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ANIXTER INTERNATIONAL INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) Executive Overview For a number of years and through the end of the third quarter of 2012, our reporting units were consistent with our operating segments of North America, Europe and Emerging Markets (Latin America and Asia Pacific). In the fourth quarter of 2012, we reorganized our business segments from geography to end market to reflect our realigned segment reporting structure and management of these global businesses: Enterprise Cabling and Security Solutions ("ECS"), Electrical and Electronic Wire and Cable ("W&C") and OEM Supply. All prior period amounts related to the segment change have been retrospectively reclassified throughout these Consolidated Financial Statements to conform to the new presentation. At the outset of fiscal 2013, we anticipated improved capital spending trends by our customers in the second half of the year; however the acceleration was both delayed and more modest than we expected, resulting in flat year-to-date sales growth. While we experienced gradually improving trends by the end of 2013 in all of our segments and geographies, we were especially pleased with our OEM Supply segment which, as a result of actions taken to reposition the business, achieved significant operating profit growth year-over-year. The performance in this segment fueled sales and operating profit growth in our European geography. Overall, we are encouraged by the improving performance within each of our segments across our global markets, reflecting the value of our global capabilities to an increasing number of global customers. Even in a slow growth environment we have demonstrated the discipline to manage through short term challenges while continuing to invest for long term growth. Highlights of the year included the following: • Adjusted earnings per diluted share from continuing operations of $5.90, up from $5.42 in 2012; • Gross margin of 22.8%, up from 22.5% in 2012; • OEM Supply segment achieved four straight quarters of improved operating margin; • We generated $334.5 million of cash flow from operations in the year, up from $142.9 million in 2012; • Payment of special dividend of $5.00 per common share in the fourth quarter; • The retirement of the $300 million principal amount of convertible senior notes in the first quarter; • The 2012 mid-year acquisition of Jorvex, a Peruvian wire & cable distributor, added an incremental $60.7 million of sales during fiscal 2013, compared to the prior year. As we enter 2014, we believe we are well-positioned for global growth in all of our segments. In addition to a gradually improving economy, we believe our strategic initiatives will enable us to gain market share and exceed market growth across our business. For the fiscal year 2014, we expect mid-single digit organic growth, compared to a 0.5% decrease in organic sales for 2013. We have taken aggressive measures to align our cost structure with the current economic environment, while continuing to invest in our strategic growth initiatives, including security, industrial communication and control, in-building wireless, e-commerce and emerging markets. As companies continue their focus on managing expenses, our business model, which is based on helping our customers lower their supply chain costs and reduce execution risk across the globe, is of even greater value. We are well positioned financially, operationally and strategically to capitalize on opportunities in our target markets. 11 --------------------------------------------------------------------------------Consolidated Results of Operations (In millions, except per share amounts) Years Ended January 3, December 28, December 30, 2014 2012 2011 Net sales $ 6,226.5 $ 6,253.1 $ 6,146.9 Gross profit 1,422.7 1,408.7 1,407.4 Operating expenses 1,066.2 1,077.7 1,044.6 Impairment of goodwill and long-lived assets 1.7 48.5 - Operating income 354.8 282.5 362.8 Other expense: Interest expense (47.4 ) (59.7 ) (50.1 ) Other, net (11.4 ) (13.6 ) (9.2 ) Income from continuing operations before income taxes 296.0 209.2 303.5 Income tax expense 95.6 84.6 102.8 Net income from continuing operations 200.4 124.6 200.7 Income (loss) from discontinued operations, net of tax 0.1 0.2 (12.5 ) Net income $ 200.5 $ 124.8 $ 188.2 Diluted income (loss) per share: Continuing operations $ 6.04 $ 3.69 $ 5.71 Discontinued operations $ - $ - $ (0.35 ) Net income $ 6.04 $ 3.69 $ 5.36 Items Impacting Comparability of Results In addition to the results provided in accordance with U.S. Generally Accepted Accounting Principles ("GAAP") above, this report includes certain financial measures computed using non-GAAP components as defined by the Securities and Exchange Commission. Specifically, net sales comparisons to the prior corresponding period, both worldwide and in relevant segments, are discussed in this report both on a GAAP and non-GAAP basis, which excludes acquisitions, foreign exchange effects and the impact of copper prices. We believe that by reporting non-GAAP organic growth, which excludes the impact of acquisitions, foreign exchange effects and the impact of copper prices, both management and investors are provided with meaningful supplemental sales information to understand and analyze our underlying trends and other aspects of our financial performance. From time to time, we may also exclude other items from reported financial results (e.g., impairment charges, inventory adjustments, restructuring charges, tax benefits, etc.) so that both management and financial statement users can use these non-GAAP financial measures to better understand and evaluate our performance period over period and to analyze the underlying trends of our business. Non-GAAP financial measures provide insight into selected financial information and should be evaluated in the context in which they are presented. These non-GAAP financial measures have limitations as analytical tools, and should not be considered in isolation from, or as a substitute for, financial information presented in compliance with GAAP, and non-GAAP financial measures as reported by us may not be comparable to similarly titled amounts reported by other companies. The non-GAAP financial measures should be considered in conjunction with the Consolidated Financial Statements, including the related notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report. Management