasers pursuant to SEC rules, including any treasury shares withheld to satisfy employee withholding obligations upon vesting of restricted stock and the execution of stock option exercises.

 

 

Stock and Cash Dividends

The Company declares and pays dividends on a quarterly basis. During 2014 and 2015, the Company declared and paid a dividend of $0.14 per share per quarter. In the aggregate, the Company declared dividends of $21.1 million and $21.8 million in 2015 and 2014, respectively. On February 10, 2016, the Board of Directors approved a dividend of $0.14 to be paid on April 15, 2016 to shareholders of record as of March 15, 2016.

 

Securities Authorized for Issuance under Equity Compensation Plans

The information required by Item 201(d) of Regulation S-K (Securities Authorized for Issuance under Equity Compensation Plans) is included in Item 12 of this Annual Report.

 

 

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The selected consolidated financial data of the Company for the years ended December 31, 2011 through 2015 have been derived from the Consolidated Financial Statements of the Company, which have been audited by Ernst & Young LLP, an independent registered public accounting firm. The adoption of new accounting pronouncements, changes in certain accounting policies, and reclassifications are reflected in the financial information presented below. The selected consolidated financial data below should be read in conjunction with, and is qualified in its entirety by, Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements of the Company included in Items 7 and 8, respectively, of this Annual Report. Except for per share data, all amounts presented are in thousands:

 

 

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

(2) 2015— $115.8 million charge related to ORS Industrial impairment of goodwill and intangible assets, $18.6 million charge related to workforce reductions and facility consolidations, $12.0 million intangible asset impairment charge related to rebranding and accelerated amortization related to rebranding efforts, $10.7 million an impairment of seller notes receivable related to the company’s prior year sale of its software service provider, and a $17.0 million loss on sale and related costs of our Mexican subsidiary.  2014—$8.2 million loss on disposition of business. 2013—$13.0 million charge for a workforce reduction and facility closures and a $1.2 million asset impairment charge. 2012—$6.2 million charge for a distribution network optimization and cost reduction program. 2011—$0.7 million reversal of a charge for early retirement/workforce realignment, $4.4 million charge for a transition agreement with the company’s former Chief Executive Officer, and a $1.6 million asset impairment charge.

(3) 2011—a reversal of prior acquisition earn-out and deferred payment liabilities.

(4) Total debt includes current maturities where applicable.

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FORWARD LOOKING INFORMATION

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act. Forward-looking statements often contain words such as “expects”, “anticipates”, “estimates”, “intends”, “plans”, “believes”, “seeks”, “will”, “is likely”, “scheduled”, “positioned to”, “continue”, “forecast”, “predicting”, “projection”, “potential” or similar expressions. Forward-looking statements include references to goals, plans, strategies, objectives, projected costs or savings, anticipated future performance, results or events and other statements that are not strictly historical in nature. These forward-looking statements are based on management’s current expectations, forecasts and assumptions. This means they involve a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied here. These risks and uncertainties include, without limitation, those set forth above under the heading “Risk Factors.”

Readers should not place undue reliance on forward-looking statements contained in this Annual Report on Form 10-K. The forward-looking information herein is given as of this date only, and the Company undertakes no obligation to revise or update it.

 

 

The following discussion should be read in conjunction with the information included in this Annual Report on Form 10-K in Item 1, Item 6, and the Company’s Consolidated Financial Statements and related notes contained in Item 8.

Key Trends and Recent Results

The following is a summary of selected trends, events or uncertainties that the Company believes may have a significant impact on its future performance.

Recent Results

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Repositioning Actions

 

Guidance

The company reaffirms its previously announced outlook regarding 2016, and currently expects the following:

 

The guidance above excludes the impact of business acquired in the Staples transaction, any new acquisitions or unusual charges.  

Critical Accounting Policies, Judgments and Estimates

The Company’s significant accounting policies are more fully described in Note 2 of the Consolidated Financial Statements. As described in Note 2, the preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results may differ from those estimates.

The Company’s critical accounting policies are most significant to the Company’s financial condition and results of operations and require especially difficult, subjective or complex judgments or estimates by management. In most cases, critical accounting policies require management to make estimates on matters that are uncertain at the time the estimate is made. The basis for the estimates is historical experience, terms of existing contracts, observance of industry trends, information provided by customers or vendors, and information available from other outside sources, as appropriate. These critical accounting policies include the following:

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Supplier Allowances

Supplier allowances are common practice in the business products industry and have a significant impact on the Company’s overall gross margin. Receivables related to supplier allowances totaled $111.0 million and $124.4 million as of December 31, 2015 and 2014, respectively.

The majority of the Company’s annual supplier allowances and incentives are variable, based solely on the volume and mix of the Company’s product purchases from suppliers. These variable allowances are recorded based on the Company’s annual inventory purchase volumes and product mix and are included in the Company’s Consolidated Financial Statements as a reduction to cost of goods sold, thereby reflecting the net inventory purchase cost. The potential amount of variable supplier allowances often differs based on purchase volumes by supplier and product category. Changes in the Company’s sales volume (which can increase or reduce inventory purchase requirements), changes in product sales mix (especially because higher-margin products often benefit from higher supplier allowance rates), or changes in the amount of purchases Essendant makes to attain supplier allowances can create fluctuations in future results.

Customer Rebates

Customer rebates and discounts are common practice in the business products industry and have a significant impact on the Company’s overall sales and gross margin. Accrued customer rebates were $63.6 million and $63.2 million as of December 31, 2015 and 2014, respectively.

Customer rebates include volume rebates, sales growth incentives, advertising allowances, participation in promotions and other miscellaneous discount programs. Estimates for volume rebates and growth incentives are based on estimated annual sales volume to the Company’s customers. The aggregate amount of customer rebates depends on product sales mix and customer mix changes. Reported results reflect management’s current estimate of such rebates. Changes in estimates of sales volumes, product mix, customer mix or sales patterns, or actual results that vary from such estimates may impact future results.

Allowance for doubtful accounts

Management estimates an allowance for doubtful accounts, which addresses the collectability of trade accounts receivable. This allowance adjusts gross trade accounts receivable downward to its estimated collectible or net realizable value. To determine the allowance for doubtful accounts, management reviews specific customer risks and the Company’s trade accounts receivable aging. Uncollectible trade receivable balances are written off against the allowance for doubtful accounts when it is determined that the trade receivable balance is uncollectible. Allowance for doubtful accounts totaled $17.8 million and $19.7 million as of December 31, 2015 and 2014, respectively.  

Goodwill and Intangible Assets

The Company tests goodwill for impairment annually as of October 1 and whenever events or circumstances indicate that an impairment may have occurred, such as a significant adverse change in the business climate, loss of key personnel or a decision to sell or dispose of a reporting unit. Determining whether an impairment has occurred requires valuation of the respective reporting unit, which the Company estimates using forecasted future results and a discounted cash flow method. When available and as appropriate, comparative market multiples are used to corroborate discounted cash flow results.

Intangible assets are initially recorded at their fair market values determined on quoted market prices in active markets, if available, or recognized valuation models. Intangible assets that have finite useful lives are amortized on a straight-line basis over their useful lives. Intangible assets that have indefinite useful lives are not amortized but are tested at least annually for impairment or whenever events or circumstances indicate impairment may have occurred. The Company makes an annual impairment assessment of its intangibles.

As of December 31, 2015 and 2014, the Company’s Consolidated Balance Sheets reflected $299.4 million and $398.0 million of goodwill, and $96.4 million and $112.0 million in net intangible assets, respectively.

Inventory Reserves

The Company also records adjustments to inventory that is obsolete, damaged, defective or slow moving. Inventory is recorded at the lower of cost or market. These adjustments are determined using historical trends such as age of inventory, market demands, customer commitments, and new products introduced to the market. The reserves are further adjusted, if necessary, as new information becomes available; however, based on historical experience, the Company does not believe the estimates and assumptions will have a material impact on the financial statements.

In the third quarter of 2015, the Company changed its method of inventory costing for certain operating segments to the last-in-first-out (“LIFO”) method from the first-in-first-out (“FIFO”) accounting method.  See Note 2, “Change in Accounting Principles” for more information.

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Income Taxes

The Company accounts for income taxes using the liability method in accordance with the accounting guidance for income taxes. The Company estimates actual current tax expense and assesses temporary differences that exist due to differing treatments of items for tax and financial statement purposes. These temporary differences result in the recognition of deferred tax assets and liabilities. A provision has not been made for deferred U.S. income taxes on the undistributed earnings of the Company’s foreign subsidiaries as these earnings have historically been permanently invested. It is not practicable to determine the amount of unrecognized deferred tax liability for such unremitted foreign earnings. The Company accounts for interest and penalties related to uncertain tax positions as a component of income tax expense.

Pension Benefits

To select the appropriate actuarial assumptions when determining pension benefit obligations, the Company relied on current market conditions, historical information and consultation with and input from the Company’s outside actuaries. These actuarial assumptions include discount rates, expected long-term rates of return on plan assets, and life expectancy of plan participants. The expected long-term rate of return on plan assets assumption is based on historical returns and the future expectation of returns for each asset category, as well as the target asset allocation of the asset portfolio.

Pension expense for 2015 was $5.4 million, compared to $3.6 million in 2014 and $4.5 million in 2013. A one percentage point decrease in the assumed discount rate would have resulted in an increase in pension expense for 2015 of approximately $3.3 million and increased the year-end projected benefit obligation by $34.5 million. Additionally, a one percentage point decrease in the expected rate of return assumption would have resulted in an increase in the net periodic benefit cost for 2015 of approximately $1.7 million. See Note 13 “Pension Plans and Defined Contribution Plan” for more information.

Results for the Years Ended December 31, 2015, 2014 and 2013

The following table presents the Consolidated Statements of Operations as a percentage of net sales:

 

 

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Adjusted Gross Profit, Adjusted Operating Income, Adjusted Net Income, and Adjusted Diluted Earnings Per Share

The following table presents Adjusted Gross Profit, Adjusted Operating Income, Adjusted Net Income and Adjusted Diluted Earnings Per Share for the years ended December 31, 2015, 2014, and 2013 (in thousands, except share data). These amounts have been adjusted from Generally Accepted Accounting Principles (GAAP) as reflected in the following table. GAAP requires that the effects of these items be included in the Consolidated Statements of Operations. The Company believes that excluding these items is an appropriate comparison of its ongoing operating results and to the results of the prior year, and that it is helpful to provide readers of its financial statements with a reconciliation of these items to its Consolidated Statements of Operations reported in accordance with GAAP.

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Comparison of Results for the Years Ended December 31, 2015 and 2014

Net Sales. Net sales for the year ended December 31, 2015 were $5.4 billion, a 0.7% increase from $5.3 billion in sales during 2014. The following table shows net sales by product category for 2015 and 2014 (in thousands):

 

 

 

Sales in the janitorial and breakroom supplies product category increased 1.1% in 2015 compared to 2014. Sales growth in this category was driven by being named the primary supplier for Office Depot’s janitorial business and growth in sales through the internet (“e-tail”), partially offset by lower sales in the independent dealer channel.

 

Sales in the technology products category (primarily ink and toner) decreased 5.8% in 2015 versus 2014. Sales declined due to the loss of business with large national customers and lower sales due to the divestiture of the Mexican subsidiary. The sales decline was partially offset by growth in e-tail.

 

Sales of traditional office products decreased 9.3% in 2015 versus 2014. The decline in this category was primarily driven by decline of cut-sheet paper and loss of first call supplier status with Office Depot, partially offset by growth in e-tail.

Industrial supplies sales increased 36.0% in 2015 compared to 2014. Our acquisitions contributed $304.5 million in incremental sales. Excluding sales from acquisitions, industrial supplies sales declined 10.6% over the same period last year, due to declines in our general industrial, oilfield and energy channels. We expect the impact of low energy prices and weak industrial demand to continue in 2016.

Office furniture sales increased 2.0% in 2015 compared to 2014. Improved sales with a large national customer and growth in e-tail and independent resellers more than offset lost sales.

The remainder of the Company’s consolidated 2015 net sales was composed of freight and other revenues.

Gross Profit and Gross Margin Rate. Gross profit for 2015 was $836.5 million, compared to $802.5 million in 2014. Gross profit as a percentage of net sales (the gross margin rate) of 15.6% for 2015 was up 50 basis points (bps) from the prior-year period gross margin rate of 15.1%. This increase was due to acquisitions (28 bps) and a favorable product margin (41 bps) driven by favorable product mix and purchase driven inventory allowances.

