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BLACK BOX CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations("MD&A").(Edgar Glimpses Via Acquire Media NewsEdge) The discussion and analysis for the three and six-months ended September 30, 2014 and 2013 as set forth below in this Part I, Item 2 should be read in conjunction with the response to Part I, Item 1 of this report and the consolidated financial statements of Black Box Corporation ("Black Box," the "Company," "we" or "our"), including the related notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's most recent Annual Report on Form 10-K, as filed with the Securities and Exchange Commission ("SEC") for the fiscal year ended March 31, 2014 (the "Form 10-K"). References to "2Q15" mean the three-month period ended September 30, 2014 while references to "2Q14" mean the three-month period ended September 30, 2013. References to "2QYTD15" mean the six-month period ended September 30, 2014 while references to "2QYTD14" mean the six-month period ended September 30, 2013. The Company's fiscal year ends on March 31. The fiscal quarters consist of 13 weeks and generally end on the Saturday nearest each calendar quarter end, adjusted to provide relatively equivalent business days for each fiscal quarter. The actual ending dates for the periods presented as of September 30, 2014 and 2013 were September 27, 2014 and September 28, 2013, respectively. References to "Fiscal Year" or "Fiscal" mean the Company's fiscal year ended March 31 for the year referenced. All dollar amounts are presented in thousands except for per share amounts or unless otherwise noted. The Company Black Box is a leading technology solutions provider dedicated to helping customers design, build, manage, and secure their IT infrastructure. The Company offers Products and Services that it distributes through two platforms that it has built over its 38 year history. The Products Platform ("Product") is comprised of global sales and distribution, free 24/7/365 technical support, custom solutions, same-day delivery, lifetime warranties, quality control, global product management and sourcing. The current products offered through the platform include but are not limited to IT infrastructure, specialty networking, multimedia and KVM switching. The Company generates revenues in its Product business from the sale of technology products through its catalogs and Internet Web site. These products are sold in a highly fragmented and competitive market. The Company has been in this business for over 38 years and has developed a reputation for being a reliable provider of high-quality communications and infrastructure products. With an average order size of less than one thousand dollars, product revenues are less impacted by capital spending and more so by general information technology spending. The Services Platform ("Service") is comprised of engineering and design, network operations centers, technical certifications, local and national sales teams, remote monitoring, on-site service teams and technology partner centers of excellence which include dedicated sales and engineering resources. The primary services offered through this platform include but are not limited to telephony and unified communications, wired and wireless infrastructure and managed services. The Company generates revenues in its Service business from the design, sale and/or installation of new communications and data infrastructure systems, the support of existing systems and MAC (moves, adds and changes) work. The Company's diverse portfolio of offerings allows it to service the needs of its clients independent of the technology that they choose, which it believes is a unique competitive advantage. For the sale and implementation of new communications systems, or other major projects, most significant orders are subject to competitive bidding processes and, generally, competition can be significant for such new orders. The Company is continually bidding on new projects to maintain and grow service revenues. Projects account for the majority of Service revenues and are primarily driven by the overall economic environment and information technology capital spending. The Company also serves government clients whose revenues are not as dependent on the overall economic environment as commercial clients but are subject to governmental budgetary constraints. New communications systems orders often generate a post-implementation maintenance agreement to support the system, which generally ranges from 1-3 years for commercial clients and 3-5 years for government clients. Historically, such an agreement would result in a fixed fee earned ratably over the term of the contract. Recently, some of our clients have adopted a variable fee model based on time and materials per occurrence, similar to MAC work. While this shift decreases our contractually obligated revenues, the variable model also generates profitable revenues. Revenues from maintenance contracts generally are not dependent on the economy as clients contract for maintenance to extend the life of their existing equipment and delay capital spending on new communications systems. Maintenance and MAC work revenues are also dependent upon the Company's relationship with its clients and its long track record of providing high-quality service. 