does not use these non-GAAP financial measures for any purpose other than the reasons stated above. Our operating results can be affected by changes in prices of commodities, primarily copper, which are components in some of the electrical wire and cable products sold. Generally, as the costs of inventory purchases increase due to higher commodity prices, our mark-up percentage to customers remains relatively constant, resulting in higher sales revenue and gross profit. In addition, existing inventory purchased at previously lower prices and sold as prices increase may result in a higher gross profit margin. Conversely, a decrease in commodity prices in a short period of time would have the opposite effect, negatively affecting financial results. The degree to which spot market copper prices change affects product prices and the amount of gross profit earned will be affected by end market demand and overall economic conditions. Importantly, however, there is no exact measure of the effect of changes in copper prices, as there are thousands of transactions in any given year, each of which has various factors involved in the individual pricing decisions. Therefore, all references to the effect of copper prices are estimates. 12 --------------------------------------------------------------------------------The following summarizes the various items that favorably / (unfavorably) impact the comparability of the results for the last three fiscal years: 2013 • We recorded net benefits of $4.7 million primarily related to closing prior tax years. The net benefit included related interest income of $0.7 million which is included in "Other, net." 2012• We recorded non-cash impairment charge related to goodwill and long-lived assets of $10.8 million and $16.4 million, respectively, in our former European operating segment during the third quarter. In the fourth quarter, we recorded an additional non-cash impairment charge related to goodwill and long-lived assets of $15.3 million and $6.0 million, respectively, due to the change in reporting segments. • We recorded a settlement charge of $15.3 million related to a one-time lump sum payment option to terminated vested participants enrolled in the Anixter Inc. Pension Plan in the United States. • We recognized the ongoing challenging global economic conditions and took aggressive actions to restructure our costs across all segments and geographies. As a result, a restructuring charge of $10.1 million was recorded primarily related to severance costs associated with a reduction of over 200 positions along with certain lease termination costs. • We recorded a lower-of-cost-or-market adjustment of $1.2 million in our former European reporting segment. • We recorded an interest and penalties charge of $1.7 million associated with prior year tax liabilities which is included in "Other, net." • We recorded a tax benefit of $9.7 million primarily related to the reversal of deferred income tax valuation allowances in certain foreign jurisdictions. 2011• In order to improve the profitability of our former European segment, management approved a facility consolidation and headcount reduction plan during the first quarter of 2011 that eliminated a number of European facilities and reduced operating costs. The restructuring charge of $5.3 million included certain exit costs for leased facilities and employee severance charges. • We recorded a net tax benefit of $10.8 million primarily related to the reversal of deferred income tax valuation allowances. Items Impacting Comparability of Results: (In millions, except per share amounts) Years Ended January 3, 2014 December 28, 2012 December 30, 2011 Items impacting operating income: Favorable / (Unfavorable) Impairment of goodwill and long-lived assets $ - $ (48.5 ) $ - Post-retirement benefit charges $ - $ (15.3 ) $ - Restructuring charge - (10.1 ) (5.3 ) Inventory lower-of-cost-or-market adjustment - (1.2 ) - Total of items impacting operating income $ - $ (75.1 ) $ (5.3 ) Items impacting other expenses: Penalty and interest from prior year tax liabilities 0.7 (1.7 ) - Total of items impacting other expenses $ 0.7 $ (1.7 ) $ - Total of items impacting pre-tax income $ 0.7 $ (76.8 ) $ (5.3 ) Items impacting income taxes: Tax impact of items impacting pre-tax income above (0.2 ) 10.0 2.0 Tax benefits related to closing prior tax years 4.2 - - Reversal of deferred income tax valuation allowances/other - 9.7 10.8 Total of items impacting income taxes $ 4.0 $ 19.7 $ 12.8 Net income impact of these items $ 4.7 $ (57.1 ) $ 7.5 Diluted EPS impact of these items $ 0.14 $ (1.73 ) $ 0.22 13-------------------------------------------------------------------------------- In 2013, there were no items that significantly impacted operating income. The items impacting operating income in 2012 and 2011 by segment are reflected in the table below. All other items impacted consolidated results only and were not allocated to segments. Items Impacting Comparability of 2012 and 2011 Operating Income by Segment: (In millions) ECS W&C OEM Supply Corporate (a) Total Favorable / (Unfavorable) 2012 impairment of goodwill and long-lived assets $ (0.3 ) $ (0.1 ) $ (37.3 ) $ (10.8 ) $ (48.5 ) 2012 pension-related charge (8.2 ) (5.7 ) (1.4 ) - (15.3 ) 2012 restructuring charge (4.1 ) (2.8 ) (3.2 ) - (10.1 ) 2012 inventory lower-of-cost-or-market adjustment - - (1.2 ) - (1.2 ) Total of items impacting operating income in 2012 $ (12.6 ) $ (8.6 ) $ (43.1 ) $ (10.8 ) $ (75.1 ) 2011 restructuring (2.3 ) (0.8 ) (2.2 ) - (5.3 ) Total of items impacting operating income in 2011 $ (2.3 ) $ (0.8 ) $ (2.2 ) $ - $ (5.3 ) (a) Prior to the change in segments, and in connection with our annual assessment of goodwill recoverability in the third quarter, we recorded a non-cash impairment charge to write-off the goodwill of $10.8 million associated with our former European reporting unit. For further information, see Note 4. "Impairment of Goodwill and Long-lived Assets". GAAP to Non-GAAP Net Income and EPS Reconciliation: (In millions, except per share amounts) Years Ended January 3, December 30, 2014 December 28, 2012 2011 Reconciliation to most directly comparable GAAP financial measure: Net income from continuing operations - Non-GAAP $ 195.7 $ 181.7 $ 193.2 Items impacting net income from continuing operations $ 4.7 $ (57.1 ) $ 7.5 Net income from continuing operations - GAAP $ 200.4 $ 124.6 $ 200.7 Diluted EPS from continuing operations - Non-GAAP $ 5.90 $ 5.42 $ 5.49 Diluted EPS impact of these items $ 0.14 $ (1.73 ) $ 0.22 Diluted EPS from continuing operations - GAAP $ 6.04 $ 3.69 $ 5.71 At the end of the second quarter of 2012, we acquired all of the outstanding shares of Jorvex, S.A. ("Jorvex"), an electrical wire and cable distributor based in Lima, Peru. We paid $55.3 million, net of cash acquired, and assumed approximately $12.7 million in debt. The acquisition resulted in the allocation of $15.7 million to goodwill. As a result of the acquisition of Jorvex, sales and operating income were favorably affected in 2013 and 2012 as compared to the corresponding prior year by $60.7 million and $62.8 million, respectively, and $1.9 million and $5.2 million, respectively. The acquisition was accounted for as a purchase and the results of operations are included in the Consolidated Financial Statements from the date of acquisition. Had the acquisition occurred at the beginning of the year of the acquisition, our operating results would not have been significantly different. 14 -------------------------------------------------------------------------------- Net Sales 2013 vs. 2012 (In millions) ECS W&C OEM Supply Total Net sales, 2013 $ 3,174.5 $ 2,116.6 $ 935.4 $ 6,226.5 Net sales, 2012 3,236.3 2,111.2 905.6 6,253.1 $ Change $ (61.8 ) $ 5.4 $ 29.8 $ (26.6 ) % Change (1.9 )% 0.3 % 3.3 % (0.4 )% Less the % Impact of: Foreign exchange (0.3 )% (0.8 )% 0.3 % (0.4 )% Copper pricing - (1.6 )% - (0.5 )% Acquisition of Jorvex - 2.9 % - 1.0 % Organic * (1.6 )% (0.2 )% 3.0 % (0.5 )% * Amounts may not sum due to rounding ECS - The 1.9% decline in 2013 was due to the ongoing delay in the recovery of the North America data center market, macro-economic weakness in our Emerging Markets geographies and the impact of the 2012 conclusion of a large security solutions contract. ECS security sales, which accounted for 27.0% of segment sales, were up 1.3% from 2012 and would have been up 6.2% excluding the above mentioned contract conclusion impact. Total ECS sales were down 1.6% organically from the prior year. W&C - This segment's sales were flat against the prior year. Growth in our Emerging Markets geographies, including incremental sales of $60.7 million as a result of the Jorvex acquisition, was offset by the negative impact of a 7% decline in the average price of copper as well as fewer large projects in Canada. Excluding the $33.7 million unfavorable impact from a $0.27 decline in the average price of copper, the $17.5 million unfavorable impact from foreign exchange and the favorable impact of the Jorvex acquisition, organic sales decreased by 0.2%. OEM Supply - Sales of $935.4 million increased by 3.3% from the prior year, reflecting continued strength in our U.K. business, the continued ramp up of a new contract in Europe and increased production levels by our North America heavy truck customers. Sales were up 3.0% organically from the prior year. 2012 vs. 2011 (In millions) ECS W&C OEM Supply Total Net sales, 2012 $ 3,236.3 $ 2,111.2 $ 905.6 $ 6,253.1 Net sales, 2011 3,245.3 1,949.9 951.7 6,146.9 $ Change $ (9.0 ) $ 161.3 $ (46.1 ) $ 106.2 % Change (0.3 )% 8.3 % (4.8 )% 1.7 % Less the % Impact of: Foreign exchange (0.8 )% (0.8 )% (2.3 )% (1.0 )% Copper pricing - (2.3 )% - (0.7 )% Acquisition of Jorvex - % 3.2 % - 1.0 % Organic * 0.5 % 8.1 % (2.5 )% 2.4 % * Amounts may not sum due to rounding ECS - We believe the overall data infrastructure market in North America declined in the high-single to low-double digit range from 2011 to 2012 but that our segment gained share in the addressable data infrastructure market in 2012. In Europe, the recessionary pressure caused the market to decline in 2012 as well. In the Emerging Markets the results were mixed. Our ECS segment continued to benefit from strong global trends in security, with the ECS security sales growing by 9.5% in 2012 and accounting for 26.1% of segment sales. W&C - Our strength in Wire and Cable was global in 2012, with organic growth across nearly all geographies, led by 32.6% organic growth in Emerging Markets, record sales in Canada and continued strength in the U.S. The segment continued to experience solid project activity in the power generation, industrial, oil and gas and mining sectors during 2012. The initiative to expand into industrial automation continued to build momentum with additional products and an expanded vendor base during 2012. 15 -------------------------------------------------------------------------------- OEM Supply - The sales decline in 2012 reflected reduced production by many of the segment's large customers. The reductions were primarily driven by weaker demand for customers' products, consistent with widely reported industrial production statistics in the U.S. and Europe where over 90% of the segment's business is concentrated with each region roughly equal in size. In the U.S., OEM Supply continued to be impacted by the heavy truck industry, which had a soft second half of 2012. The Europe OEM Supply business had a similar decline in sales in 2012, reflecting the broader and more persistent weakness in the European region. Gross Margin Gross margin increased in 2013 to 22.8% as compared to 22.5% in 2012 and 22.9% in 2011. During 2012, we recorded an inventory lower-of-cost-or-market adjustment of $1.2 million. The effects of lower copper prices did not impact gross margin percentages significantly in any year. The year-over-year increase in gross margin in 2013 was driven by improvements in all three segments as a result of our continued focus on margin realization combined with favorable product mix shifts in North America and Europe. The lower margin in 2012 versus the prior year was driven primarily by a product and geographic mix shift. Operating Expenses Operating expenses were $1,067.9 million, $1,126.2 million and $1,044.6 million in 2013, 2012 and 2011, respectively. Operating expenses in 2013 include an incremental $9.1 million related to the Jorvex acquisition, while foreign exchange rates decreased operating expenses by $2.1 million as compared to 2012. Operating expenses were negatively impacted in 2013 due to having one extra week as well as higher employee incentives and benefit costs. Operating expenses for 2012 include an incremental $7.4 million related to the Jorvex acquisition while changes in foreign exchange rates decreased operating expenses by $13.6 million as compared to 2011. The 2012 increase in