Operating Expenses. Operating expenses for 2015 were $806.7 million or 12.6% of sales, compared with $603.9 million or 11.2% of sales in the same period last year. Excluding the Repositioning Actions in 2015 and an $8.2 million loss on disposition of business in 2014, adjusted operating expenses were $632.6 million or 11.8% of sales in 2015 compared to $566.3 million or 11.1% of sales in 2014. The 2015 operating expenses were affected by acquisitions which added an incremental 23 bps, partly offset by reduced expenses including variable management compensation. We also incurred approximately $12 million of operating expense related to the initiative to combine the Company’s office product and janitorial platforms.

Interest Expense, net. Net interest expense for 2015 was $19.6 million, compared with $15.7 million in 2014. This increase was driven by the increase in outstanding debt over the prior year related to our acquisitions.

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Income Taxes. Income tax expense was $54.5 million in 2015, compared with $70.8 million in 2014. The Company’s effective tax rate was 534.8% and 38.7% in 2015 and 2014, respectively. The increase was driven by the Repositioning Actions, particularly the noncash impairment charges for goodwill which is nondeductible for tax purposes and the capital loss resulting from the sale of Azerty de Mexico which cannot be recognized at this time and carries a full valuation allowance.  The Company’s 2015 effective tax rate excluding these Repositioning Actions would have been 39.1%.  

Net Income (Loss). Net loss for 2015 was $44.3 million and diluted earnings per share were $(1.18), compared to 2014 net income of $112.1 million and diluted earnings per share of $2.87. Excluding the Repositioning Actions in 2015 and $8.2 million on disposition of business in 2014, adjusted net income for 2015 and 2014 were $116.4 million and $120.3 million, respectively. Adjusted diluted earnings per share were $3.08 and $3.08 for 2015 and 2014, respectively.

Comparison of Results for the Years Ended December 31, 2014 and 2013

Net Sales. Net sales for the year ended December 31, 2014 were $5.3 billion, a 4.8% increase from $5.1 billion in sales during 2013. The following table shows net sales by product category for 2014 and 2013 (in thousands):

 

Sales in the janitorial and breakroom supplies product category increased 7.5% in 2014 compared with 2013. This category represented the largest percentage of the Company’s consolidated net sales, accounting for 27.0% of net sales of 2014. Growth in this category was driven by increased sales of janitorial and breakroom products in nearly all channels as enhanced product lines were launched.  Incremental sales from becoming the primary supplier to Office Depot’s janitorial business beginning in 2014 accounted for 2.0% of the increase in sales.

Sales in the technology products category decreased 0.8% in 2014 versus 2013. This category accounted for 27.2% of net sales of 2014. Early in the fourth quarter of 2013 our largest product line manufacturer adopted a new distribution policy that restricts wholesalers, including the Company, to resell its products only to certain authorized resellers.  In the fourth quarter of 2014, additional restrictions in this supplier’s distribution policy went into effect, again decreasing the amount of authorized resellers for their products. This new distribution policy resulted in a decline in our sales of the manufacturer’s products.  Offsetting these declines was increased business with certain large customers and the addition of new business.

 

Sales of traditional office products increased 1.1% in 2014 versus 2013. Traditional office supplies represented 24.9% of the Company’s consolidated net sales in 2014. Within this category, higher sales of cut-sheet paper, continued double-digit growth in sales to e-tail, and a rebound in government spending were partially offset by the continued effects of workplace digitization which is lowering overall consumption. In addition, there were lower sales due to being named the second-call office products supplier for Office Depot’s office products’ business in 2014, after being the primary supplier of a portion of its business in prior years.

Industrial supplies sales in 2014 increased 23.4% compared with 2013. Sales of industrial supplies accounted for 12.0% of the Company’s net sales in 2014. Sales growth in industrial supplies was largely driven by the acquisitions of CPO in May of 2014 and MEDCO in October of 2014. Organic industrial sales grew 4.7%, driven by the Company’s Value of Wholesale (VOW) initiatives.  Additionally in 2014, the Company became the exclusive distributor for a major safety buying group.

Office furniture sales in 2014 was comparable to 2013. Office furniture accounted for 5.8% of the Company’s 2014 consolidated net sales.

The remainder of the Company’s consolidated 2014 net sales was composed of freight and other revenues.

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Gross Profit and Gross Margin Rate. Gross profit for 2014 was $802.5 million, compared with $787.3 million in 2013. Gross profit as a percentage of net sales (the gross margin rate) for 2014 was 15.1%, as compared with 15.5% for 2013. The gross margin rate was favorably impacted 10 bps from our acquisitions. Excluding the acquisitions, gross margin declined due to unfavorable product margin (11 bps) including an unfavorable product category and customer mix and higher net freight costs (20 bps).

Operating Expenses. Operating expenses in 2014 were $603.9 million or 11.2% as a percent of sales for the year, compared with $580.1 million or 11.4% in 2013. Operating expenses were unfavorably impacted by 10 bps from our acquisitions in 2014. Excluding the acquisitions, adjusted operating expense decreased due a decline in variable management compensation expense from the prior year (10 bps) and a reduction in health-care expenses (5 bps) offset by approximately $4.0 million in higher costs related to the Company’s initiative to combine our office product and janitorial/breakroom platforms.

Interest Expense, net. Net interest expense for 2014 was $15.7 million, compared with $11.6 million in 2013. This increase was primarily driven by the increase in outstanding debt over the prior year as well as the issuance of seven-year notes in January 2014 which replaced floating rate debt with long-term fixed rate debt.

Income Taxes. Income tax expense was $70.8 million in 2014, compared with $73.5 million in 2013. The Company’s effective tax rate was 38.7% and 37.6% in 2014 and 2013, respectively.

Net Income. Net income for 2014 was $112.1 million and diluted earnings per share were $2.87, compared to 2013 net income of $122.1 million and diluted earnings per share of $3.03. Included in the 2014 results are an $8.2 million charge related to a loss on disposition of a business. This loss was not fully recognizable for tax in 2014. Included in the 2013 results are a $13.0 million pre-tax charge related to a workforce reduction and facility closure program and $1.2 million non-tax deductible asset impairment charge. Excluding these non-operating items, adjusted net income for 2014 and 2013 was $120.3 million and $131.3 million, respectively. Adjusted diluted earnings per share were $3.08 and $3.26 for 2014 and 2013, respectively.

Liquidity and Capital Resources

Essendant’s growth has historically been funded by a combination of cash provided by operating activities and debt financing. The Company believes that its cash from operations and collections of receivables, coupled with its sources of borrowings and available cash on hand, are sufficient to fund its currently anticipated requirements. These requirements include payments of interest and dividends, scheduled debt repayments, capital expenditures, working capital needs, restructuring activities, the funding of pension plans, and funding for additional share repurchases and acquisitions, if any. Due to our credit profile over the years, external funds have been available at an acceptable cost. We believe that current credit arrangements are sound and that the strength of our balance sheet affords us the financial flexibility to respond to both internal growth opportunities and those available through acquisitions.

 

The Company’s outstanding debt consisted of the following amounts (in millions):

 

 

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This increase in the debt-to-capitalization ratio at December 31, 2015 is due to the decrease in equity related to the charges from the Repositioning Actions.

Operating cash requirements and capital expenditures are funded from operating cash flow and available financing. Financing available from debt and the sale of accounts receivable as of December 31, 2015, is summarized below (in millions):

Availability

The 2013 Credit Agreement, the 2013 Note Purchase Agreement and the Amended and Restated Transfer and Administration Agreement (each as defined in Note 11 “Debt” in the Notes to the Consolidated Financial Statements) prohibit the Company from exceeding a Leverage Ratio of 3.50 to 1.00 (4.00 to 1.00 or 3.75 to 1.00 for the first four fiscal quarters following certain acquisitions). The 2013 Credit Agreement and the 2013 Note Purchase Agreement also impose limits on the Company’s ability to repurchase stock and issue dividends when the Leverage Ratio is greater than 3.00 to 1.00. The Company was in compliance with all applicable financial covenants at December 31, 2015, and expects to have leverage ratio in excess of 3.00 to 1.00 when reporting to its counterparties in the first quarter of 2016.

The 2013 Credit Agreement provides for a revolving credit facility with an aggregate committed principal amount of $700 million. The 2013 Credit Agreement also provides for the issuance of letters of credit. The Company had outstanding letters of credit of $11.6 million and $11.1 million under the 2013 Credit Agreement as of December 31, 2015 and 2014, respectively.

The Company believes that its operating cash flow and financing capacity, as described, provide adequate liquidity for operating the business for the foreseeable future. Refer to Note 11 “Debt” in the Notes to the Consolidated Financial Statements, for further descriptions of the provisions of our financing facilities.

Disclosures About Contractual Obligations

The following table aggregates all contractual obligations that affect financial condition and liquidity as of December 31, 2015 (in millions):

  

In December 2015, the Company’s Board of Directors approved cash contributions to the Company’s pension plans.  In January 2016, a cash contribution of $3 million was made to the Essendant Union Employee Pension Plan and $7 million was made to the Essendant Pension Plan. Additional fundings, if any, for 2016 have not yet been determined.

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The Company has announced its plan to offer lump sum distributions to eligible terminated, vested plan participants of the Essendant Pension Plan during an offering period in the first half of 2016. Settlement charges are likely in the future as the Company settles pension obligations by making lump sum distributions. The impact on the benefit obligation and assets of the non-union plan will not be determinable until the eligible participants elect this voluntary option.

At December 31, 2015, the Company had a liability for unrecognized tax benefits of $3.4 million as discussed in Note 15, “Income Taxes”, and an accrual for the related interest, that are excluded from the Contractual Obligations table. Due to the uncertainties related to these tax matters, the Company is unable to make a reasonably reliable estimate when cash settlement with a taxing authority may occur.

Cash Flows

Cash flows for the Company for the years ended December 31, 2015, 2014 and 2013 are summarized below (in thousands):

 

Cash Flows From Operations

Net cash provided by operating activities for 2015 totaled $162.7 million versus $77.1 million in 2014 and $74.7 million in 2013. The 2015 improvement over the prior year demonstrates market factors and our commitment to effectively manage working capital such as lower increases in Accounts Receivable and increases in Accounts Payable. Cash flows in 2014 was impacted primarily by the timing of higher inventory levels related to strategic inventory purchases, a decrease in accounts payable, and higher accounts receivable.

Cash Flows From Investing Activities

Net cash used in investing activities for the years ended December 31, 2015, 2014 and 2013 was $67.9 million, $183.6 million, and $30.3 million, respectively. Gross capital spending for 2015, 2014 and 2013 was $28.3 million, $25.0 million and $33.8 million, respectively, which was used for various investments in fleet equipment, information technology systems, technology hardware, and distribution center equipment including several facility projects. Additionally, cash used in 2015 and 2014 included $40.5 million and $161.4 million, respectively, for acquisitions.  

Cash Flows From Financing Activities

The Company’s cash flow from financing activities is largely dependent on levels of borrowing under the Company’s credit agreements, the acquisition or issuance of treasury stock, and quarterly dividend payments.

Net cash used in financing activities for 2015 totaled $85.0 million, compared to net cash provided by financing activities for 2014 totaling $106.0 million, and used in financing activities for 2013 totaling $53.1 million. Cash outflows from financing activities in 2015 included the repurchase of shares at a cost of $68.1 million and the payment of cash dividends of $21.2 million. As of December 31, 2015 there are $75.0 million remaining on the current share repurchase authorization.

The Company paid a $0.14 per share dividend on January 15, 2016, totaling $5.1 million. On February 10, 2016, the Board of Directors approved a dividend of $0.14 to be paid on April 15, 2016 to shareholders of record as of March 15, 2016. In the aggregate, the Company declared dividends of $21.1 million and $21.8 million in 2015 and 2014.

Inflation/Deflation and Changing Prices

The Company maintains substantial inventories to accommodate the prompt service and delivery requirements of its customers. Accordingly, the Company purchases its products on a regular basis in an effort to maintain its inventory at levels that it believes are sufficient to satisfy the anticipated needs of its customers, based upon historical buying practices and market conditions. Although the Company historically has been able to pass through manufacturers’ price increases to its customers on a timely basis, competitive conditions will influence how much of future price increases can be passed on to the Company’s customers. Conversely, when manufacturers’ prices decline, lower sales prices could result in lower margins as the Company sells existing inventory. As a result, changes in the prices paid by the Company for its products could have a material effect on the Company’s net sales, gross margins and net income. See the information under the heading “Comparison of Results for the Years Ended December 31, 2015 and 2014” in Part I, Item 7 of this Annual Report on Form 10-K for further analysis on these changes in prices in 2015.