18-------------------------------------------------------------------------------- Table of Contents The Company generates backlog which is defined by the Company as orders and contracts considered to be firm. At September 30, 2014, the Company's total backlog, which relates primarily to Services, was $389,920, of which $257,939 is expected to be completed within the next twelve months. Our platforms introduce scale, flexibility and leverage to the business, and provide the following competitive advantages: • A diversified client base: We have built a diversified client base that ranges from small organizations to many of the world's largest corporations and institutions. Black Box clients participate in many industries, including government, healthcare, business services, manufacturing, retail, technology and banking, among others. Revenues from our clients are segmented with approximately 60% from large companies (i.e., revenues greater than $1 billion, including federal governments), approximately 20% from medium-sized companies (i.e., revenues between $50 million and $1 billion, including state governments) and approximately 20% from small companies (i.e., revenues less than $50 million, including local governments). We strive to develop extensive and long-term relationships with high-quality clients as we believe that satisfied clients will demand quality services and product offerings even in economic downturns. Also, we believe that our distinctive portfolio of products and services will allow us to introduce additional offerings to satisfied clients. • Key relationships with leading technology partners: We have built long-term relationships with all major communications equipment manufacturers and we are a top partner with the market leaders. • Broad geographic footprint: We have built a global footprint with offices throughout the world. • Deep organic resources: We have approximately 4,000 team members world-wide, with the experience and certifications to serve our clients with on-site and remote capabilities. • Dedicated sales force: We have a team of direct sales people world-wide. • Strong financial position: We have a stable balance sheet and have generated positive cash flow for 38 consecutive years. The Company services a variety of clients within most major industries, with the highest concentration in the government, business services, manufacturing, banking, retail, healthcare and technology industry verticals. Factors that impact those verticals, therefore, could have an impact on the Company. While the Company generates most of its revenues in North America, the Company also generates revenues from around the world, primarily Europe, such that factors that impact European markets could impact the Company. 19-------------------------------------------------------------------------------- Table of Contents 2QYTD15 vs 2QYTD14 Summary 2QYTD15 2QYTD14 % Change Revenues $ 494,099 $ 493,707 - % Gross profit margin 30.1 % 31.2 % (4 )% Operating income margin 3.2 % 5.3 % (40 )% Diluted EPS $ 0.46 $ 0.78 (41 )% Net cash provided by (used for) operating activities $ 9,158 $ 29,462 (69 )% Diluted EPS was $0.46, a decrease of 41% compared to Diluted EPS of $0.78 in the same period last year as a result of: • a $392 increase in Revenues as a result of an increase in Service Revenues primarily due to an increase in core commercial revenues in North America Services, which includes the Cisco solutions practice, and Wireless solutions practice, also in North America Services, partially offset by a decrease in Product Revenues primarily due to a non-recurring large order in International Products in Fiscal 2014, • a $5,221 decrease in Gross profit as a result of a decrease in Gross profit margin related to both Product and Service Revenues as discussed herein, • a $6,271 increase in Selling, general and administrative expenses which were primarily the result of current period investments for growth programs and an increase in restructuring expense of $875 partially offset by cost savings from restructuring activity in the prior year, • a $143 decrease in Interest expense (income), net resulting from the change in the fair value of the interest-rate swap of $76 (from a gain of $470 in 2QYTD14 to a gain of $546 in 2QYTD15), • a $3,993 decrease in Provision for income taxes as a result of a decrease in Income before provision for income taxes partially offset by an increase in the effective rate from 44.9% to 46.3% due to the write-off of certain deferred tax assets related to equity awards partially offset by a reduction of certain deferred tax liabilities associated with previously taxed income and foreign earnings taxed at lower statutory rates, and • a 539 reduction in Diluted weighted-average common shares outstanding resulting from the Company's common stock repurchases. Net cash provided by operating activities was $9,158, which included Net income of $7,146 and an increase in working capital of $4,770, a decrease of 69% compared to $29,462, which included Net income of $12,490 and a decrease in working capital of $2,832, in the same period last year. The decrease was primarily due to the timing of working capital items. 