operating expenses include goodwill and long-lived assets, pension and restructuring charges of $73.9 million, which are more fully described in the Notes to the Consolidated Financial Statements. Operating Income 2013 vs. 2012 (In millions) ECS W&C OEM Supply Corporate (a) Total Operating income, 2013 $ 160.5 $ 161.8 $ 32.5 $ - $ 354.8 Operating income, 2012 156.7 166.5 (29.9 ) (10.8 ) 282.5 $ Change $ 3.8 $ (4.7 ) $ 62.4 $ 10.8 $ 72.3 % Change 2.5 % (2.9 )% nm nm 25.6 % Add back unfavorable items impacting operating income in 2012 $ 12.6 $ 8.6 $ 43.1 $ 10.8 $ 75.1 Adjusted operating income, 2012 $ 169.3 $ 175.1 $ 13.2 $ - $ 357.6 Adjusted Change % (5.1 )% (7.7 )% 145.7 % nm (0.8 )% Less the % impact of: Foreign exchange 1.0 % 1.0 % (1.9 )% nm 0.9 % Copper pricing - 4.1 % - nm 2.0 % Acquisition of Jorvex - (1.1 )% - nm (0.5 )% Organic * (4.1 )% (3.6 )% 143.7 % nm 1.6 % * Amounts may not sum due to rounding ** nm - percentages are not meaningful (a) Prior to the change in segments, and in connection with our annual assessment of goodwill recoverability in the third quarter, we recorded a non-cash impairment charge to write-off the goodwill of $10.8 million associated with our former European reporting unit. For further information, see Note 4. "Impairment of Goodwill and Long-lived Assets". 16-------------------------------------------------------------------------------- 2012 vs. 2011 (In millions) ECS W&C OEM Supply Corporate Total Operating income, 2012 $ 156.7 $ 166.5 $ (29.9 ) $ (10.8 ) $ 282.5 Operating income, 2011 184.8 161.2 16.8 - 362.8 $ Change $ (28.1 ) $ 5.3 $ (46.7 ) $ (10.8 ) $ (80.3 ) % Change (15.2 )% 3.3 % nm nm (22.1 )% Add back unfavorable items impacting operating income in 2012 $ 12.6 $ 8.6 $ 43.1 $ 10.8 $ 75.1 Adjusted operating income, 2012 $ 169.3 $ 175.1 $ 13.2 $ - $ 357.6 Add back unfavorable items impacting operating income in 2011 $ 2.3 $ 0.8 $ 2.2 $ - $ 5.3 Adjusted operating income, 2011 $ 187.1 $ 162.0 $ 19.0 $ - $ 368.1 Adjusted Change % (9.6 )% 8.1 % (30.4 )% nm (2.9 )% Less the % impact of: Foreign exchange 0.6 % (0.3 )% 0.5 % nm 0.2 % Copper pricing - (6.1 )% - nm (2.7 )% Acquisition of Jorvex - 3.2 % - nm 1.4 % Organic * (10.1 )% 11.3 % (30.9 )% nm (1.8 )% * Amounts may not sum due to rounding ** nm - percentages are not meaningful ECS - Adjusted operating margin was 5.1% in 2013 compared to 5.2% in the previous year and 5.8% in 2011. The year-over-year decrease in 2013 was caused primarily by lower volume in Emerging Markets and Canada. The decline in 2012 was due to the persistent weakness in the European economy and a product mix shift as security became an increasing part of the overall sales mix. Over the past few years, this segment has also experienced a slowdown in the higher margin data center market and pricing pressure in some geographies. W&C - Adjusted operating margin was 7.6% in 2013 compared to 8.3% in both 2012 and 2011. The year over year decrease in 2013 is largely a result of weaker geographic and product mix. The flat year-over-year results in 2012 was largely a result of a mix shift from OEM to Industrial products in North America and an increase in lower margin project activity outside of the U.S. which was offset by the lower operating expenses as a percentage of sales. OEM Supply - Adjusted operating margin was 3.5% in 2013 compared to 1.5% and 2.0% in 2012 and 2011, respectively. The improvement in this segment in 2013 as compared to 2012 and 2011 was a result of our improved competitive position in the European region, which accounts for nearly 50% of OEM Supply segment revenues and higher production levels in the heavy truck market in North America. Interest Expense and Other Consolidated interest expense was $47.4 million, $59.7 million and $50.1 million in 2013, 2012, and 2011, respectively. Our average cost of debt was 5.3%, 6.1% and 5.1% in 2013, 2012, and 2011, respectively. The decrease in interest expense was driven by the retirement of convertible debt in the first quarter of 2013 and the change in the mix of lower-cost borrowings. Our average cost of debt increase in 2012 was due to the issuance of $350 million of Notes due 2019 to pre-fund the retirement of $300 million convertible notes due in February 2013 ("Notes due 2013"). Due to the strengthening of the U.S. dollar against certain foreign currencies, primarily in our Europe and Latin America regions, we recorded a foreign exchange loss of $10.9 million in 2013, $11.7 million in 2012 and $7.1 million in 2011. In February 2013, the Venezuela government announced a devaluation of the bolivar from the rate of 4.30 bolivars to one U.S. dollar to 6.30 bolivars to one U.S. dollar. As a result, we recorded a foreign exchange loss of $1.1 million in the first quarter of 2013. The combined effect of changes in both the equity and bond markets in each of the last three fiscal years resulted in changes in the cash surrender value of our company owned life insurance policies associated with our sponsored deferred compensation program. We recorded gains on the cash surrender value in 2013 and 2012 of $0.2 million and $0.5 million, respectively. In 2011, we recorded a loss of $0.9 million. 17 -------------------------------------------------------------------------------- Income Taxes The tax provision on continuing operations for 2013 was $95.6 million compared to $84.6 million in the prior year and $102.8 million in 2011. During the third quarter of 2013, we recorded net benefits of $4.7 million primarily related to closing prior tax years. This net benefit includes related interest income of $0.7 million which is included in "Other, net" ($0.5 million, net of tax). During the first quarter of 2012, we recorded a tax benefit of $9.7 million primarily related to the reversal of deferred income tax valuation allowances in certain foreign jurisdictions. The 2011 results included a net tax benefit of $10.8 million primarily related to the reversal of deferred income tax valuation allowances. As a result, our effective tax rate for 2013 was 32.3% as compared to 40.5% in the prior year and 33.9% in 2011. Excluding the impact of these items as well as the other items impacting the comparability of results discussed above, the adjusted tax rate in 2013 was 33.7% compared to 36.5% in the prior year and 37.4% in 2011. The declining adjusted tax rate from 2011 is due to the favorable mix of taxable income and changes to the capital structure in several countries. Net Income from