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New Accounting Pronouncements

For information about recently issued accounting pronouncements, see Note 2, “Summary of Significant Accounting Policies,” in the Notes to the Consolidated Financial Statements.

 

The Company is subject to market risk associated principally with changes in interest rates and foreign currency exchange rates.

Interest Rate Risk

The Company’s exposure to interest rate risk is principally limited to the Company’s outstanding debt at December 31, 2015 and 2014 of $716.3 million and $710.8 million, respectively. As of December 31, 2015 and 2014, the Company had $568.4 and $563.0 million of outstanding debt with interest based on variable market rates. See Note 2, “Summary of Significant Accounting Policies”, and Note 19, “Derivative Financial Instruments”, to the Consolidated Financial Statements. As of December 31, 2015 and 2014, the overall weighted average effective borrowing rate, excluding the impact of commitment fees, of the Company’s debt was 2.2% and 1.9%, respectively. A 50 basis point movement in interest rates would result in a $2.1 million increase or decrease in annualized interest expense, and upon cash flows from operations.

Foreign Currency Exchange Rate Risk

The Company’s foreign currency exchange rate risk is limited principally to the Canadian Dollar and the Arab Emirate Dirham due to its operations in those countries. Many of the products the Company sells in those countries are purchased in U.S. dollars, while the sale is invoiced in the local currency. The Company’s foreign currency exchange rate risk is not material to its financial position, results of operations and cash flows. However, the Company does enter into foreign currency forward contracts from time to time to hedge the exposure to the Canadian Dollar.  

 

 

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MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act to mean a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers 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. 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 Consolidated Financial Statements.

Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2015 in relation to the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies and the Company’s overall control environment. That assessment was supported by testing and monitoring performed both by the Company’s Internal Audit organization and its Finance organization.

Based on that assessment, management concluded that as of December 31, 2015, the Company’s internal control over financial reporting was effective. Management reviewed the results of its assessment with the Audit Committee of the Company’s Board of Directors.

Ernst & Young LLP, an independent registered public accounting firm, who audited and reported on the Consolidated Financial Statements included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as stated in their report which appears on page 27 of this Annual Report on Form 10-K.

 

 

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Essendant Inc.

We have audited Essendant Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Essendant Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying report, Management Report of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

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 (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) 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 (3) 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.

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.

In our opinion, Essendant Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Essendant Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015, and our report dated February 18, 2016, expressed an unqualified opinion thereon.

 

/s/ Ernst & Young LLP

 

 

Chicago, Illinois

February 18, 2016

 

 

 

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Essendant Inc.

We have audited the accompanying consolidated balance sheets of Essendant Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. Our audits also included the financial statement schedule listed in the index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Essendant Inc. and subsidiaries at December 31, 2015 and 2014, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.

As discussed in Note 3 to the consolidated financial statements, the Company has elected to change its method of accounting for certain inventory in 2015.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Essendant Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 18, 2016 expressed an unqualified opinion thereon.

 

/s/ Ernst & Young LLP

 

Chicago, Illinois

February 18, 2016

 

 

 

 

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ESSENDANT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

* Revised in the third quarter of 2015 for the impact of the changes in accounting principle related to inventory accounting and debt transaction costs.

See notes to Consolidated Financial Statements.

 

 

 

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ESSENDANT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(dollars in thousands)

 

* Revised in the third quarter of 2015 for the impact of the changes in accounting principle related to inventory accounting and debt transaction costs.

See notes to Consolidated Financial Statements.

 

 

 

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ESSENDANT INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

 

*Revised in the third quarter of 2015 for the impact of the changes in accounting principle related to inventory accounting and debt transaction costs.

 

See notes to Consolidated Financial Statements.

 

 

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ESSENDANT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(dollars in thousands, except share data)

* Revised in the third quarter of 2015 for the impact of the changes in accounting principle related to inventory accounting and debt transaction costs.

See notes to Consolidated Financial Statements.

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ESSENDANT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

 

* Revised in the third quarter of 2015 for the impact of the changes in accounting principle related to inventory accounting and debt transaction costs.

 

See notes to Consolidated Financial Statements.

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ESSENDANT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

1. Basis of Presentation

The accompanying Consolidated Financial Statements represent Essendant Inc. (“ESND”) with its wholly owned subsidiary Essendant Co. (“ECO”), and ECO’s subsidiaries (collectively, “Essendant” or the “Company”). The Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States and include the accounts of ESND and its subsidiaries. The Company operates in a single reportable segment as a leading national wholesale distributor of workplace essentials, with net sales of approximately $5.4 billion for the year ended December 31, 2015. The Company stocks over 180,000 items on a national basis. These items include a broad spectrum of janitorial and breakroom supplies, technology products, traditional office products, industrial supplies, and office furniture. The Company sells its products through a national distribution network of 74 distribution centers to its approximately 30,000 reseller customers, who in turn sell directly to end-consumers. The Company’s customers include independent office products dealers; contract stationers; office products superstores; computer products resellers; office furniture dealers; mass merchandisers; mail order companies; sanitary supply, paper and foodservice distributors; drug and grocery store chains; healthcare distributors; e-commerce merchants; oil field, welding supply and industrial/MRO distributors; aftermarket automotive supply distributors and retailers; other independent distributors and end consumers. Many resellers have online capabilities. The Company also operates as an online retailer which sells direct to end consumers.

 

2. Summary of Significant Accounting Policies

Principles of Consolidation

The Consolidated Financial Statements include the accounts of the Company. All significant intercompany accounts and transactions have been eliminated in consolidation. For all acquisitions, account balances and results of operations are included in the Consolidated Financial Statements as of the date acquired.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Actual results could differ from these estimates.

Various assumptions and other factors underlie the determination of significant accounting estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, product mix, and in some cases, actuarial techniques. The Company periodically reevaluates these significant factors and makes adjustments where facts and circumstances dictate.

Revenue Recognition

Revenue is recognized when a service is rendered or when title to the product has transferred to the customer. Management records an estimate for future product returns related to revenue recognized in the current period. This estimate is based on historical product return trends and the gross margin associated with those returns. Management also records customer rebates that are based on annual sales volume to the Company’s customers. Annual rebates earned by customers include growth components, volume hurdle components, and advertising allowances.

Shipping and handling costs billed to customers are treated as revenues and recognized at the time title to the product has transferred to the customer. Freight costs are included in the Company’s Consolidated Financial Statements as a component of cost of goods sold and are not netted against shipping and handling revenues. Net sales do not include sales tax charged to customers.

The Company owned a software service provider from 2010 to 2014. The subsidiary’s revenue was generated from the sale of software licenses, delivery of subscription services (including the right to use software and software maintenance services), and professional services. Revenue was recognized when persuasive evidence of an arrangement existed, delivery occurred, the fees were fixed and determinable, and collection was considered probable. If collection was not considered probable, the Company recognized revenue when the fees were collected. If fees were not fixed and determinable, the Company recognized revenues when the fees became due from the customer. This entity was sold in 2014 and, therefore, the Company no longer had such contracts beginning in 2015.

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Customer Rebates

Customer rebates and discounts are common practice in the business products industry and have a significant impact on the Company’s overall sales and gross margin. Customer rebates include volume rebates, sales growth incentives, advertising allowances, participation in promotions and other miscellaneous discount programs. These rebates are paid to customers monthly, quarterly and/or annually. Such rebates are reported in the Consolidated Financial Statements as a reduction of sales. Accrued customer rebates were $63.6 million and $63.2 million as of December 31, 2015 and 2014, respectively, and are included as a component of “Accrued liabilities” in the Consolidated Balance Sheets.

Share-Based Compensation

At December 31, 2015, the Company had two active share-based employee compensation plans covering key associates and/or non-employee directors of the Company. See Note 5 “Share-Based Compensation” to the Consolidated Financial Statements for more information.

Cash Equivalents

An unfunded check balance (payments in-transit) exists for the Company’s primary disbursement accounts. Under the Company’s cash management system, the Company utilizes available borrowings, on an as-needed basis, to fund the clearing of checks as they are presented for payment. As of December 31, 2015, and 2014, outstanding checks totaling $46.0 million and $62.1 million, respectively, were included in “Accounts payable” in the Consolidated Balance Sheets.  

Accounts Receivable

In the normal course of business, the Company extends credit to customers. Accounts receivable, as shown in the Consolidated Balance Sheets, include such trade accounts receivable and are net of allowances for doubtful accounts and anticipated discounts. The Company makes judgments as to the collectability of trade accounts receivable based on historical trends and future expectations. Management estimates an allowance for doubtful accounts, which addresses the collectability of trade accounts receivable. This allowance adjusts gross trade accounts receivable downward to its estimated collectible or net realizable value. To determine the allowance for doubtful accounts, management reviews specific customer risks and the Company’s trade accounts receivable aging. Uncollectible trade receivable balances are written off against the allowance for doubtful accounts when it is determined that the trade receivable balance is uncollectible.

Supplier Allowances

Supplier allowances (fixed or variable) are common practice in the business products industry and have a significant impact on the Company’s overall gross margin. Receivables related to supplier allowances totaled $111.0 million and $124.4 million as of December 31, 2015 and 2014, respectively. These receivables are included in “Accounts receivable” in the Consolidated Balance Sheets.

The majority of the Company’s annual supplier allowances and incentives are variable, based solely on the volume and mix of the Company’s product purchases from suppliers. These variable allowances are recorded based on the Company’s annual inventory purchase volumes and product mix and are included in the Company’s Consolidated Financial Statements as a reduction to cost of goods sold, thereby reflecting the net inventory purchase cost. The remaining portion of the Company’s annual supplier allowances and incentives are fixed and are earned based primarily on supplier participation in specific Company advertising and marketing publications. Fixed allowances and incentives are taken to income through cost of goods sold as inventory is sold. Supplier allowances and incentives attributable to unsold inventory are carried as a component of net inventory cost.

Inventories

During the third quarter of 2015, the Company elected a change in accounting principle for the valuation method of certain inventories. This change required a retrospective application to all periods presented.  See Note 3, “Change in Accounting Principles,” for further details.  Approximately 98.4% and 97.0% of total inventory as of December 31, 2015 and 2014, respectively has been valued under the last-in, first-out (“LIFO”) accounting method. LIFO results in a better matching of costs and revenues. The remaining inventory, which is not domestic, is valued under the first-in, first-out (“FIFO”) accounting method. Inventory valued under the FIFO and LIFO accounting methods is recorded at the lower of cost or market. If the Company had valued its entire inventory under the lower of FIFO cost or market, inventory would have been $147.8 million (includes $1.6  million LIFO reserve related to Nestor acquired in 2015) and $139.5 million higher than reported as of December 31, 2015 and December 31, 2014, respectively. The annual change in the LIFO reserve as of December 31, 2015, December 31, 2014 and December 31, 2013 resulted in an $8.3 million increase, an $17.4 million increase and an $6.2 million increase, respectively, in cost of goods sold.

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The change in the LIFO reserve in 2015 included a LIFO liquidation relating to decrements in three of the Company’s thirteen LIFO pools. These decrements resulted in liquidation of LIFO inventory quantities carried at lower costs in prior years as compared with the cost of current year purchases. This liquidation resulted in LIFO income of $1.1 million which was more than offset by LIFO expense of $7.8 million related to current inflation for an overall net increase in cost of sales of $6.7 million.

The change in the LIFO reserve in 2014 included a LIFO liquidation relating to decrements in three of the Company’s seven LIFO pools. These decrements resulted in liquidation of LIFO inventory quantities carried at lower costs in prior years as compared with the cost of current year purchases. This liquidation resulted in LIFO income of $0.9 million which was more than offset by LIFO expense of $18.3 million related to current inflation for an overall net increase in cost of sales of $17.4 million.

The change in the LIFO reserve in 2013 included a LIFO liquidation relating to a decrement in one of the Company’s five LIFO pools. This decrement resulted in liquidation of LIFO inventory quantities carried at lower costs in prior years as compared with the cost of current year purchases. This liquidation resulted in LIFO income of $0.3 million which was more than offset by LIFO expense of $6.5 million related to current inflation for an overall net increase in cost of sales of $6.2 million.

The Company also records adjustments to inventory for shrinkage. Inventory that is obsolete, damaged, defective or slow moving is recorded at the lower of cost or market. These adjustments are determined using historical trends and are adjusted, if necessary, as new information becomes available. The Company charges certain warehousing and administrative expenses to inventory each period with $46.1 million, $44.7 million, and $43.0 million remaining in inventory as of December 31, 2015, December 31, 2014, and December 31, 2013, respectively.