20-------------------------------------------------------------------------------- Table of Contents Results of Operations Segments We conduct our business globally and manage our business by geographic-service type under the following four operating segments: North America Products, North America Services, International Products and International Services. The Revenues, Gross profit and Operating income amounts in the table below are presented on a basis consistent with accounting principles generally accepted in the United States. 2Q15 2Q14 % Change 2QYTD15 2QYTD14 % Change Revenues North America Products $ 23,167 $ 21,615 7 % $ 42,894 $ 42,651 1 % International Products $ 21,382 $ 21,576 (1 )% $ 44,874 $ 48,748 (8 )% Total Products $ 44,549 $ 43,191 3 % $ 87,768 $ 91,399 (4 )% North America Services $ 197,519 $ 194,518 2 % $ 391,784 $ 384,184 2 % International Services $ 6,805 $ 9,101 (25 )% $ 14,547 $ 18,124 (20 )% Total Services $ 204,324 $ 203,619 - % $ 406,331 $ 402,308 1 % Total Revenues $ 248,873 $ 246,810 1 % $ 494,099 $ 493,707 - % Gross profit North America Products $ 9,683 $ 9,377 3 % $ 17,642 $ 18,289 (4 )% % of Revenues 41.8 % 43.4 % (4 )% 41.1 % 42.9 % (4 )% International Products $ 8,923 $ 9,565 (7 )% $ 18,912 $ 20,366 (7 )% % of Revenues 41.7 % 44.3 % (6 )% 42.1 % 41.8 % 1 % Total Products $ 18,606 $ 18,942 (2 )% $ 36,554 $ 38,655 (5 )% % of Revenues 41.8 % 43.9 % (5 )% 41.6 % 42.3 % (2 )% North America Services $ 53,462 $ 56,220 (5 )% $ 108,679 $ 111,407 (2 )% % of Revenues 27.1 % 28.9 % (6 )% 27.7 % 29.0 % (5 )% International Services $ 1,641 $ 1,966 (17 )% $ 3,705 $ 4,097 (10 )% % of Revenues 24.1 % 21.6 % 12 % 25.5 % 22.6 % 13 % Total Services $ 55,103 $ 58,186 (5 )% $ 112,384 $ 115,504 (3 )% % of Revenues 27.0 % 28.6 % (6 )% 27.7 % 28.7 % (4 )% Total Gross Profit 73,709 77,128 (4 )% 148,938 154,159 (3 )% % of Revenues 29.6 % 31.2 % (5 )% 30.1 % 31.2 % (4 )% Operating income (loss)(1) North America Products $ 1,860 $ 2,624 (29 )% $ 2,089 $ 3,503 (40 )% % of Revenues 8.0 % 12.1 % (34 )% 4.9 % 8.2 % (40 )% International Products $ (252 ) $ 924 (127 )% $ 51 $ 2,573 (98 )% % of Revenues (1.2 )% 4.3 % (128 )% 0.1 % 5.3 % (98 )% Total Products $ 1,608 $ 3,548 (55 )% $ 2,140 $ 6,076 (65 )% % of Revenues 3.6 % 8.2 % (56 )% 2.4 % 6.6 % (63 )% North America Services $ 5,404 $ 9,928 (46 )% $ 12,857 $ 19,576 (34 )% % of Revenues 2.7 % 5.1 % (47 )% 3.3 % 5.1 % (35 )% International Services $ 38 $ 53 (28 )% $ 617 $ 329 88 % % of Revenues 0.6 % 0.6 % - % 4.2 % 1.8 % 133 % Total Services $ 5,442 $ 9,981 (46 )% $ 13,474 $ 19,905 (32 )% % of Revenues 2.7 % 4.9 % (45 )% 3.3 % 4.9 % (33 )% Total Operating Income (loss) 7,050 13,529 (48 )% 15,614 25,981 (40 )% % of Revenues 2.8 % 5.5 % (49 )% 3.2 % 5.3 % (40 )% (1) These results reflect a reclassification of expense that reduced Operating income (loss) in North America Products by $250, $1,218 and $475 in 2Q14, 2QYTD15 and 2QYTD14, respectively, with a corresponding increase of the same amounts for Operating income (loss) in North America Services. This reclassification had no effect on our consolidated financial results. 21-------------------------------------------------------------------------------- Table of Contents 2Q15 vs 2Q14 Total Revenues were $248,873, an increase of 1% when compared to Total Revenues of $246,810 in the same period last year. Product Revenues were $44,549, an increase of 3% compared to Product Revenues of $43,191 in the same period last year primarily as a result of sales generated by a new direct sales program focused on larger opportunities. Service Revenues were $204,324, consistent with Service Revenues of $203,619 in the same period last year primarily due to an increase in core commercial revenues, which includes the Cisco solutions practice, and Wireless solutions practice in North America Services, partially offset by a decrease in government revenues in North America Services due to lower project bidding volume. Total Gross profit margin was 29.6%, a decrease of 5% compared to Total Gross profit margin of 31.2% in the same period last year. Product Gross profit margin was 41.8%, a decrease of 5% compared to Product Gross profit margin of 43.9% in the same period last year primarily due to the impact of our new direct sales program focused on large competitive deals which tend to carry lower margins and product mix. Service Gross profit margin was 27.0%, a decrease of 6% compared to Service Gross profit margin of 28.6% in the same period last year primarily due to $3,067 of unanticipated costs required to complete a fixed price contract, which decreased gross profit margin by 1.2%, and a decrease in profitability associated with core commercial revenues in North America as a result of continued competition for lower priority budget dollars partially offset by an increase in profitability associated with government revenues in North America due to multiple projects with higher than normal profitability. Total Operating income margin was 2.8%, a decrease of 49% compared to Total Operating income margin of 5.5% in the same period last year. Product Operating income margin was 3.6%, a decrease of 56% compared to Product Operating income margin of 8.2% in the same period last year, primarily due to current period investments for growth programs and infrastructure and a decrease in Gross profit margins as noted above. Service Operating income margin was 2.7%, a decrease of 45% compared to Service Operating income margin of 4.9% in the same period last year, primarily due to current period investments for growth programs and a decrease in Gross profit margins as noted above. 