Continuing Operations As a result of the discussion herein, adjusted net income from continuing operations in 2013 was $195.7 million and $181.7 million in 2012. Adjusted net income from continuing operations in 2011 was $193.2 million. Financial Liquidity and Capital Resources Cash Flow As a distributor, our use of capital is largely for working capital to support our revenue growth. Capital commitments for property, plant and equipment are limited to information technology assets, warehouse equipment, office furniture and fixtures and leasehold improvements, since we operate almost entirely from leased facilities. Therefore, in any given reporting period, the amount of cash consumed or generated by operations other than from net earnings will primarily be due to changes in working capital as a result of the rate of increases or decreases in sales. In periods when sales are increasing, the expanded working capital needs will be funded first by cash from operations, then from additional borrowings and lastly from additional equity offerings. In periods when sales are decreasing, we will have improved cash flows due to reduced working capital requirements. During such periods, we will use the expanded cash flow to reduce the amount of leverage in our capital structure until such time as the outlook for improved economic conditions and growth is clear. We will also from time to time issue or retire borrowings or equity in an effort to maintain a cost-effective capital structure consistent with our anticipated capital requirements. Net cash provided by operations was $334.5 million in 2013 which compares to $142.9 million of cash provided by operations in 2012. Excluding the $34.0 million contribution to the pension plan to fund the majority of the lump-sum payment option offered to terminated vested participants, cash flow provided by operations in 2012 was $176.9 million. The $334.5 million in 2013 represented an increase of $157.6 million compared to 2012, excluding the $34.0 million pension plan contribution. The increase in cash flow provided by operations is a result of improved earnings and our continued focus on improving working capital efficiency combined with the effects of slower sales growth in the business. Net cash provided by operating activities in 2012 compares to $145.8 million in 2011. Consolidated net cash used in investing activities was $32.2 million. This compares to net cash used in investing activities of $89.5 million in 2012, which included $55.3 million for the acquisition of Jorvex and $34.2 million for capital expenditures. In 2012, we paid $55.3 million, net of cash acquired, and assumed approximately $12.7 million in debt to acquire Jorvex. This compares to net cash provided by investing activities of $118.8 million in 2011, which included $143.6 million from the sale of our Aerospace business offset by $26.4 million in capital expenditures. Capital expenditures of $32.2 million in fiscal 2013 compared to $34.2 million and $26.4 million in 2012 and 2011, respectively. Capital expenditures are expected to be approximately $40 - $45 million in 2014 as we continue to invest in the warehouse equipment, information system upgrades and new software to support our infrastructure. Net cash used in financing activities was $324.1 million in 2013 compared to $68.8 million and $235.5 million in 2012 and 2011, respectively. During 2013, our Notes due 2013 matured and, pursuant to the terms of the indenture, we settled our conversion obligations up to the $300 million principal amount of the Notes due 2013 in cash. Available borrowings under our accounts receivable securitization facility and long-term revolving credit facility were used to retire the Notes due 2013. In 2012, we issued $350 million principal amount of Notes due 2019 and repaid $209.3 million of borrowings under revolving credit facilities. This compares to repayments of borrowings of $49.4 million in 2011. Over the last three fiscal years, we have returned over $480 million of excess capital to shareholders through the repurchase of common stock and special dividends. 18 -------------------------------------------------------------------------------- Liquidity and Capital Resources We maintain the flexibility to utilize future cash flows to invest in the growth of the business, and we believe that the current leverage on the balance sheet positions us to effectively capitalize on the current economic environment as well as additional acquisition opportunities when they become available. We will continue to balance our focus on sales and earnings growth with continuing efforts in cost control and working capital management. Maintaining a strong and flexible financial position continues to be vital to funding investment in strategic long-term growth initiatives. At the end of the fiscal 2013, we had approximately $323.9 million in available, committed, unused credit lines with financial institutions that have investment-grade credit ratings, as well as $145.0 million of outstanding borrowings under our $300 million accounts receivable securitization facility, also with financial institutions with investment grade credit ratings, resulting in $478.9 million of available borrowings at the end of 2013. With a year-end cash balance of $57.3 million, along with available committed credit facilities, we will continue to evaluate the optimal use of these funds. Our debt-to-total capitalization was 44.9%, 50.3% and 44.7% at the end of fiscal years 2013, 2012 and 2011, respectively. We are in compliance with all of our covenant ratios and believe that there is adequate margin between the covenant ratios and the actual ratios given the current trends of the business. As of January 3, 2014, all of our available borrowings would be permitted. For further information, including information regarding our credit arrangements, see Note 5. "Debt" in the Notes to the Consolidated Financial Statements. 