Property, Plant and Equipment

Property, plant and equipment is recorded at cost. Depreciation and amortization are determined by using the straight-line method over the estimated useful lives of the assets. The estimated useful life assigned to fixtures and equipment is from two to ten years; the estimated useful life assigned to buildings does not exceed forty years; leasehold improvements are amortized over the lesser of their useful lives or the term of the applicable lease. Repair and maintenance costs are charged to expense as incurred.

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Software Capitalization

The Company capitalizes internal use software development costs in accordance with guidance on accounting for costs of computer software developed or obtained for internal use. Amortization is recorded on a straight-line basis over the estimated useful life of the software, generally not to exceed ten years. Capitalized software is included in “Property, plant and equipment” on the Consolidated Balance Sheets. The total costs are as follows (in thousands):

 

 

Goodwill and Intangible Assets

Goodwill is initially recorded based on the premium paid for acquisitions and is subsequently tested for impairment. Intangible assets are initially recorded at their fair market values determined on quoted market prices in active markets, if available, or recognized valuation models. Intangible assets that have finite useful lives are amortized on a straight-line basis over their useful lives. Intangible assets that have indefinite useful lives are not amortized but are tested at least annually for impairment or whenever events or circumstances indicate impairment may have occurred. See Note 6 “Goodwill and Intangible Assets” to the Consolidated Financial Statements.

Insured Loss Liability Estimates

The Company is primarily responsible for retained liabilities related to workers’ compensation, vehicle, and certain employee health benefits. The Company records expense for paid and open claims and an expense for claims incurred but not reported based upon historical trends and certain assumptions about future events. The Company has an annual per-person maximum cap, provided by a third-party insurance company, on certain employee medical benefits. In addition, the Company has a per-occurrence maximum on workers’ compensation and auto claims.

Leases

The Company leases real estate and personal property under operating leases. Certain operating leases include incentives from landlords including, landlord “build-out” allowances, rent escalation clauses and rent holidays or periods in which rent is not payable for a certain amount of time. The Company accounts for landlord “build-out” allowances as deferred rent at the time of possession and amortizes this deferred rent on a straight-line basis over the term of the lease.

The Company also recognizes leasehold improvements associated with the “build-out” allowances and amortizes these improvements over the shorter of the term of the lease or the expected life of the respective improvements. The Company accounts for rent escalation and rent holidays as deferred rent at the time of possession and amortizes this deferred rent on a straight-line basis over the term of the lease. As of December 31, 2015, any capital leases to which the Company is a party are immaterial to the Company’s financial statements.

Pension Benefits

Calculating the Company’s obligations and expenses related to its pension requires selection and use of certain actuarial assumptions. As more fully discussed in Note 13 to the Consolidated Financial Statements, these actuarial assumptions include discount rates, expected long-term rates of return on plan assets, and life expectancy of plan participants. To select the appropriate actuarial assumptions, management relies on current market conditions and historical information. Pension expense for 2015 was $5.4 million, compared to $3.6 million and $4.5 million in 2014 and 2013, respectively.

Derivative Financial Instruments

The Company’s risk management policies allow for the use of derivative financial instruments to manage foreign currency exchange rate and interest rate exposure subject to the management, direction and control of its financial officers. Risk management practices, including the use of all derivative financial instruments, are presented to the Board of Directors for approval. The policies do not allow such derivative financial instruments to be used for speculative purposes.

All derivatives are recognized on the balance sheet date at their fair value. See Note 19, “Derivative Financial Instruments” for further detail.

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The Company’s interest rate swap is classified as a cash flow hedge in accordance with accounting guidance on derivative instruments and hedging activities as it is hedging the variability of cash flow to be paid by the Company. The Company uses foreign currency exchange contracts to hedge certain of its foreign exchange rate exposures related to inventory purchases, and classifies the designation contracts as cash flow hedges. Changes in the fair value are recorded in other comprehensive income, net of tax, until earnings are affected by the forecasted transaction or the variability of cash flow, and then are reported in current earnings.

The Company formally documents all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives designated as cash flow hedges to specific forecasted transactions or variability of cash flow.

The Company formally assesses, at both the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in cash flow of hedged items. When it is determined that a derivative is not highly effective as a hedge then hedge accounting is discontinued prospectively in accordance with accounting guidance on derivative instruments and hedging activities.

Income Taxes

The Company accounts for income taxes using the liability method in accordance with the accounting guidance for income taxes. The Company estimates actual current tax expense and assesses temporary differences that exist due to differing treatments of items for tax and financial statement purposes. These temporary differences result in the recognition of deferred tax assets and liabilities. A provision has not been made for deferred U.S. income taxes on the undistributed earnings of the Company’s foreign subsidiaries as these earnings have historically been permanently invested except to the extent a liability was recorded in purchase accounting for the undistributed earnings of the foreign subsidiaries of O.K.I. Supply Co. as of the date of the acquisition. It is not practicable to determine the amount of unrecognized deferred tax liability for such unremitted foreign earnings.

The current and deferred tax balances and income tax expense recognized by the Company are based on management’s interpretation of the tax laws of multiple jurisdictions. Income tax expense also reflects the Company’s best estimates and assumptions regarding, among other things, the level of future taxable income, interpretation of tax laws, and tax planning. Future changes in tax laws, changes in projected levels of taxable income, and tax planning could impact the effective tax rate and current and deferred tax balances recorded by the Company. Management’s estimates as of the date of the Consolidated Financial Statements reflect its best judgment giving consideration to all currently available facts and circumstances. As such, these estimates may require adjustment in the future, as additional facts become known or as circumstances change. Further, in accordance with the accounting guidance on income taxes, the tax effects from uncertain tax positions are recognized in the Consolidated Financial Statements, only if it is more likely than not that the position will be sustained upon examination, based on the technical merits of the position. The Company accounts for interest and penalties related to uncertain tax positions as a component of income tax expense.  

Foreign Currency Translation

The functional currency for the Company’s foreign operations is the local currency. Assets and liabilities of these operations are translated into U.S. currency at the rates of exchange at the balance sheet date. The resulting translation adjustments are included in other comprehensive income (loss) in the Consolidated Statements of Comprehensive Income, a separate component of stockholders’ equity. Income and expense items are translated at average monthly rates of exchange. Realized gains and losses from foreign currency transactions included a $11.1 million loss related to the sale of the Mexican subsidiary in 2015.

New Accounting Pronouncements

In September 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments (Topic 805): Business Combinations,” which replaces the requirement that an acquirer in a business combination account for measurement period adjustments retrospectively with a requirement that an acquirer recognize adjustments to the provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. ASU 2015-16 requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. For public business entities, ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The guidance is to be applied prospectively to adjustments to provisional amounts that occur after the effective date of the guidance, and early adoption is permitted. The Company has elected to early adopt the guidance as of December 31, 2015 and the impact of adoption was not material to the consolidated financial statements.

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In April 2015, the FASB issued ASU No. 2015-05, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement”, that provides guidance to customers about whether a cloud computing arrangement includes a software license. If such an arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the arrangement does not include a software license, the customer should account for it as a service contract. This standard will be effective for annual periods beginning after December 15, 2015, and early application is permitted. The Company does not expect the impact of adoption to be material to its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period. The standard requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition, and compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved. This ASU is effective for fiscal years beginning after December 15, 2015, and for interim periods within those fiscal years. This new standard will not have an effect on the Company’s consolidated financial statements as it is in alignment with the Company’s current accounting policies for equity based compensation.

In May 2014, the FASB issued ASU No. 2014-09, Revenue From Contracts With Customers, that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of 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 ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers, which deferred the effective date of ASU No. 2014-09. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company is currently evaluating the new guidance to determine the impact it will have on its consolidated financial statements.

 

3. Change in Accounting Principles

 

Change in Method of Accounting for Inventory Valuation

In the third quarter of 2015, the Company changed its method of inventory costing for certain inventory in its Business and Facility Essentials (formerly separately known as Supply and Lagasse) operating segment to the LIFO method from the FIFO accounting method.  Prior to the change, the Business and Facility Essentials operating segment was comprised of two separate legal entities that each utilized different methods of inventory costing: LIFO for inventories related to Business Essentials which is comprised mainly of office product and breakroom categories and FIFO for inventories related to Facility Essentials which consists of the janitorial product category. The Company believes that the LIFO method is preferable because i) the Company is executing an initiative to combine the office products and janitorial categories onto a single information technology and operating platform, ii) it allows for consistency in financial reporting (all domestic inventories will now be on LIFO), and iii) it allows for better matching of costs and revenues as historical inflationary inventory acquisition prices are expected to continue in the future and the LIFO method uses the current acquisition cost to value cost of goods sold. The change has been reported through retrospective application of the new accounting policy to all periods presented. The impact of the change in the method of inventory costing for certain inventory to the third quarter 2015 was a $4.2 million decrease to cost of goods sold, $2.3 million increase to net income, and $0.06 increase in basic and diluted EPS.  

 

Change in Method of Accounting for Debt Issuance Costs

In April 2015, the FASB issued ASU 2015-03 Simplifying the Presentation of Debt Issuance Costs which amends the FASB Accounting Standards Codification (ASC) subtopic 835-30 Interest-Imputation of Interest.  This guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability, consistent with debt discounts. The Company has elected to early adopt the guidance as of September 30, 2015 and has retrospectively applied the changes to all periods presented.

 

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Change in Method of Accounting for Deferred Taxes

In November 2015, the FASB issued ASU 2015-17 Balance Sheet Classification of Deferred Taxes which amends the FASB ASC topic 740 Income Taxes.  This guidance requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The Company has elected to early adopt the guidance as of December 31, 2015 and apply the guidance prospectively, therefore, prior periods were not retrospectively adjusted.

4. Acquisitions and Dispositions

Acquisitions

CPO Commerce, Inc.

On May 30, 2014, Essendant Co. completed the acquisition of CPO Commerce, Inc. (“CPO”), a leading online retailer of brand name power tools and equipment. The acquisition of CPO significantly expanded the Company’s digital resources and capabilities to support resellers as they transition to an increasingly online environment. CPO’s expertise strengthens Essendant’s ability to offer features like improved product content, real-time access to inventory and pricing, digital marketing and merchandising, and an enhanced digital platform.  

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The purchase price was $37.8 million, including $5.5 million related to the estimated fair value of contingent consideration. The contingent consideration ultimately paid will be determined based on CPO’s sales during a three-year period immediately following the acquisition date, and will be between zero and $10 million. The Company has currently recorded a liability for contingent consideration of $9.2 million. Any changes to the estimated fair value of contingent consideration after the original purchase accounting is completed are recorded in “warehousing, marketing and administrative expenses” in the period in which a change occurs. The Company financed the 100% stock acquisition with borrowings under the Company’s available committed bank facilities. Purchase accounting for this transaction was completed as of May 30, 2015.

CPO contributed $119.7 million to the Company’s 2015 net sales. Had the CPO acquisition been completed as of the beginning of 2013, the Company’s unaudited pro forma net sales and net income for the twelve-month periods ending December 31, 2014 and 2013 would not have been materially impacted.

MEDCO

On October 31, 2014, Essendant Co. completed the acquisition of 100% of the capital stock of Liberty Bell Equipment Corp., a United States wholesaler of automotive aftermarket tools and equipment, and its affiliates (collectively, MEDCO) including G2S Equipement de Fabrication et d’Entretien, a Canadian wholesaler. MEDCO advances a key pillar of the Company’s strategy, which is to diversify into channels and categories that leverage the common platform. It also brings expanded categories and services to customers.

The purchase price was $150.4 million, including $4.7 million related to the estimated fair value of contingent consideration.  The contingent consideration ultimately paid will be determined based on MEDCO’s sales and EBITDA during a three-year period immediately following the acquisition date. Additionally, $6.0 million was reserved as a payable upon completion of an eighteen month indemnification period. The final payments related to the contingent consideration will be determined by actual achievement in the earn-out periods and will be between zero and $10 million. The Company has currently recorded a liability for contingent consideration of $5.2 million. Any changes to the estimated fair value of contingent consideration after the original purchase accounting is completed are recorded in “warehousing, marketing and administrative expenses” in the period in which a change occurs. This acquisition was funded through a combination of cash on hand and cash available under the Company’s committed bank facilities. Purchase accounting for this transaction was completed as of October 31, 2015.

MEDCO contributed $274.4 million to the Company’s 2015 net sales. Had the MEDCO acquisition been completed as of the beginning of 2013, the Company’s unaudited pro forma net sales for the years ended December 31, 2014 and 2013 would have been $5.5 billion and $5.3 billion, respectively, and the Company’s unaudited pro forma net income for the years ended December 31, 2014 and 2013 would have been $117.9 million, and $127.9 million, respectively.