2QYTD15 vs 2QYTD14 Total Revenues were $494,099, consistent with Total Revenues of $493,707 in the same period last year. Product Revenues were $87,768, a decrease of 4% compared to Product Revenues of $91,399 in the same period last year primarily as a result of a non-recurring large order in International Products sold through integrators within business services whose end-users were government clients and reduced spending in both direct and indirect channels by our government clients in North America Products. The decrease in Product Revenues was partially offset by sales generated by a new direct sales program focused on larger opportunities. Service Revenues were $406,331, an increase of 1% compared to Service Revenues of $402,308 in the same period last year primarily due to an increase in core commercial revenues, which includes the Cisco solutions practice, and Wireless solutions practice in North America Services, partially offset by a decrease in government revenues in North America Services due to lower project bidding volume. Total Gross profit margin was 30.1%, a decrease of 4% compared to Total Gross profit margin of 31.2% in the same period last year. Product Gross profit margin was 41.6%, a decrease of 2% compared to Product Gross profit margin of 42.3% in the same period last year primarily due to the impact of our new direct sales program focused on large competitive deals which tend to carry lower margins and product mix partially offset by lower margins on the non-recurring order in International Products noted above. Service Gross profit margin was 27.7%, a decrease of 4% compared to Service Gross profit margin of 28.7% in the same period last year primarily due to $3,067 of unanticipated costs required to complete a fixed price contract, which decreased gross profit margin by 0.7%, and a decrease in profitability associated with core commercial revenues in North America as a result of continued competition for lower priority budget dollars partially offset by an increase in profitability associated with government revenues in North America due to multiple projects with higher than normal profitability. Total Operating income margin was 3.2%, a decrease of 40% compared to Total Operating income margin of 5.3% in the same period last year. Product Operating income margin was 2.4%, a decrease of 63% compared to Product Operating income margin of 6.6% in the same period last year, primarily due to current period investments for growth programs and infrastructure and a decrease in Gross profit margins as noted above. Service Operating income margin was 3.3%, a decrease of 33% compared to Service Operating income margin of 4.9% in the same period last year, primarily due to current period investments for growth programs and a decrease in Gross profit margins as noted above. The Company anticipates it will continue its investment in longer-term programs designed to accelerate the growth in revenue and market penetration which are expected to result in its Operating income margin remaining at or near current levels for Fiscal 2015. 22-------------------------------------------------------------------------------- Table of Contents Interest expense, Other expense and Income Taxes 2Q15 2Q14 % Change 2QYTD15 2QYTD14 % Change Interest expense $ 1,027 $ 1,378 (26 )% $ 2,158 $ 2,301 (6 )% % of Revenues 0.4 % 0.6 % (33 )% 0.4 % 0.5 % (20 )% Income taxes $ 2,640 $ 5,656 (53 )% $ 6,171 $10,164 (39 )% Effective income tax rate 45.2 % 50.3 % (10 )% 46.3 % 44.9 % 3 % 2Q15 vs 2Q14 Interest expense was $1,027, a decrease of 26% compared to Interest expense of $1,378 in the same period last year primarily as a result of a change in the fair value of the interest-rate swap of $284 (from a gain of $13 in 2Q14 to a gain of $297 in 2Q15). Interest expense as a percent of Revenues was 0.4%, a decrease of 33% compared to Interest expense as a percent of Revenues of 0.6% in the same period last year. The weighted-average outstanding debt and weighted-average interest rate was $186,676 and 1.6%, respectively, compared to $187,704 and 1.5% in the same period last year. Income taxes were $2,640, a decrease of 53% compared to Income taxes of $5,656 in the same period last year. The effective income tax rate was 45.2%, a decrease of 10% compared to the effective income tax rate of 50.3% in the same period last year. The effective income tax rate decrease from 50.3% to 45.2% was primarily due to the reduction of certain deferred tax liabilities associated with previously taxed income and foreign earnings taxed at lower statutory rates. The Company expects an effective income tax rate of approximately 39.0% for Fiscal 2015. 