19 -------------------------------------------------------------------------------- Contractual Cash Obligations and Commitments At the end of fiscal 2013, we have various contractual cash obligations and commitments and the following table represents the associated payments due by period. The amounts due by period will not necessarily correlate to amounts reflected as short-term and long-term liabilities on our Consolidated Balance Sheets at the end of any given period. This is due to the difference in the recognition of liabilities of non-cancellable obligations for accounting purposes at the end of a given period as well giving consideration to our intent and ability to settle such contractual commitments that might be considered short term. Payments due by period 2014 2015 2016 2017 2018 Beyond 2018 Total (In millions) Debt a $ 39.7 $ 345.0 $ - $ - $ 101.5 $ 350.0 $ 836.2 Contractual Interest b 41.9 32.2 24.0 24.0 20.9 6.6 149.6 Purchase Obligations c 524.4 10.0 5.0 - - - 539.4Operating Leases 57.8 45.5 34.1 23.1 18.3 43.2 222.0 Deferred Compensation Liability d 3.0 3.8 3.9 3.6 3.1 28.7 46.1 Pension Plans e 15.1 - - - - - 15.1 Total Obligations $ 681.9 $ 436.5 $ 67.0 $ 50.7 $ 143.8 $ 428.5 $ 1,808.4 Liabilities related to unrecognized tax benefits of $4.4 million were excluded from the table above, as we cannot reasonably estimate the timing of cash settlements with taxing authorities. Various of our foreign subsidiaries had aggregate cumulative net operating loss ("NOL") carryforwards for foreign income tax purposes of approximately $115.0 million at January 3, 2014, which are subject to various provisions of each respective country. Approximately $21.6 million of this amount expires between 2014 and 2023, and $93.4 million of the amount has an indefinite life. See Note 7. "Income Taxes" in the notes to the Consolidated Financial Statements for further information related to unrecognized tax benefits. (a) The $145.0 million outstanding under the accounts receivable securitization facility will mature in 2015. The book value of the Notes due 2014 was $32.1 million at January 3, 2014 and will accrete to $32.3 million when contractually due in 2014. Other borrowings of $7.4 million are contractually due in 2014 Borrowings under our long-term revolving credit facilities of $101.5 million mature in 2018. The Notes due 2015 and the Notes due 2019 are $200.0 million and $350.0 million, respectively. (b) Interest payments on debt outstanding at January 3, 2014 through maturity. For variable rate debt, we computed contractual interest payments based on the borrowing rate at January 3, 2014. (c) Purchase obligations primarily consist of purchase orders for products sourced from unaffiliated third party suppliers, in addition to commitments related to various capital expenditures. Many of these obligations may be canceled with limited or no financial penalties. (d) A non-qualified deferred compensation plan was implemented on January 1, 1995. The plan provides for benefit payments upon retirement, death, disability, termination or other scheduled dates determined by the participant. At January 3, 2014, the deferred compensation liability was $46.1 million. In an effort to ensure that adequate resources are available to fund the deferred compensation liability, we have purchased variable, separate account life insurance policies on the plan participants with benefits accruing to us. At January 3, 2014, the cash surrender value of these company-owned life insurance policies was $34.6 million. (e) The majority of our various pension plans are non-contributory and cover substantially all full-time domestic employees and certain employees in other countries. Retirement benefits are provided based on compensation as defined in the plans. Our policy is to fund these plans as required by the Employee Retirement Income Security Act, the Internal Revenue Service and local statutory law. At January 3, 2014 the current portion of our net pension liability of $31.1 million was $0.8 million. We currently estimate that we will contribute $15.1 million to our foreign and domestic pension plans in 2014, which includes $0.8 million of benefit payments directly to participants of our two domestic unfunded non-qualified pension plans. Due to the future impact of various market conditions, rates of return and changes in plan participants, we cannot provide a meaningful estimate of our future contributions beyond 2014. Critical Accounting Policies and Estimates We believe that the following are critical areas of accounting that either require significant judgment by management or may be affected by changes in general market conditions outside the control of management. As a result, changes in estimates and general market conditions could cause actual results to differ materially from future expected results. Historically, with the exception of the goodwill and related long-lived asset impairment charges in 2009 and 2012, our estimates in these critical areas have not differed materially from actual results. 20 -------------------------------------------------------------------------------- Allowance for Doubtful Accounts At January 3, 2014 and December 28, 2012, we reported net accounts receivable of $1,182.8 million and $1,225.5 million, respectively. We carry our accounts receivable at their face amounts less an allowance for doubtful accounts which was $16.8 million and $21.4 million at the end of 2013 and 2012, respectively. On a regular basis, we evaluate our accounts receivable and establish the allowance for doubtful accounts based on a combination of specific customer circumstances, as well as credit conditions and history of write-offs and collections. Each quarter we segregate the doubtful receivable balances into the following major categories and determine the bad debt reserve required as outlined below: • Customers that are no longer paying their balances are reserved based on the historical write-off percentages; • Risk accounts are individually reviewed and the reserve is based on the probability of potential default. We continually monitor payment patterns of customers, investigate past due accounts to assess the likelihood of collection and monitor industry and economic trends to estimate required allowances; and • The outstanding balance for customers who have declared bankruptcy is reserved at the outstanding balance less the estimated net realizable value. If circumstances related to the above factors change, our estimates of the recoverability of amounts due to us could be reduced or increased by a material amount. Inventory Obsolescence At January 3, 2014 and December 28, 2012, we reported inventory of $959.8 million and $1,060.9 million, respectively (net of inventory reserves of $57.0 million and $61.5 million, respectively). Each quarter we review for excess inventories and make an assessment of the net realizable value. There are many factors that management considers in determining whether or