Nestor Sales LLC

On July 31, 2015, Essendant Co. completed the acquisition of 100% of the capital stock of Nestor Sales LLC (“Nestor”), a leading wholesaler and distributor of tools, equipment and supplies to the transportation industry.  This acquisition accelerates the Company’s growth in the automotive aftermarket, complements the Company’s existing industrial offerings while providing access to new customer segments, and advances a key strategic pillar to diversify into channels and categories that leverage our common platform.

The purchase price was $41.8 million. This acquisition was funded through a combination of cash on hand and cash available under the Company’s revolving credit facility. 

Nestor contributed $27.3 million to the Company’s 2015 net sales after its acquisition on July 31, 2015. Had the Nestor acquisition been completed as of the beginning of 2013, the Company’s unaudited pro forma net sales and net income for the twelve-month periods ended December 31, 2015, 2014 and 2013 would not have been materially impacted.

The Company has developed preliminary estimates of the fair values of assets acquired and liabilities assumed from the Nestor acquisition for purposes of allocating the purchase prices. The estimate is subject to change as the valuation activities are completed. The fair values of the assets and liabilities acquired in the Nestor acquisition was estimated using various valuation methods including estimated selling prices, market approach, and discounted cash flows using both an income and cost approach. The same methods were used for determining the fair values of the assets and liabilities acquired for the CPO and Medco acquisitions.

Any changes to the preliminary allocations of the purchase prices, some of which may be material, are allocated to residual goodwill.

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At December 31, 2015, the allocations of the purchase prices were as follows (amounts in thousands):

 

 

The purchased identifiable intangible assets were as follows (amounts in thousands):

Agreement with Staples, Inc.

On February 16, 2016, the company announced an agreement to purchase more than $550 million worth of annual contracts with minority and woman-owned office supply resellers and their large corporate and other enterprise customers from Staples, Inc. The transaction is subject to the successful completion of the proposed merger of Staples and Office Depot, as well as other regulatory and customary closing conditions.  Under the terms of the agreement, Essendant will pay Staples approximately $22.5 million.

Disposition of Azerty de Mexico

On September 18, 2015, the Company completed the 100% stock-sale of its subsidiary, Azerty de Mexico, to the local general manager. The sale price was a combination of cash and a seller’s note, totaling $8.7 million. The seller’s note matures in 180 days and requires periodic repayments. As of December 31, 2015 the balance of the note was $0.7 million. When the decision to sell the subsidiary was approved, in accordance with Accounting Standards Codification (ASC) 360-10-45-9 Property, Plant, and Equipment, Azerty de Mexico met all of the criteria to be classified as a held-for-sale asset disposal group. In accordance with ASC 350-20-40, Intangibles – Goodwill and Other, the Company allocated a proportionate share of the goodwill balance from the office product and janitorial and breakroom supply reporting unit based on the subsidiary’s relative fair value to the reporting unit and performed an impairment test for the allocated goodwill utilizing the cost approach to value the subsidiary. Based upon the impairment test, the $3.3 million of goodwill allocated to the subsidiary was determined to be fully impaired.  Additionally, in conjunction with classifying the subsidiary as a held-for-sale asset disposal group, the Company revalued the subsidiary to fair value using the cost-approach method less the estimated cost to sell. The carrying value of the disposal group, including a $10.1 million cumulative foreign currency translation adjustment, was then compared to the fair value less the estimated cost to sell, resulting in a pre-tax impairment loss of $10.1 million. The goodwill impairment of $3.3 million, the held-for-sale impairment of $10.1 million, the additional costs to sell of $3.6 million were recorded in 2015 within “warehousing, marketing and administrative expenses. The loss recorded upon the disposition of Azerty de Mexico was $1.5 million. The pre-tax loss, excluding the foreign currency translation adjustment noted above, attributable to Azerty de Mexico was $5.2 million and $0.3 million for the years ended December 31, 2015 and 2014, respectively.

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Disposition of MBS Dev

On December 16, 2014, the Company sold MBS Dev, as subsidiary focused on software solutions for distribution companies. In conjunction with this sale, the Company recognized an $8.2 million loss on the disposition of the business. This consisted of a $9.0 million goodwill impairment and an $0.8 million gain on the disposal. See Note 6 “Goodwill and Intangible Assets” for further detail.

 

 

 

5. Share-Based Compensation

Overview

As of December 31, 2015, the Company has two active equity compensation plans. A description of these plans is as follows:

Nonemployee Directors’ Deferred Stock Compensation Plan

Pursuant to the Essendant Inc. Nonemployee Directors’ Deferred Stock Compensation Plan, non-employee directors may defer receipt of all or a portion of their retainer and meeting fees. Fees deferred are credited quarterly to each participating director in the form of stock units, based on the fair market value of the Company’s common stock on the quarterly deferral date. Each stock unit account generally is distributed and settled in whole shares of the Company’s common stock on a one-for-one basis, with a cash-out of any fractional stock unit interests, after the participant ceases to serve as a Company director. For each of the years ended December 31, 2015, 2014 and 2013, the Company recorded compensation expense of $0.1 million. As of December 31, 2015, 2014 and 2013 the accumulated number of stock units outstanding under this plan was 41,051; 43,082; and 56,737; respectively.

2015 Long-Term Incentive Plan (“LTIP”)

In May 2015, the Company’s shareholders approved the LTIP to, among other things, attract and retain managerial talent, further align the interest of key associates to those of the Company’s stockholders and provide competitive compensation to key associates. Award vehicles include, but are not limited to, stock options, restricted stock awards, restricted stock units (“RSUs”) and performance-based awards. Associates and non-employee directors of the Company are eligible to become participants in the LTIP, except that non-employee directors may not be granted stock options.

Accounting For Share-Based Compensation

The following table summarizes the share-based compensation expense (in thousands):

 

The following tables summarize the intrinsic value of options outstanding, exercisable, and exercised for the applicable periods listed below:

 

 

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The following tables summarize the intrinsic value of restricted shares outstanding and vested for the applicable periods listed below:

 

 

 

The aggregate intrinsic values summarized in the tables above are based on the closing sale price per share for the Company’s Common Stock on the last day of trading in each year which was $32.51, $42.16, and $45.89 per share for the years ended December 31, 2015, 2014 and 2013, respectively. Additionally, the aggregate intrinsic value of options exercisable does not include the value of options for which the exercise price exceeds the stock price as of the last day of trading in each year.

Stock Options

The fair value of option awards and modifications to option awards is estimated on the date of grant or modification using a Black-Scholes option valuation model that uses various assumptions including the expected stock price volatility, risk-free interest rate, and expected life of the option. The expected term of options granted is derived from the historical forfeiture and exercise behavior and represents the period of time that options granted are expected to be outstanding. The expected volatility of the price of the underlying shares is implied based on historical volatility of the Company’s common stock. The expected dividends were based on the current dividend yield of the Company’s stock as of the date of the grant. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. There were no stock options granted in 2015. The assumptions used for 2014 are shown in the following table.

 

 

Stock options granted in 2014 vest at the end of 2.25 years, and have a term of 10 years. Previously issued stock options generally vested in annual increments over three years and have a term of 10 years. Compensation costs for all stock options are recognized, net of estimated forfeitures, on a straight-line basis over the vesting period. As of December 31, 2015, there was $0.5 million of unrecognized compensation cost related to stock option awards granted. The cost is expected to be recognized over a weighted-average period of 0.25 years. In 2015, there were no stock options granted. In 2014 and 2013, there were 5,538 and 585,189 stock options granted, respectively.

 

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The following table summarizes the transactions, excluding restricted stock, under the Company’s equity compensation plans for the last three years:

 

 

The following table summarizes outstanding and exercisable options granted under the Company’s equity compensation plans as of December 31, 2015:

 

 

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Restricted Stock and Restricted Stock Units

The Company granted 462,697 shares of restricted stock and 162,092 restricted stock units (“RSUs”) during 2015. During 2014, the Company granted 253,042 shares of restricted stock and 176,717 RSUs. During 2013, the Company granted 181,916 shares of restricted stock and 166,348 RSUs. The majority of the RSUs granted in 2015 vest in 2018 and the majority of the RSUs granted in 2014 and 2013 vest in three annual installments based on the terms of the agreements, to the extent earned based on the Company’s cumulative net income, cumulative working capital efficiency or economic profit performance against target economic profit goals. The performance-based RSUs granted in 2015, 2014, and 2013 have a minimum and maximum payout of zero to 200%. Included in the 2015, 2014, and 2013 grants were 333,268, 271,594, and 194,517 shares of restricted stock and RSUs granted to employees who were not executive officers, as of December 31, 2015, 2014 and 2013, respectively. In addition, there were 30,778, 20,664, and 23,898 shares of restricted stock and RSUs granted to non-employee directors during the years ended December 31, 2015, 2014 and 2013, respectively. For the years ended December 31, 2015, 2014 and 2013, there were also 260,743, 137,501, and 129,849 shares of restricted stock and RSUs granted to executive officers, respectively. The restricted stock granted to executive officers vests with respect to each officer in annual increments over three years, provided that the officer is still employed as of the anniversary date of the grant, and the Company’s cumulative diluted earnings per share for the four calendar quarters immediately preceding the vesting date exceed $0.50 per diluted share as defined in the officers’ restricted stock agreement. As of December 31, 2015, there was $16.9 million of total unrecognized compensation cost related to non-vested restricted stock and RSUs granted. The cost is expected to be recognized over a weighted-average period of 2.1 years. The following table summarizes restricted stock and RSU transactions for the last three years.

 

 

 

6. Goodwill and Intangible Assets

Goodwill is tested for impairment at the reporting unit level on an annual basis as of October 1, as well as between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. All four reporting units were evaluated for impairment using the market based and/or the discounted cash flow approach to determine fair value. At the Company’s annual impairment test date of October 1, 2015, the Company concluded for three of the four reporting units that goodwill was not impaired as prescribed by related accounting guidance.

 

During the 2015 annual impairment test, it was determined that the fair value of the ORS Industrial reporting unit was below its carrying value. The fair value of the business was impacted by the macroeconomic environment in the oilfield and energy sectors that is now projected to have a long-term downturn, causing a change in strategic direction for ORS Industrial. ORS Industrial, under new leadership, plans to diversify its offerings to lessen dependencies on the oilfield and energy sectors by revising its merchandising and sales strategy.  

The determination of fair value for the reporting unit was based on a combination of prices of comparable businesses and historic and forecasted future discounted cash flows. The amount of the goodwill impairment was determined by valuing the entity’s assets and liabilities at fair value and comparing the fair value of the implied goodwill to its carrying value.  Upon completion of this calculation, the carrying amount of the goodwill exceeded the implied fair value resulting in a goodwill impairment of $113.8 million.  

In addition, as part of this strategic review, the Company determined a portion of its inventory would no longer be offered and, therefore, is obsolete as of December 31, 2015.  This determination resulted in an additional reserve of $4.9 million.

 

Impairment losses are reported in warehousing, marketing, and administrative expenses and inventory reserve is a component of cost of goods sold on the Company’s Consolidated Statement of Operations.

In connection with the sale of Azerty de Mexico in 2015, the Company performed an impairment test and determined that $3.3 million of goodwill allocated to the subsidiary was fully impaired. See Note 4, “Acquisitions and Dispositions,” for further detail.

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At the Company’s annual impairment test date of October 1, 2014, the Company concluded for four out of five reporting units that goodwill was not impaired. Prior to the completion of the 2014 annual goodwill impairment test for MBS Dev, the Company began negotiating the sale of MBS Dev with third parties and concluded that this change in strategy for MBS Dev was an interim indicator of impairment that necessitated an interim test for goodwill impairment. The Company completed a goodwill impairment test as of the date the assets were classified as held for sale, and used a market approach to determine the fair value of the MBS Dev reporting unit. The fair value of the MBS Dev reporting unit did not exceed its carrying value, requiring the Company to determine the amount of goodwill impairment loss by valuing the entity’s assets and liabilities at fair value and comparing the fair value of the implied goodwill to the carrying value of goodwill. Upon completion of this calculation, the carrying amount of the goodwill exceeded the implied fair value of that goodwill, resulting in a goodwill impairment of $9.0 million. The goodwill impairment was partially offset by the fair value of the consideration received for MBS Dev being in excess of the carrying value, leading to a total loss on disposition of MBS Dev of $8.2 million.  The recognized and unrecognized intangible assets were valued using the cost method and relief from royalty approach using estimates of forecasted future revenues.