2QYTD15 vs 2QYTD14 Interest expense was $2,158, a decrease of 6% compared to Interest expense of $2,301 in the same period last year primarily as a result of a change in the fair value of the interest-rate swap of $76 (from a gain of $470 in 2QYTD14 to a gain of $546 in 2QYTD15). Interest expense as a percent of Revenues was 0.4%, a decrease of 20% compared to Interest expense as a percent of Revenues of 0.5% in the same period last year. The weighted-average outstanding debt and weighted-average interest rate was $181,478 and 1.5%, respectively, compared to $190,415 and 1.6% in the same period last year. Income taxes were $6,171, a decrease of 39% compared to Income taxes of $10,164 in the same period last year. The effective income tax rate was 46.3%, an increase of 3% compared to the effective income tax rate of 44.9% in the same period last year. The effective income tax rate increase from 44.9% to 46.3% was primarily due to the write-off of certain deferred tax assets related to equity awards partially offset by the reduction of certain deferred tax liabilities associated with previously taxed income and foreign earnings taxed at lower statutory rates. The Company expects an effective income tax rate of approximately 39.0% for Fiscal 2015. Liquidity and Capital Resources Overview A majority of our revenue is generated through individual sales of products and services. Less than 20% of our revenue is generated from long-term support contracts. We depend on repeat client business, as well as our ability to develop new client business, to sustain and grow our revenue. Most significant orders are subject to a competitive bidding process and, generally, competition can be significant for such new orders. Our business model provides us with flexibility in terms of capital expenditures and other required operating expenses. For the foreseeable future, we expect to continue to generate net cash provided by operating activities that exceeds our capital expenditures and other required operating expenses and will be available for discretionary investments. We seek to allocate company resources in a manner that will enhance stockholder value. Our discretionary investments include: investments in growth programs and infrastructure, strategic acquisitions of high quality growth-oriented companies, a return to our stockholders through dividends and common stock repurchases and repaying our debt. 23-------------------------------------------------------------------------------- Table of Contents Liquidity Position The following is a summary of our capitalization and liquidity position. 2Q15 4Q14 2Q14 Cash and cash equivalents $ 28,352 $ 30,810 $ 26,841 Working capital $ 180,462 $ 175,692 $ 181,397 Long-term debt $ 161,423 $ 160,429 $ 173,096 Stockholders' equity $ 346,888 $ 351,117 $ 486,911 Unused portion of the Credit Agreement $ 234,590 $ 235,595 $ 222,945 We expect that our cash, the unused portion of the Credit Agreement (hereinafter defined) and net cash provided by operating activities should be sufficient to cover the Company's working capital requirements, capital expenditures, dividend program, potential stock repurchases, potential future acquisitions or strategic investments and other cash needs for at least the next 12 months. Sources and Uses of Cash The following is a summary of our sources and uses of cash. 2QYTD15 2QYTD14 Net cash provided by (used for) operating activities $ 9,158 $ 29,462 Net cash provided by (used for) investing activities $ (4,253 ) $ (4,845 ) Net cash provided by (used for) financing activities $ (6,096 ) $ (28,312 ) Net cash provided by (used for) operating activities Net cash provided by operating activities was $9,158, due primarily to Net income of $7,146, inclusive of non-cash charges, an increase in Accounts receivable, net of $9,890 and a decrease in All other liabilities of $6,252, compared to net cash provided by operating activities of $29,462 in the same period last year, due primarily to Net income of $12,490, inclusive of non-cash charges, a decrease in Accounts receivable, net of $4,912 and a decrease in All other liabilities of $11,071. Changes in the above accounts are based on average Fiscal 2015 and Fiscal 2014 exchange rates, as applicable. Changes in working capital, and particularly changes in accounts receivable, costs in excess of billings and billings in excess of cost, can have a significant impact on net cash provided by operating activities, largely due to the timing of payments and receipts. The Company expects that its cash provided by operating activities and the availability under its Credit Agreement will be sufficient to fund the Company's working capital requirements, capital expenditures, dividend program, potential stock repurchases, potential future acquisitions or strategic investments and other cash needs for the next twelve-months. Net cash provided by (used for) investing activities Capital expenditures The Company made investments of $3,522 compared to $4,090 in the same period last year which primarily related to information technology infrastructure, computer hardware and software and vehicles. Net cash provided by (used for) financing activities Proceeds from long-term debt Proceeds from long-term debt was $945, which was used to fund common stock repurchases and operations, compared to repayment of long-term debt of $14,662 in the same period last year, which was funded by cash flow provided by operations. 