not the amount by which a reserve should be established. These factors include the following: • Return or rotation privileges with vendors • Price protection from vendors • Expected future usage • Whether or not a customer is obligated by contract to purchase the inventory • Current market pricing • Historical consumption experience • Risk of obsolescence If circumstances related to the above factors change, there could be a material impact on the net realizable value of the inventories. Pension Expense Accounting rules related to pensions and the policies we use generally reduce the recognition of actuarial gains and losses in the net benefit cost, as any significant actuarial gains/losses are amortized over the remaining service lives of the plan participants. These actuarial gains and losses are mainly attributable to the return on plan assets that differ from that assumed and differences in the obligation due to changes in the discount rate, plan demographic changes and other assumptions. A significant element in determining our net periodic benefit cost in accordance with U.S. Generally Accepted Accounting Principles ("GAAP") is the expected return on plan assets. For 2013, we had assumed that the weighted-average expected long-term rate of return on plan assets would be 5.86%. This expected return on plan assets is included in the net periodic benefit cost for the fiscal year ended 2013. As a result of the combined effect of valuation changes in both the equity and bond markets, the plan assets produced an actual gain of approximately 11.9% in 2013 as compared to a gain of 9.3% in 2012. As a result, the fair value of plan assets is $436.7 million at the end of fiscal 2013, compared to $385.7 million at the end of fiscal 2012. When the difference between the expected return and the actual return on plan assets is significant, the difference is amortized into expense over the service lives of the plan participants. These amounts are reflected on the balance sheet through charges to "Accumulated other comprehensive loss," a component of "Stockholders' Equity" in the Consolidated Balance Sheets. 21 -------------------------------------------------------------------------------- The measurement date for all of our plans is December 31st. Accordingly, at the end of each fiscal year, we determine the discount rate to be used to discount the plan liabilities to their present value. The discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year. In estimating this rate at the end of 2013 and 2012, we reviewed rates of return on relevant market indices (i.e., the Citigroup pension liability index). These rates are adjusted to match the duration of the liabilities associated with the pension plans. At January 3, 2014 and December 28, 2012, we determined the consolidated weighted-average rate of all plans to be 4.64% and 4.08%, respectively, and used this rate to measure the projected benefit obligation at the end of each respective fiscal year end. The increase in the discount rate and the strengthening of the U.S. dollar has decreased the projected benefit obligation. The decrease in the projected benefit obligation is also due to the pension plan changes outlined below. As a result, the projected benefit obligation decreased to $467.8 million at the end of fiscal 2013 from $481.1 at the end of fiscal 2012. Our consolidated net pension liability was $31.1 million at the end of fiscal 2013 compared to $95.4 million at the end of 2012. In the fourth quarter of 2012, we took two actions related to the Anixter Inc. Pension Plan in the United States that will reduce future expenses and contributions. First, we offered a one-time lump sum payment option to terminated vested participants that resulted in $34.0 million of additional contributions we made to fund $36.2 million of payments. This resulted in a settlement charge of $15.3 million related to the immediate recognition of actuarial losses accumulated in other comprehensive income, a component of stockholders' equity. The additional contributions of $34.0 million were made using excess cash from operations, positively influencing the funded status of the plan. Second, we made changes to our existing U.S. defined benefit plan which were effective as of December 31, 2013 that froze benefits provided to employees hired on or before June 1, 2004. This change resulted in a remeasurement of the projected benefit obligation, resulting in a reduction of the balance by $44.6 million in the fourth quarter of 2012. These employees are covered under the personal retirement account pension formula described more fully in Note 8. "Pension Plans, Post-Retirement Benefits and Other Benefits" in the Notes to the Consolidated Financial Statements. We recognized net periodic cost of $16.7 million in 2013, down from $41.0 million in 2012. Excluding the settlement charge in 2012, our 2013 net periodic costs decreased approximately 35%. The decline in pension cost is primarily due to the amendments to the U.S. pension plan described above which more than offset the impact of the decline in the consolidated weighted average discount rate from 4.56% in 2012 to 4.08% in 2013. Due to its long duration, the pension liability is very sensitive to changes in the discount rate. As a sensitivity measure, the effect of a 50-basis-point decline in the assumed discount rate would result in an increase in the 2014 pension expense of approximately $2.6 million and an increase in the projected benefit obligations at January 3, 2014 of $39.3 million. A 50-basis-point decline in the assumed rate of return on assets would result in an increase in the 2014 expense of approximately $2.2 million. Goodwill and Indefinite-Lived Intangible Assets In September 2011, the FASB issued new guidance related to testing goodwill for impairment, giving companies the option to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount and, in some cases, skip the two-step impairment test. The qualitative assessment considers specific factors, based on the weight of evidence, and the significance of all identified events and circumstances in the context of determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Beginning in 2012, we utilized the qualitative assessment approach to test goodwill for impairment during the annual assessment performed in the third quarter for three of our four reporting units. In addition to the qualitative approach, we also performed a combination of the