Indefinite lived intangible assets are tested for impairment annually as of October 1 or more frequently if events or changes in circumstances indicate that the assets might be impaired. Based on the testing completed in 2015, the carrying amount of certain indefinite lived intangible assets of ORS Industrial exceeded the implied fair value, resulting in an impairment totaling $2.1 million. The recognized and unrecognized intangible assets were valued using the excess earnings method, cost method and relief from royalty approach using forecasted future revenues.

In the first quarter of 2015, the Company recorded a pre-tax non-cash impairment charge of $10.2 million to write-down the trademarks of ORS Industrial and certain OKI brands to their fair value related to the corporate name change that was approved in February 2015 and effective June 1, 2015. The Company utilized the discounted cash flow method to determine the fair value of these trademarks based upon management’s current forecasted future revenues from the trademarks. These trademarks were fully amortized as of December 31, 2015.

As of December 31, 2015 and 2014, the Company’s Consolidated Balance Sheets reflected $299.4 million and $398.0 million of goodwill, and $96.4 million and $112.0 million in net intangible assets, respectively.

 

The changes in the carrying amount of goodwill are noted in the following table (in thousands):

 

 

Net intangible assets consist primarily of customer lists, trademarks, and non-compete agreements purchased as part of acquisitions. The Company has no intention to renew or extend the terms of acquired intangible assets and accordingly, did not incur any related costs during 2015 or 2014. Amortization of intangible assets purchased as part of acquisitions totaled $13.4 million, $8.6 million, and $7.0 million for the years ended December 31, 2015, 2014 and 2013, respectively. Accumulated amortization of intangible assets as of December 31, 2015 and 2014 totaled $59.9 million and $45.2 million, respectively.

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The following table summarizes the intangible assets of the Company by major class of intangible assets and the cost, accumulated amortization, net carrying amount, and weighted average life, if applicable (in thousands):

 

The following table summarizes the amortization expense expected to be incurred over the next five years on intangible assets (in thousands):

 

 

 

7. Severance and Restructuring Charges

Commencing in the first quarter of 2015, the Company began certain restructuring actions which included workforce reduction and facility closures. For the quarter and year ended December 31, 2015, the Company recorded $1.0 million and $2.5 million, respectively, of pre-tax expense relating to facility consolidations. During the first quarter of 2015, the Company recorded a $6.0 million pre-tax charge relating to a workforce reduction, and reversed $0.7 million of this charge during the fourth quarter of 2015. These charges were included in “warehousing, marketing and administrative expenses.” Cash outflows for these actions occurred primarily in 2015 and were approximately $0.4 million and $3.4 million in the quarter and year ended December 31, 2015. As of December 31, 2015, the Company has accrued liabilities for these actions of $1.9 million.  

In the fourth quarter of 2015 and continuing through the first quarter of 2016, the Company executed actions to reduce costs through management de-layering in order to achieve broader functional alignment of the organization. The Company recorded an $11.9 million pre-tax charge relating to this workforce reduction. These charges were included in “warehousing, marketing and administrative expenses.” Cash outflows for these actions began in 2015 and will continue into 2016. Cash outlays associated with these charges were approximately $0.8 million in the year ended December 31, 2015. As of December 31, 2015, the Company has accrued liabilities for these actions of $11.1 million.

During the first quarter of 2013, the Company recorded a $14.4 million pre-tax charge related to a workforce reduction and facility closures. These actions were substantially completed in 2013. The pre-tax charge is comprised of certain OKI facility closure expenses of $1.2 million and severance and workforce reduction-related expenses of $13.2 million which were included in operating expenses. Cash outflows for these actions occurred primarily during 2013 and 2014 but continued into 2015. Cash outlays associated with these charges were $0.3 million, $3.9 million, and $8.6 million during 2015, 2014, and 2013, respectively. During 2014 and 2013, the Company reversed a portion of these charges totaling $0.3 million and $1.4 million, respectively. As of December 31, 2015, the Company had no accrued liabilities for these actions and as of December 31, 2014 the Company recorded $0.2 million in accrued liabilities related to workforce reduction charges.

 

 

 

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8. Accumulated Other Comprehensive Income (Loss)

The change in Accumulated Other Comprehensive Income (Loss) (“AOCI”) by component, net of tax, for the year ended December 31, 2015 is as follows:

 

 

The following table details the amounts reclassified out of AOCI into the income statement during the twelve-month period ending December 31, 2015:

 

 

 

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9. Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if dilutive securities were exercised into common stock. Stock options, restricted stock and deferred stock units are considered dilutive securities. Stock options to purchase 0.3 million, 0.5 million, and 0.5 million shares of common stock were outstanding at December 31, 2015, 2014, and 2013, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares and, therefore, the effect would be antidilutive. An additional 0.4 million shares of commons stock outstanding at December 31, 2015 were excluded from the computation of diluted earnings per share due to the net loss. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):

 

Common Stock Repurchases

In 2015 and 2014, the Company repurchased 1,822,227 and 1,255,705 shares of ESND’s common stock at an aggregate cost of $67.4 million and $50.6 million, respectively. Depending on market and business conditions and other factors, the Company may continue or suspend purchasing its common stock at any time without notice. Acquired shares are included in the issued shares of the Company and treasury stock, but are not included in average shares outstanding when calculating earnings per share data. As of December 31, 2015 the Company had $75.0 million remaining on its current Board authorization to repurchase ESND common stock.

During 2015, 2014 and 2013, the Company reissued 362,874, 250,747, and 1,086,502 shares, respectively, of treasury stock to fulfill its obligations under its equity incentive plans.

 

 

10. Segment Information

Management defines operating segments as individual operations that the Chief Operating Decision Maker (“CODM”) (in the Company’s case, the Chief Executive Officer) reviews for the purpose of assessing performance and making operating decisions. When evaluating operating segments, management considers whether:

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Based on the factors referenced above, management has determined that the Company has four operating segments, Business and Facility Essentials, ORS Industrial, CPO, and Automotive. Business and Facility Essentials also included operations in Mexico conducted through a ESND subsidiary, Azerty de Mexico, which was consolidated into the operating segment up to the date it was sold in 2015. See Note 4, “Acquisitions and Dispositions”, for further information. ORS Industrial includes operations in Canada and Dubai, UAE.  The Automotive operating segment includes operations in Canada.  For the years ended December 31, 2015, 2014 and 2013, the Company’s net sales from its foreign operations totaled $128.3 million, $151.3 million and $138.2 million, respectively. As of December 31, 2015, 2014, and 2013, long-lived assets of the Company’s foreign operations totaled $32.2 million, $42.5 million, and $13.8 million, respectively.

Management has also concluded that three of the Company’s operating segments (Business and Facility Essentials, ORS Industrial, and Automotive) meet all of the aggregation criteria required by the accounting guidance. Such determination is based on company-wide similarities in (1) the nature of products and/or services provided, (2) customers served, (3) production processes and/or distribution methods used, (4) economic characteristics including earnings before interest and taxes, and (5) regulatory environment. This aggregate presentation reflects management’s approach to assessing performance and allocating resources. CPO does not meet the materiality thresholds for reporting individual segments and was combined with the other operating segments.

The Company’s product offerings may be divided into the following primary categories: (1) janitorial and breakroom supplies, including foodservice consumables, safety and security items, and paper and packaging supplies;  (2) technology products such as computer supplies and peripherals; (3) traditional office products, including writing instruments, paper products, organizers and calendars and various office accessories; (4) industrial supplies, including hand and power tools, safety and security supplies, janitorial equipment and supplies, welding products, and automotive aftermarket tools and equipment and (5) office furniture, including desks, filing and storage solutions, seating and systems furniture. In 2015, the Company’s largest supplier was Hewlett-Packard Company which represented approximately 14% of its total purchases. No other supplier accounted for more than 10% of the Company’s total purchases.  For the year ended December 31, 2015, the Company had purchases of $13.8 million and payables of $1.4 million to a buying group in which the Company participates through its equity ownership.

The Company’s customers include independent office products dealers and contract stationers, office products mega-dealers, office products superstores, computer products resellers, office furniture dealers, mass merchandisers, mail order companies, sanitary supply distributors, drug and grocery store chains, e-commerce dealers, other independent distributors and end consumers. The Company had one customer, W.B. Mason Co., Inc., which constituted approximately 12% of its 2015 consolidated net sales. No other single customer accounted for more than 10% of the 2015 consolidated net sales. The following table shows net sales by product category for 2015, 2014 and 2013 (in thousands):

 

 

 

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11. Debt

ESND is a holding company and, as a result, its primary sources of funds are cash generated from operating activities of its direct operating subsidiary, ECO, and from borrowings by ECO. The 2013 Credit Agreement, the 2013 Note Purchase Agreement, and the Receivables Securitization Program (each of which are defined below) contain restrictions on the use of cash transferred from ECO to ESND.

Debt consisted of the following amounts (in millions):

 

As of December 31, 2015, 79.0% of the Company’s outstanding debt, excluding capital leases and transaction costs, was priced at variable interest rates based primarily on the applicable bank prime rate or London InterBank Offered Rate (“LIBOR”). As of December 31, 2015, the overall weighted average effective borrowing rate, excluding the impact of commitment fees, of the Company’s debt was 2.23%. At December 31, 2015, 58.0% of the Company’s debt was unhedged and a 50 basis point movement in interest rates would result in a $2.1 million change in annualized interest expense, on a pre-tax basis, and upon cash flows from operations.

Receivables Securitization Program

The Company’s accounts receivable securitization program (“Receivables Securitization Program” or the “Program”) provides maximum financing of up to $200 million. The parties to the program are ESND, ECO, Essendant Receivables, LLC (“ESR”), and Essendant Financial Services (“EFS”) and PNC Bank, National Association and the Bank of Tokyo – Mitsubishi UFJ, Ltd New York Branch (the “Investors”). The Program is governed by the following agreements:

Pursuant to the Receivables Sale Agreement, ECO sells to EFS, on an on-going basis, all the customer accounts receivable and related rights originated by ECO. Pursuant to the Receivables Purchase Agreement, EFS sells to ESR, on an on-going basis, all the accounts receivable and related rights purchased from ECO. Pursuant to the Amended and Restated Transfer and Administration Agreement, ESR then sells the receivables and related rights to the Investors. The Program provides for maximum funding available of the lesser of $200 million or the total amount of eligible receivables less excess concentrations and applicable reserves. EFS retains servicing responsibility over the receivables. ESR is a wholly-owned, bankruptcy remote special purpose subsidiary of EFS. The assets of ESR are not available to satisfy the creditors of any other person, including EFS, ECO or ESND, until all amounts outstanding under the Program are repaid and the Program has been terminated.

The receivables sold to the Investors remain on ESND’s Consolidated Balance Sheets, and amounts advanced to ESR by the Investor or any successor Investors are recorded as debt on ESND’s Consolidated Balance Sheets. The cost of such debt is recorded as interest expense on ESND’s Consolidated Statements of Operations. As of December 31, 2015 and 2014, $448.6 million and $360.3 million, respectively, of receivables had been sold to the Investors. As of December 31, 2015, ESR had $200.0 million outstanding under the Program.

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Credit Agreement and Other Debt

On November 25, 2013, ESND and ECO, entered into a Note Purchase Agreement (the “2013 Note Purchase Agreement”) with the note purchasers identified therein (collectively, the “Note Purchasers”). Pursuant to the 2013 Note Purchase Agreement, ECO issued and the Note Purchasers purchased an aggregate of $150 million of senior secured notes due January 15, 2021 (the “2014 Notes”). The issuance of the 2014 Notes occurred on January 15, 2014. ECO used the proceeds from the sale of the 2014 Notes to repay the notes previously issued in 2007 and to reduce borrowings under the 2013 Credit Agreement, which is described below. Interest on the 2014 Notes is payable semi-annually at a rate per annum equal to 3.75%. At the time ECO priced the 2014 Notes, ECO terminated the June 2013 Swap Transaction (as described in Note 19 “Derivative Financial Instruments”). After giving effect to the impact of terminating the June 2013 Swap Transaction, the effective per annum interest rate on the 2014 Notes is 3.66%. The full principal amount of the 2014 Notes matures on January 15, 2021. If ECO elects to prepay some or all of the 2014 Notes prior to January 15, 2021, ECO will be obligated to pay a make-whole amount calculated as set forth in the Agreement.

On July 8, 2013, the Company and ECO entered into a Fourth Amended and Restated Five-Year Revolving Credit Agreement (the “2013 Credit Agreement”) with JPMorgan Chase Bank, National Association, as Agent, and the lenders identified therein. The 2013 Credit Agreement extended the maturity date of the loan agreement to July 6, 2018.