24-------------------------------------------------------------------------------- Table of Contents Common stock repurchases The Company made discretionary investments in the form of common stock repurchases of $4,987 compared to $11,426 in the same period last year. The Company also made tax payments of $949 compared to $1,322 in the prior year related to share withholding to satisfy employee income taxes due as a result of the vesting of certain restricted stock units and performance shares. Since the inception of the repurchase program in April 1999 through September 30, 2014, the Company has repurchased 10,638,827 shares of common stock for an aggregate purchase price of $398,360, or an average purchase price per share of $37.44. These shares do not include the treasury shares withheld for tax payments due upon the vesting of certain restricted stock units and performance shares. As of September 30, 2014, 861,173 shares were available under repurchase programs. Additional repurchases of common stock may occur from time to time depending upon factors such as the Company's cash flows and general market conditions. There can be no assurance as to the timing or amount of such repurchases. Under the Credit Agreement, the Company is permitted to repurchase its common stock as long as no Event of Default or Potential Default (as defined in the Credit Agreement) shall have occurred and is continuing or shall occur as a result thereof. In addition, no repurchase of common stock is permitted under the Credit Agreement if such event would violate a consolidated leverage ratio required to be maintained under the Credit Agreement. Dividends The Company made discretionary investments in the form of dividends to its stockholders of $2,954 compared to $2,736 in the prior year. While the Company expects to continue to declare quarterly dividends, the payment of future dividends is at the discretion of the Company's Board of Directors (the "Board") and the timing and amount of any future dividends will depend upon earnings, cash requirements and the financial condition of the Company. Under the Credit Agreement, the Company is permitted to make any distribution or dividend as long as no Event of Default or Potential Default (as defined in the Credit Agreement) shall have occurred and is continuing or shall occur as a result thereof. In addition, no distribution or dividend is permitted under the Credit Agreement if such event would violate a consolidated leverage ratio required to be maintained under the Credit Agreement other than regular quarterly dividends not exceeding $15,000 per year. Credit Agreement On March 23, 2012, the Company entered into a Credit Agreement (the "Credit Agreement") with Citizens Bank of Pennsylvania, as administrative agent, and certain other lender parties. The Credit Agreement expires on March 23, 2017. Borrowings under the Credit Agreement are permitted up to a maximum amount of $400,000, which includes up to $25,000 of swing-line loans and $25,000 of letters of credit. The Credit Agreement may be increased by the Company up to an additional $100,000 with the approval of the lenders and may be unilaterally and permanently reduced by the Company to not less than the then outstanding amount of all borrowings. Interest on outstanding indebtedness under the Credit Agreement accrues, at the Company's option, at a rate based on either: (a) the greater of (i) the prime rate per annum of the agent then in effect and (ii) 0.50% plus the rate per annum announced by the Federal Reserve Bank of New York as being the weighted-average of the rates on overnight Federal funds transactions arranged by Federal funds brokers on the previous trading day, in each case plus 0% to 0.75% (determined by a leverage ratio based on the Company's consolidated Earnings Before Interest Taxes Depreciation and Amortization ("EBITDA")) or (b) a rate per annum equal to the LIBOR rate plus 0.875% to 1.750% (determined by a leverage ratio based on the Company's consolidated EBITDA). The Credit Agreement requires the Company to maintain compliance with certain non-financial and financial covenants such as leverage and fixed-charge coverage ratios which could limit the Company's ability to borrow the full amount of the credit facility. As of September 30, 2014, the Company was in compliance with all covenants under the Credit Agreement. Legal Proceedings See Note 14 of the Notes to the Consolidated Financial Statements of this Quarterly Report on Form 10Q (this "Form 10-Q"), which information is incorporated herein by reference. Inflation The overall effects of inflation on the Company have been nominal. Although long-term inflation rates are difficult to predict, the Company continues to strive to minimize the effect of inflation through improved productivity and cost reduction programs as well as price adjustments within the constraints of market competition. 25-------------------------------------------------------------------------------- Table of Contents Valuation of Goodwill As previously disclosed, the Company completed its annual goodwill assessment during the fourth quarter of Fiscal 2014 that resulted in a goodwill impairment loss. The Company then adjusted the carrying value of its reporting units to reflect the goodwill impairment loss and compared that adjusted carrying value to the fair value of the reporting units. The excess of the fair value over this adjusted carrying value was $24,909, $51,957, $16,430 and $1,859 for North America Products, North America Services, International Products and International Services, respectively. A 100 basis point increase in the weighted-average cost of capital, which, holding all other assumptions constant, would have a significant impact on the fair value of a reporting unit and would decrease the fair value of the reporting units by $8,911, $39,375, $3,333 and $1,402 for North America Products, North