quantitative evaluation of the income and market approach to determine the fair value of our former European reporting unit, during the third quarter of 2012. As a result of the change in segments in the fourth quarter of 2012 and in accordance with ASC 350 related to Goodwill and Intangibles, we reassigned the carrying amount of goodwill to our new reporting units based on the relative fair value assigned as of the effective date of our change in segment reporting. We performed an interim assessment of the recoverability of goodwill assigned to the reporting units as a result of this change. In connection with our fourth quarter interim assessment to test for goodwill impairment, we performed a quantitative test for all reporting units and utilized a combination of the income and market approach, both of which are broadly defined below. For further information, see Note 4. "Impairment of Goodwill and Long-lived Assets". The income approach is a quantitative evaluation to determine the fair value of the reporting unit. Under the income approach we determine the fair value based on estimated future cash flows discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of the reporting unit and the rate of return a market participant would expect to earn. The inputs used for the income approach were significant unobservable inputs, or Level 3 inputs, as described in the accounting fair value hierarchy. Estimated future cash flows were based on our internal projection models, industry projections and other assumptions deemed reasonable by management. 22 -------------------------------------------------------------------------------- The market approach measures the fair value of a reporting unit through the analysis of recent sales, offerings, and financial multiples (sales or EBITDA) of comparable businesses. Consideration is given to the financial conditions and operating performance of the reporting unit being valued relative to those publicly-traded companies operating in the same or similar lines of business. If it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying amount using the qualitative assessment, we perform the two-step impairment test. The first step of the impairment test is to identify a potential impairment by comparing the fair value of a reporting unit with its carrying amount. The estimates of fair value of a reporting unit are determined using the income approach and/or the market approach as described above. If step one of the test indicates a carrying value above the estimated fair value, the second step of the goodwill impairment test is performed by comparing the implied residual value of the reporting unit's goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. Other than goodwill, we do not have any material indefinite-lived intangible assets. Our long-lived assets consist of definite-lived intangible assets which are primarily related to customer relationships, as well as property and equipment which consists of office furniture and equipment, computer software and hardware, warehouse equipment and leasehold improvements. We continually evaluate whether events or circumstances have occurred that would indicate the remaining estimated useful lives of our long-lived assets warrant revision or that the remaining balance of such assets may not be recoverable. If impairment indicators are present, we assess whether the future estimated undiscounted cash flows attributable to the assets in question are greater than their carrying amounts. If these future estimated cash flows are less than carrying value, we then measure an impairment loss for the amount that carrying value exceeds fair value of the assets. At the end of fiscal 2013, we expect the carrying amount of goodwill, allocated to each of our segments, and our long-lived assets to be fully recoverable. Deferred Tax Assets At January 3, 2014 and December 28, 2012, our allowance for deferred tax assets was $21.9 million and $22.2 million, respectively. We maintain valuation allowances to reduce deferred tax assets if it is more likely than not that some portion or all of the deferred tax asset will not be realized. Changes in valuation allowances are included in our tax provision in the period of change. In determining whether a valuation allowance is warranted, management evaluates factors such as prior earnings history, expected future earnings, carryback and carryforward periods and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. Assessments are made at each balance sheet date to determine how much of each deferred tax asset is realizable. These estimates are subject to change in the future, particularly if earnings of a particular subsidiary are significantly higher or lower than expected, or if management takes operational or tax planning actions that could impact the future taxable earnings of a subsidiary. Uncertain Tax Positions In the normal course of business, we are audited by federal, state and foreign tax authorities, and are periodically challenged regarding the amount of taxes due. These challenges relate to the timing and amount of deductions and the allocation of income among various tax jurisdictions. Management believes our tax positions comply with applicable tax law and we intend to defend our positions. We recognize the benefit of tax positions when a benefit is more likely than not (i.e., greater than 50% likely) to be sustained on its technical merits. Recognized tax benefits are measured at the largest amount that is more likely than not to be sustained, based on cumulative probability, in final settlement of the position. Our effective tax rate in a given period could be impacted if, upon final resolution with taxing authorities, we prevailed in positions for which reserves have been established, or were required to pay amounts in excess of established reserves. As of January 3, 2014, the aggregate amount of global uncertain tax position liabilities and related interest and penalties recorded was approximately $4.4 million. The uncertain tax positions cover a range of issues, including intercompany charges and withholding taxes, and involve numerous different taxing jurisdictions. New Accounting Pronouncements For information about recently issued accounting pronouncements, see Note 1. "Summary of Significant Accounting Policies" in the Notes to the Consolidated Financial Statements. 23-------------------------------------------------------------------------------- |