On June 26, 2015, the Company and its subsidiaries Essendant Co., Essendant Financial Services LLC (“EFS") and Essendant Receivables LLC ("ESR") entered into a Third Omnibus Amendment to Transaction Documents (the “Omnibus Amendment”) with The Bank of Tokyo-Mitsubishi UFJ, Ltd., New York Branch ("BTMU") and PNC Bank, National Association (“PNC Bank”). The Omnibus Agreement amended the transaction documents of the Receivable Securitization Program to reflect rebranded legal entity names. On June 29, 2015, Lagasse, LLC, a subsidiary of Essendant Co. merged into Essendant Co.  All accounts receivable originated by Lagasse prior to the merger are excluded from the Program. The Omnibus Agreement amended the Transaction Documents to also exclude “Excluded Receivables” from the Receivables Securitization Program, which are defined as “any receivable which, at the time of such Receivable’s origination, was processed on the [enterprise resource planning system previously used by Lagasse, LLC].”

The 2013 Credit Agreement provides for a revolving credit facility with an aggregate committed principal amount of $700 million. The 2013 Credit Agreement also provides for the issuance of letters of credit. The Company had outstanding letters of credit of $11.6 million under the 2013 Credit Agreement as of December 31, 2015. Subject to the terms and conditions of the 2013 Credit Agreement, ECO may seek additional commitments to increase the aggregate committed principal amount to a total amount of $1.05 billion.

Borrowings under the 2013 Credit Agreement bear interest at LIBOR for specified interest periods or at the Alternate Base Rate (as defined in the 2013 Credit Agreement), plus, in each case, a margin determined based on the Company’s debt to EBITDA ratio calculated as provided in Section 6.20 of the 2013 Credit Agreement (the “Leverage Ratio”). Depending on the Company’s Leverage Ratio, the margin on LIBOR-based loans ranges from 1.00% to 2.00% and on Alternate Base Rate loans ranges from 0.00% to 1.00%. As of December 31, 2015, the applicable margin for LIBOR-based loans was 1.75% and for Alternate Base Rate loans was 0.75%. In addition, ECO is required to pay the lenders a fee on the unutilized portion of the commitments under the 2013 Credit Agreement at a rate per annum between 0.15% and 0.35%, depending on the Company’s Leverage Ratio.

Subject to the terms and conditions of the 2013 Credit Agreement, ECO is permitted to incur up to $300 million of indebtedness in addition to borrowings under the 2013 Credit Agreement plus up to $200 million under the Company’s Receivables Securitization Program and up to $150 million in replacement or refinancing of the 2013 Note Purchase Agreement.

ECO has entered into several interest rate swap transactions to mitigate its floating rate risk on a portion of its total long-term debt. See Note 19, “Derivative Financial Instruments”, for further details on these swap transactions and their accounting treatment.

Obligations of ECO under the 2013 Credit Agreement and the 2014 Notes are guaranteed by ESND and certain of ECO’s domestic subsidiaries. ECO’s obligations under these agreements and the guarantors’ obligations under the guaranty are secured by liens on substantially all Company assets other than real property and certain accounts receivable already collateralized as part of the Receivables Securitization Program.

The 2013 Credit Agreement, the 2014 Notes and the Amended and Restated Transfer and Administration Agreement prohibit the Company from exceeding a leverage ratio of 3.50 to 1.00 (3.75 to 1.00 or 4.00 to 1.00 for the first four fiscal quarters following certain acquisitions). The 2013 Credit Agreement and the 2013 Note Purchase Agreement also impose limits on the Company’s ability to repurchase stock and issue dividends when the leverage ratio is greater than 3.00 to 1.00.

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The 2013 Credit Agreement, the 2014 Notes, and the Amended and Restated Transfer and Administration Agreement contain additional representations and warranties, covenants and events of default that are customary for these types of agreements. The 2013 Credit Agreement, the 2013 Note Purchase Agreement, and the Amended and Restated Transfer and Administration Agreement contain cross-default provisions. As a result, if a termination event occurs under any of those agreements, the lenders under all of the agreements may cease to make additional loans, accelerate any loans then outstanding and/or terminate the agreements to which they are party.

Debt maturities as of December 31, 2015, were as follows (in millions):

 

 

 

12. Leases, Contractual Obligations and Contingencies

The Company has entered into non-cancelable long-term leases for certain property and equipment. Future minimum lease payments under operating leases in effect as of December 31, 2015 having initial or remaining non-cancelable lease terms in excess of one year are as follows (in thousands):

 

Operating lease expense was approximately $48.4 million, $45.1 million, and $46.3 million in 2015, 2014 and 2013, respectively.

 

 

13. Pension Plans and Defined Contribution Plan

Pension Plans

As of December 31, 2015, the Company has pension plans covering approximately 2,400 of its active associates. Non-contributory plans covering non-union associates provide pension benefits that are based on years of credited service and a percentage of annual compensation. Beginning in 2009, benefits were frozen in the plans covering non-union employees. Non-contributory plans covering union members generally provide benefits of stated amounts based on years of service. The Company funds the plans in accordance with all applicable laws and regulations. The Company uses December 31 as its measurement date to determine its pension obligations.

Change in Projected Benefit Obligation

The following table sets forth the plans’ changes in Projected Benefit Obligation for the years ended December 31, 2015 and 2014 (in thousands):

 

The accumulated benefit obligation for the plan as of December 31, 2015 totaled $211.4 million.

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Plan Assets and Investment Policies and Strategies

The following table sets forth the change in the plans’ assets for the years ended December 31, 2015 and 2014 (in thousands):

 

 

The Company’s pension plan investment allocations, as a percentage of the fair value of total plan assets, as of December 31, 2015 and 2014, by asset category are as follows:

 

The investment policies and strategies for the Company’s pension plan assets are established with the goals of generating above-average investment returns over time, while containing risks within acceptable levels and providing adequate liquidity for the payment of plan obligations. The Company recognizes that there typically are tradeoffs among these objectives, and strives to minimize risk associated with a given expected return.

The Company’s defined benefit plan assets are measured at fair value on a recurring basis and are invested primarily in a diversified mix of fixed income investments and equity securities. The Company establishes target ranges for investment allocation and sets specific allocations. The target allocations for the non-union plan assets are 45.0% fixed income, 36.0% equity securities, 9.0% real assets, and 10.0% hedge funds. The target allocations for the union plan assets are 16.0% fixed income, 61.0% equity securities, 12.0% real assets and 10.0% hedge funds. Equity securities include investments in large cap and small cap corporations located in the U.S. and a mix of both international and emerging market corporations. Fixed income securities include investment grade bonds and U.S. treasuries. Other types of investments include commodity futures, real estate investment trusts (REITs) and hedge funds.

Fair values for equity and fixed income securities are primarily based on valuations for identical instruments in active markets.

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The fair values of the Company’s pension plan assets at December 31, 2015 and 2014 by asset category are as follows:

Fair Value Measurements at

December 31, 2015 (in thousands)

 

 

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Fair Value Measurements at

December 31, 2014 (in thousands)

 

 

 

 

 

 

 

 

Plan Funded Status

The following table sets forth the plans’ funded status as of December 31, 2015 and 2014 (in thousands):

 

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Amounts Recognized in Consolidated Balance Sheets

 

Components of Net Periodic Benefit Cost

Net periodic pension cost for the years ended December 31, 2015, 2014 and 2013 for pension and supplemental benefit plans includes the following components (in thousands):

 

The estimated net actuarial loss and prior service cost that will be amortized from accumulated other comprehensive loss into the net periodic benefit cost during 2016 are approximately $5.7 million and $0.3 million, respectively.

Assumptions Used

The following tables summarize the Company’s actuarial assumptions for discount rates, expected long-term rates of return on plan assets:

 

To select the appropriate actuarial assumptions, management relied on current market conditions, historical information and consultation with and input from the Company’s outside actuaries. The expected long-term rate of return on plan assets assumption is based on historical returns and the future expectation of returns for each asset category, as well as the target asset allocation of the asset portfolio.

Contributions

In December 2015, the Company’s Board of Directors approved cash contributions to the Company’s pension plans. In January 2016, a cash contribution of $3 million was made to the Essendant Union Employee Pension Plan and $7 million was made to the Essendant Pension Plan. Additional fundings, if any, for 2016 have not yet been determined.

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Estimated Future Benefit Payments

The estimated future benefit payments under the Company’s pension plans, excluding the impact of future lump sum offerings, are as follows (in thousands):

 

Defined Contribution Plan

The Company has a defined contribution plan. Salaried associates and non-union hourly paid associates are eligible to participate after completing six consecutive months of employment. The plan permits associates to have contributions made as 401(k) salary deferrals on their behalf, or as voluntary after-tax contributions, and provides for Company contributions, or contributions matching associates’ salary deferral contributions, at the discretion of the Board of Directors. Company contributions to match associates’ contributions were approximately $5.9 million, $5.5 million and $5.3 million in 2015, 2014 and 2013, respectively.

 

 

14. Preferred Stock

ESND’s authorized capital shares include 15 million shares of preferred stock. The rights and preferences of preferred stock are established by ESND’s Board of Directors upon issuance. As of December 31, 2015 and 2014, ESND had no preferred stock outstanding and all 15 million shares are classified as undesignated preferred stock.

 

 

15. Income Taxes

The provision for income taxes consisted of the following (in thousands):

 

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The Company’s effective income tax rates for the years ended December 31, 2015, 2014 and 2013 varied from the statutory federal income tax rate as set forth in the following table (in thousands):

 

The deferred tax assets and liabilities resulted from temporary differences in the recognition of certain items for financial and tax accounting purposes. The sources of these differences and the related tax effects were as follows (in thousands):

 

In the Consolidated Balance Sheets, for years prior to December 31, 2015, these deferred assets and liabilities were classified on a net basis as current and non-current, based on the classification of the related asset or liability or the expected reversal date of the temporary difference. During November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes”, which simplifies the presentation of deferred income taxes. This ASU requires that deferred tax assets and liabilities be classified as non-current in a statement of financial position. We early adopted ASU 2015-17 effective December 31, 2015 on a prospective basis. Adoption of this ASU resulted in a reclassification of our net current deferred tax asset to the net non-current deferred tax liability in our Consolidated Balance Sheet as of December 31, 2015. No prior periods were retrospectively adjusted.  

Valuation allowances principally relate to federal capital loss carryovers, state tax credits, and net operating losses.  As of December 31, 2015, the Company has capital loss carryforwards of $12.1 million that expire by 2020, state tax credit carryforwards of $9.9 million that expire by 2020, state net operating loss carryforwards of $0.7 million that expire by 2033, and acquired federal net operating losses of $4.6 million that expire by 2031.

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Accounting for Uncertainty in Income Taxes

At December 31, 2015, 2014, and 2013, the gross unrecognized tax benefits were $3.4 million, $3.2 million, and $3.1 million, respectively. The following table shows the changes in gross unrecognized tax benefits, for the years ended December 31, 2015, 2014 and 2013 (in thousands):

 

The total amount of unrecognized tax benefits as of December 31, 2015, 2014 and 2013 that, if recognized, would affect the effective tax rate are $2.2 million, $2.1 million, and $2.0 million, respectively.

The Company recognizes net interest and penalties related to unrecognized tax benefits in income tax expense. The gross amount of interest and penalties reflected in the Consolidated Statements of Operations for the years ended December 31, 2015, 2014 and 2013 were $0.1, zero, and zero, respectively. The Consolidated Balance Sheets at December 31, 2015 and 2014 include $0.6 million accrued for the potential payment of interest and penalties.

As of December 31, 2015, the Company’s U.S. Federal income tax returns for 2012 and subsequent years remain subject to examination by tax authorities. In addition, the Company’s state income tax returns for the 2008 and subsequent tax years remain subject to examinations by state and local income tax authorities. Although the Company is not currently under examination by the IRS, a number of state and local examinations are currently ongoing. Due to the potential for resolution of ongoing examinations and the expiration of various statutes of limitation, it is reasonably possible that the Company’s gross unrecognized tax benefits balance may change within the next twelve months by a range of zero to $1.0 million.

 

 

16. Supplemental Cash Flow Information

In addition to the information provided in the Consolidated Statements of Cash Flows, the following are supplemental disclosures of cash flow information for the years ended December 31, 2015, 2014 and 2013 (in thousands):

 

 

 

 

 

17. Fair Value of Financial Instruments

The estimated fair value of the Company’s financial instruments approximates their net carrying values. The estimated fair values of the Company’s financial instruments are as follows (in thousands):

 

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The fair value of the foreign exchange hedge is estimated based upon quoted market rates and the fair value of the interest rate swaps is estimated based upon the amount that the Company would receive or pay to terminate the agreements as of December 31 of each year. See Note 19, “Derivative Financial Instruments”, for further information.