America Services, International Products and International Services, respectively. Consistent with prior years, during the third quarter of Fiscal 2015, the Company will conduct its annual goodwill impairment assessment. During that process, the Company will determine whether the recent downward adjustment in its profitability outlook for the remainder of Fiscal 2015 and an expected increase in its weighted-average cost of capital will impact the valuation of goodwill. A significant decrease in the fair value of our reporting units could result in a non-cash impairment charge, which could have a material adverse effect on our consolidated balance sheet and results of operations. Future events that could result in an interim assessment of goodwill impairment and/or a potential impairment loss include, but are not limited to, (i) significant underperformance relative to historical or projected future operating results, (ii) significant changes in the manner of or use of the assets or the strategy for the Company's overall business or (iii) significant negative industry or economic trends. Critical Accounting Policies/Impact of Recently Issued Accounting Pronouncements Critical Accounting Policies The Company's critical accounting policies require the most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and are the most important to the portrayal of the Company's consolidated financial statements. The Company's critical accounting policies are disclosed in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Form 10-K. The significant accounting policies used in the preparation of the Company's consolidated financial statements are disclosed in Note 2 of the Notes to the Consolidated Financial Statements within the Form 10-K. No additional significant accounting policies have been adopted during Fiscal 2015. Impact of Recently Issued Accounting Pronouncements There have been no accounting pronouncements adopted during Fiscal 2015 that have had a material impact on the Company's consolidated financial statements. In May 2014, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Codification ("ASC") Update No. 2014-09, "Revenue from Contracts with Customers" ("ASC 2014-09") 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. The core principle of ASC 2014-09 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expected to be entitled in exchange for those goods or services. Entities can use either of two methods: (i) retrospective to each prior period presented with the option to elect certain practical expedients as defined within ASC 2014-09; or (ii) retrospective with the cumulative effect of initially applying ASC 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined per ASC 2014-09. ASC 2014-09 is effective for annual reporting periods (including interim periods therein) beginning after December 15, 2016 for public companies and early adoption is not permitted. The Company is evaluating the method of adoption and the impact of the adoption of ASU 2014-09 on its consolidated financial statements. 26-------------------------------------------------------------------------------- Table of Contents Cautionary Forward Looking Statements When included in this Quarterly Report on Form 10-Q or in documents incorporated herein by reference, the words "should," "expects," "intends," "anticipates," "believes," "estimates," "approximates," "targets," "plans" and analogous expressions are intended to identify forward-looking statements. One can also identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. Such statements are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected. Although it is not possible to predict or identify all risk factors, such risks and uncertainties may include, among others, levels of business activity and operating expenses, expenses relating to corporate compliance requirements, cash flows, global economic and business conditions, successful integration of acquisitions, the timing and costs of restructuring programs and other initiatives, successful marketing of the Company's product and services offerings, successful implementation of the Company's integration initiatives, successful implementation of the Company's government contracting programs, competition, changes in foreign, political and economic conditions, fluctuating foreign currencies compared to the U.S. dollar, rapid changes in technologies, client preferences, the Company's arrangements with suppliers of voice equipment and technology, government budgetary constraints and various other matters, many of which are beyond the Company's control. Additional risk factors are included in the Form 10-K. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and speak only as of the date of this Form 10Q. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations will prove to be correct. The Company expressly disclaims any obligation or undertaking to release publicly any updates or any changes in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. Item 3. Quantitative and Qualitative Disclosures About Market Risk. The Company is exposed to market risks in the ordinary course of business that include interest-rate volatility and foreign currency exchange rates volatility. Market risk is measured as the potential negative impact on earnings, cash flows or fair values resulting from a hypothetical change in interest rates or foreign currency exchange rates over the next year. The Company does not hold or issue any other financial derivative instruments (other than those specifically noted below) nor does it engage in speculative trading of financial derivatives. Interest-rate Risk The Company's primary interest-rate risk relates to its long-term debt obligations. As of September 30, 2014, the Company had total long-term obligations of $161,360 under the Credit Agreement. Of the outstanding debt, $125,000 was in variable rate debt that was effectively converted to fixed rate debt through an interest-rate swap agreement (discussed in more detail below) and $36,360 was in variable rate obligations. As of September 30, 2014, an instantaneous 100 basis point increase in the interest rate of the variable rate debt would reduce the Company's earnings in the subsequent fiscal quarter by $90 ($55 net of tax) assuming the Company employed no intervention strategies. To mitigate the risk of interest-rate fluctuations associated with the Company's variable rate long-term debt, the Company has implemented an interest-rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings caused by interest-rate volatility. The Company's goal is to manage interest-rate sensitivity by modifying the re-pricing characteristics of certain balance sheet liabilities so that the net-interest margin is not, on a material basis, adversely affected by the movements in interest rates. On November 15, 2011, the Company entered into a three-year floating-to-fixed interest-rate swap, with an effective start date of July 26, 2012, that is based on a three-month LIBOR rate versus a 1.25% fixed rate and has a notional value of $125,000. Changes in the fair market value of the interest-rate swap are recorded as an asset or liability within the Company's Consolidated Balance Sheets and Interest expense (income) within the Company's Consolidated Statements of Operations. 27-------------------------------------------------------------------------------- Table of Contents Foreign Exchange Rate Risk The Company has operations, clients and suppliers worldwide, thereby exposing the Company's financial results to foreign currency fluctuations. In an effort to reduce this risk of foreign currency fluctuations, the Company generally sells and purchases inventory based on prices denominated in U.S. dollars. Intercompany sales to subsidiaries are generally denominated in the subsidiaries' local currency. The Company has entered and will continue in the future, on a selective basis, to enter into foreign currency contracts to reduce the foreign currency exposure related to certain intercompany transactions, primarily trade receivables and loans. All of the foreign currency contracts have been designated and qualify as cash flow hedges. The effective portion of any changes in the fair value of the derivative instruments is recorded in Accumulated Other Comprehensive Income ("AOCI") until the hedged forecasted transaction occurs or the recognized currency transaction affects earnings. Once the forecasted transaction occurs or the recognized currency transaction affects earnings, the effective portion of any related gains or losses on the cash flow hedge is reclassified from AOCI to the Company's Consolidated Statements of Operations. In the event it becomes probable that the hedged forecasted transaction will not occur, the ineffective portion of any gain or loss on the related cash flow hedge would be reclassified from AOCI to the Company's Consolidated Statements of Operations. As of September 30, 2014, the Company had open foreign currency contracts in Australian and Canadian dollars, Danish krone, Euros, Mexican pesos, Norwegian kroner, British pounds sterling, Swedish krona, Swiss francs and Japanese yen. The open contracts have contract rates ranging from 1.06 to 1.13 Australian dollar, 1.08 to 1.11 Canadian dollar, 5.41 to 5.68 Danish krone, 0.73 to 0.76 Euro, 13.26 to 13.26 Mexican peso, 6.08 to 6.33 Norwegian kroner, 0.59 to 0.61 British pound sterling, 6.48 to 7.23 Swedish krona, 0.90 to 0.92 Swiss franc and 102.77 to 104.95 Japanese yen, all per U.S. dollar. The total open contracts had a notional amount of $56,719 and will expire within eight months. Item 4. Controls and Procedures. Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures Management, including the Company's Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), for the Company. Management assessed the effectiveness of the Company's disclosure controls and procedures as of September 27, 2014. Based upon this assessment, Management has concluded that the Company's disclosure controls and procedures were effective as of September 27, 2014 to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to Management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in Internal Control Over Financial Reporting There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting. Limitations on the Effectiveness of Controls All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of its inherent limitations, the Company's internal control over financial reporting may not prevent or detect misstatements. In addition, 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 and procedures may deteriorate. 28-------------------------------------------------------------------------------- Table of Contents |