The convertible and non-convertible notes disclosed above were part of the consideration received in the sale of MBS Dev in the fourth quarter of 2014.  In 2015, the Company determined that both notes were fully impaired and recorded a pre-tax loss for the carrying amount of these notes. See Note 20 “Fair Value Measurements” for additional information.

  

18. Other Assets and Liabilities

Other assets and liabilities as of December 31, 2015 and 2014 were as follows (in thousands):

 

 

 

19. Derivative Financial Instruments

The Company selectively uses derivative financial instruments to reduce its exposure to changes in interest rates and foreign currency exchange rates. Under Company policy, the Company does not enter into derivative financial instruments for trading or speculative purposes. A description of each type of derivative utilized by the Company to manage risk is included in the following paragraphs.  

The Company selectively uses interest rate swaps to reduce market risk associated with changes in interest rates for its debt arrangements. In July 2012, the Company entered into an interest rate swap to convert a portion of the Company’s floating-rate debt to a fixed-rate basis. The fair value is determined by using quoted market forward rates (level 2 inputs) and reflect the present value of the amount that the Company would pay for contracts involving the same notional amounts and maturity dates. The changes in fair value of this instrument is reported in AOCI and reclassified into earnings in interest expense in the same periods during which the related interest payments on the hedged debt affect earnings. This swap matures in July 2017. As of December 31, 2015 and 2014, the fair value of the Company's interest rate swap included in the Company’s Consolidated Balance Sheet as a component of “Other long-term liabilities” was $0.5 million and $0.3 million, respectively. Approximately 42% of the Company’s current outstanding debt as of December 31, 2015 is fixed with the issuance of a $150 million Private Placement note and a $150 million interest rate swap.

Under the terms of the July 2012 Swap Transaction, ECO is required to make monthly fixed rate payments to the counterparty calculated based on the notional amount of $150 million at a fixed rate of 1.05%, while the counterparty will be obligated to make monthly floating rate payments to ECO based on the one-month LIBOR on the same referenced notional amount.

The Company’s agreement with its derivative counterparty provides that if an event of default occurs on any Company debt of $25 million or more, the counterparty can terminate the swap agreement. If an event of default had occurred and the counterparty had exercised their early termination right under the outstanding swap transaction as of December 31, 2015, the Company would have been obligated to pay the aggregate fair value net liability of $0.5 million plus accrued interest to the counterparty.

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During the third quarter of 2015, the Company implemented a foreign currency cash flow hedge program in order to manage the volatility in exchange rates and the related impacts on the operations of its Canadian subsidiaries. The Company uses foreign currency exchange contracts to hedge certain of its foreign exchange rate exposures related to inventory purchases. The Company has currently hedged approximately 25%, or $2.2 million, of its Canadian subsidiaries’ US dollar denominated inventory purchases for the next two quarters. The fair value of the foreign currency cash flow hedge is determined by using quoted market spot rates (level 2 inputs). The changes in fair value of ASC 815 designated hedges are reported in AOCI and reclassified into earnings in cost of goods sold in the same periods during which the related inventory is sold and affects earnings. As of December 31, 2015, the fair value of these cash flow hedges were included in the Company’s Consolidated Balance Sheet as a component of “Other current assets” totaling $0.1 million.

The hedge transactions described above qualify as cash flow hedges in accordance with accounting guidance on derivative instruments. This guidance requires companies to recognize all of their derivative instruments as either assets or liabilities in the statement of financial position at fair value. The Company does not offset fair value amounts recognized for hedge transactions executed with the same counterparty.

By using such derivative financial instruments, the Company exposes itself to credit risk and market risk. Credit risk is the risk that the counterparty to the hedge transaction will fail to perform under the terms of the agreement. The Company attempts to minimize the credit risk in these agreements by only entering into transactions with counterparties the Company determines are creditworthy. The market risk is the adverse effect on the value of a derivative financial instrument that results from a change in interest rates and foreign currency exchange rates.

The derivative instruments that were in effect as of December 31, 2015 and 2014 contained no ineffectiveness; therefore, all gains or losses on the derivative instruments were reported as a component of other comprehensive income (“OCI”) and reclassified into earnings as “interest expense”  or “cost of goods sold” in the same period or periods during which they affected earnings. The following table depicts the effect of these derivative instruments on the statements of operations and comprehensive income for the years ended December 31, 2015 and 2014.

 

 

 

20. Fair Value Measurements

FASB accounting guidance on fair value establishes a hierarchy for those instruments measured at fair value which distinguishes between assumptions based on market data (observable inputs) and the Company’s own assumptions (unobservable inputs). The hierarchy consists of three levels:

Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter.  

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The carrying amount of accounts receivable at December 31, 2015 and 2014, including $448.6 million and $360.3 million, respectively, of receivables sold under the Current Receivables Securitization Program, approximates fair value because of the short-term nature of this item.

The notes above were obtained as part of the consideration received from the sale of MBS Dev in December 2014. Both have maturity dates of December 16, 2019. The convertible note can be converted into common units of a privately held company at the Company’s discretion. Both notes are carried at fair market value, which is revalued quarterly. The non-convertible promissory note was valued using a discounted cash flow analysis with a rate typical for investments in similar-sized companies.  The convertible subordinated promissory note was additionally valued using an option pricing model. This method values the conversion feature by using the price paid per share by the most recent, third-party investor. During 2015, an allowance was established for these notes, so that their value was fully impaired.

As of December 31, 2015, no assets or liabilities are measured at fair value on a nonrecurring basis.

 

21.  Legal Matters

The Company has been named as a defendant in two lawsuits alleging that the Company sent unsolicited fax advertisements to the named plaintiffs, as well as other persons and entities, in violation of the Telephone Consumer Protection Act of 1991, as amended by the Junk Fax Prevention Act of 2005 ("TCPA"). One lawsuit was filed in the United States District Court for the Central District of California on May 1, 2015.  The case is presently stayed.  The other lawsuit was filed in the United States District Court for the Northern District of Illinois on January 14, 2016.  In both lawsuits the plaintiffs filed a motion asking the Court to certify a class of plaintiffs comprised of persons and entities who allegedly received fax advertisements from the Company.  Under the TCPA, recipients of unsolicited fax advertisements can seek damages of $500 per fax for inadvertent violations and up to $1,500 per fax for knowing and willful violations.   Other reported TCPA lawsuits have resulted in a broad range of outcomes, with each case being dependent on its own unique set of facts and circumstances.  In each lawsuit, the Company is vigorously contesting class certification and denies that any violations occurred.  Litigation of this kind, however, is likely to lead to settlement negotiations, including negotiations prompted by pre-trial civil court procedures.  Regardless of whether the lawsuits are resolved at trial or through settlement, the Company believes that a loss associated with resolution of pending claims is probable.  However, the amount of any such loss, which could be material, cannot be reasonably estimated because the Company is continuing to evaluate its defenses based on its internal review and investigation of prior events, new information and future circumstances.

The Company is also involved in other legal proceedings arising in the ordinary course of or incidental to its business. The Company has established reserves, which are not material, for potential losses that are probable and reasonably estimable that may result from those proceedings. In many cases, however, it is difficult to determine whether a loss is probable or even possible or to estimate the amount or range of potential loss, particularly where proceedings may be in relatively early stages or where plaintiffs are seeking substantial or indeterminate damages. Matters frequently need to be more developed before a loss or range of loss can reasonably be estimated. The Company believes that such ordinary course legal proceedings will be resolved with no material adverse effect upon its financial condition or results of operations.  

 

 

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22. Quarterly Financial Data—Unaudited

 

 

 

(1) As a result of changes in the number of common and common equivalent shares during the year, the sum of quarterly earnings per share will not necessarily equal earnings per share for the total year.

(2) 2015 results were impacted by:  

(3) Diluted earnings per share for the fourth quarter of 2015 under GAAP reflect an adjustment to the basic earnings per share due to the net loss.

(4) 2014 results were impacted by a loss on disposition of MBS Dev totaling $8.2 million in the fourth quarter. This loss was not fully recognizable for tax.

 

 

 

 

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The Registrant had no disagreements on accounting and financial disclosure of the type referred to in Item 304 of Regulation S-K.

 

 

Attached as exhibits to this Annual Report are certifications of the Company’s Chief Executive Officer (“CEO”) and Senior Vice President and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 under the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in such certifications. It should be read in conjunction with the reports of the Company’s management on the Company’s internal control over financial reporting and the report thereon of Ernst & Young LLP referred to below.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. This evaluation was based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based upon our evaluation, the principal executive officer and the principal financial officer concluded that our disclosure controls and procedures are effective in providing reasonable assurance that material information required to be disclosed in our reports filed with or submitted to the Securities and Exchange Commission under the Securities Exchange Act is made known to management, including the principal executive officer and the principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

During the final quarter of 2015, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control over Financial Reporting and Related Report of Independent Registered Public Accounting Firm

Management’s report on internal control over financial reporting and the report of Ernst & Young LLP, the Company’s independent registered public accounting firm, regarding its audit of the Company’s internal control over financial reporting are included in Item 8 of this Annual Report on Form 10-K.

 

 

 

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PART III

 

 

For information about the Company’s executive officers, see “Executive Officers of the Registrant” included as Item 4A of this Annual Report on Form 10-K. In addition, the information contained under the captions “Proposal 1: Election of Directors” and “Voting Securities and Principal Holders—Section 16(a) Beneficial Ownership Reporting Compliance” in ESND’s Proxy Statement for its 2016 Annual Meeting of Stockholders (“2016 Proxy Statement”) is incorporated herein by reference.

The information required by Item 10 regarding the Audit Committee’s composition and the presence of an “audit committee financial expert” is incorporated herein by reference to the information under the captions “Governance and Board Matters—Board Committees—General” and “—Audit Committee” in ESND’s 2015 Proxy Statement. In addition, information regarding delinquent filers pursuant to Item 405 of Regulation S-K is incorporated by reference to the information under the captions “Section 16(a) Beneficial Ownership Reporting Compliance” in ESND’s 2016 Proxy Statement.

The Company has adopted a code of ethics (its “Code of Business Conduct”) that applies to all directors, officers and associates, including the Company’s CEO, CFO and Controller, and other executive officers identified pursuant to this Item 10. A copy of this Code of Business Conduct is available on the Company’s Web site at www.Essendant.com. The Company intends to disclose any significant amendments to and waivers of its Code of Conduct by posting the required information at this Web site within the required time periods.

 

 

The information required to be furnished pursuant to this Item is incorporated herein by reference to the information under the captions “Director Compensation”, “Executive Compensation” and “Compensation Committee Interlocks and Insider Participation” in ESND’s 2016 Proxy Statement.

 

 

The beneficial ownership information required to be furnished pursuant to this Item is incorporated herein by reference to the information under the captions “Voting Securities and Principal Holders—Security Ownership of Certain Beneficial Owners” and “Voting Securities and Principal Holders—Security Ownership of Management” in ESND’s 2015 Proxy Statement. Information relating to securities authorized for issuance under Essendant’s equity plans is incorporated herein by reference to the information under the caption “Equity Compensation Plan Information” in ESND’s 2016 Proxy Statement.

 

 

The information required to be furnished pursuant to this Item is incorporated herein by reference to the information under the caption “Certain Relationships and Related Transactions” in ESND’s 2016 Proxy Statement.

 

 

The information required to be furnished pursuant to this Item is incorporated herein by reference to the information under the captions “Proposal 2: Ratification of Selection of Independent Registered Public Accountants—Fee Information” and “—Audit Committee Pre-Approval Policy” in ESND’s 2016 Proxy Statement.

 

 

 

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PART IV

 

 

 

 

 

 

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The Company is including as exhibits to this Annual Report certain documents that it has previously filed with the SEC as exhibits, and it is incorporating such documents as exhibits herein by reference from the respective filings identified in parentheses at the end of the exhibit descriptions. Except where otherwise indicated, the identified SEC filings from which such exhibits are incorporated by reference were made by the Company (under ESND’s file number of 0-10653). The management contracts and compensatory plans or arrangements required to be included as exhibits to this Annual Report pursuant to Item 15(b) are listed below as Exhibits 10.18 through 10.38, and each of them is marked with a double asterisk at the end of the related exhibit description.

 

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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.

 

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:

 

 

 

 

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SCHEDULE II

ESSENDANT INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS

YEARS ENDED DECEMBER 31, 2015, 2014 and 2013

 

 

(1)—net of any recoveries.

(2)—represents the reclassification of a valuation allowance for customer deductions which also offsets accounts receivable.

(3)—represents allowance for doubtful accounts related to the retained interest in receivables sold and accounts receivable, net.

 

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