Attached files

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EX-23.1 - EXHIBIT 23.1 - Wesco Aircraft Holdings, Incwair20180930-ex231.htm
EX-32.1 - EXHIBIT 32.1 - Wesco Aircraft Holdings, Incwair20180930-ex321.htm
EX-31.2 - EXHIBIT 31.2 - Wesco Aircraft Holdings, Incwair20180930-ex312.htm
EX-31.1 - EXHIBIT 31.1 - Wesco Aircraft Holdings, Incwair20180930-ex311.htm
EX-21.1 - EXHIBIT 21.1 - Wesco Aircraft Holdings, Incwair20180930-ex211.htm
EX-10.19 - EXHIBIT 10.19 - Wesco Aircraft Holdings, Incwair20180930-ex1019.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________________________________________
FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2018
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________               
Commission File No. 001-35253
WESCO AIRCRAFT HOLDINGS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
20-5441563
(State of Incorporation)
(I.R.S. Employer Identification Number)
24911 Avenue Stanford
Valencia, California 91355
(Address of Principal Executive Offices and Zip Code)
(661) 775-7200
(Registrant’s Telephone Number, Including Area Code)
Securities Registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, par value $0.001 per share
 
New York Stock Exchange
Securities Registered pursuant to Section 12(g) of the Act: None
___________________________________________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x  No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x  No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 x
Accelerated filer
 o
Non-accelerated filer
o
Smaller reporting company
 o
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
As of March 29, 2018, the aggregate market value of the voting and non-voting common equity held by non-affiliates based on the closing price as of that day was approximately $669,796,000.
The number of shares of common stock (par value $0.001 per share) of the registrant outstanding as of November 8, 2018, was 99,557,885.
Documents Incorporated by Reference
Part III of this Annual Report on Form 10-K incorporates by reference certain information from the registrants’ definitive proxy statement for the 2019 annual meeting of stockholders, which the registrant intends to file pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the registrant’s fiscal year end of September 30, 2018. With the exception of the sections of the definitive proxy statement specifically incorporated herein by reference, the definitive proxy statement is not deemed to be filed as part of this Annual Report on Form 10-K.




TABLE OF CONTENTS

 
 
Page
 
 


CERTAIN DEFINITIONS

Unless otherwise noted in this Annual Report, the term “Wesco Aircraft” means Wesco Aircraft Holdings, Inc., our top-level holding company, and the terms “Wesco,” “the Company,” “we,” “us,” “our” and “our Company” mean Wesco Aircraft and its subsidiaries, including (1) Wesco Aircraft Hardware Corp. (Wesco Aircraft Hardware), which is our primary historical domestic operating company and the sole member of Haas Group International, LLC, which we acquired, along with Haas Group, Inc. (now Haas Group, LLC) and its direct and indirect subsidiaries (collectively, Haas), on February 28, 2014, and (2) Wesco Aircraft EMEA, Ltd. (Wesco Aircraft EMEA), which succeeded Wesco Aircraft Europe, Ltd. (Wesco Aircraft Europe) as our primary foreign operating company. References to “fiscal year” mean the year ending or ended September 30. For example, “fiscal year 2018” or “fiscal 2018” means the period from October 1, 2017 to September 30, 2018.


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PART I
 
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K contains forward-looking statements (including within the meaning of the Private Securities Litigation Reform Act of 1995) concerning Wesco and other matters. These statements may discuss goals, intentions and expectations as to future plans, trends, events, results of operations or financial condition, or otherwise, based on current beliefs of management, as well as assumptions made by, and information currently available to, management. Forward-looking statements may be accompanied by words such as “achieve,” “aim,” “anticipate,” “believe,” “can,” “continue,” “could,” “drive,” “estimate,” “expect,” “forecast,” “future,” “grow,” “improve,” “increase,” “intend,” “may,” “outlook,” “plan,” “possible,” “potential,” “predict,” “project,” “should,” “target,” “will,” “would” or similar words, phrases or expressions. These forward-looking statements are subject to various risks and uncertainties, many of which are outside our control. Therefore, you should not place undue reliance on such statements. Factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, the following:
 
general economic and industry conditions;

conditions in the credit markets;

changes in military spending;

risks unique to suppliers of equipment and services to the U.S. government;

risks associated with the loss of significant customers, a material reduction in purchase orders by significant customers or the delay, scaling back or elimination of significant programs on which we rely;

our ability to effectively compete in our industry;

risks associated with our long-term, fixed-price agreements that have no guarantee of future sales volumes;

our ability to effectively manage our inventory;

 our suppliers’ ability to provide us with the products we sell in a timely manner, in adequate quantities and/or at a reasonable cost, while also meeting our customers' quality standards;

our ability to maintain effective information technology (IT) systems and effectively implement our new warehouse management system (WMS);

our ability to successfully execute and realize the expected financial benefits from our “Wesco 2020” initiative;

our ability to retain key personnel;

risks associated with our international operations, including exposure to foreign currency movements;

changes in trade policies;

risks associated with assumptions we make in connection with our critical accounting estimates (including goodwill, excess and obsolete inventory and valuation allowance of our deferred tax assets) and legal proceedings;

changes in U.S. income tax law;

our dependence on third-party package delivery companies;

fuel price risks;

fluctuations in our financial results from period-to-period;

environmental risks;

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risks related to the handling, transportation and storage of chemical products;

risks related to the aerospace industry and the regulation thereof;

risks related to our indebtedness; and

other risks and uncertainties.

The foregoing list of factors is not exhaustive. You should carefully consider the foregoing factors and the other risks and uncertainties that affect our business, including those described under Part I, Item 1A. “Risk Factors” and the other documents we file from time to time with the Securities and Exchange Commission (SEC). All forward-looking statements included in this Annual Report on Form 10-K (including information included or incorporated by reference herein) are based upon information available to us as of the date hereof, and we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

ITEM 1.  BUSINESS
 
Company Overview

We are the world’s leading independent distributor and provider of comprehensive supply chain management services to the global aerospace industry, based on annual sales. Our services range from traditional distribution to the management of supplier relationships, quality assurance, kitting, just-in-time (JIT) delivery, chemical management services (CMS), third-party logistics (3PL) or fourth-party logistics (4PL) programs and point-of-use inventory management. We supply over 563,000 active stock-keeping units (SKUs), including C-class hardware, chemicals, electronic components, bearings, tools and machined parts. In fiscal 2018, sales of hardware including bearings and other products represented 50.9% of our net sales, sales of chemicals represented 41.8% of our net sales and sales of electronic components represented 7.3% of our net sales. We serve our customers under both (1) long-term contractual arrangements (Contracts), which include JIT contracts that govern the provision of comprehensive outsourced supply chain management services and long-term agreements (LTAs) that typically set prices for specific products, and (2) ad hoc sales. In February 2014, we acquired 100% of the outstanding stock of Haas, a provider of chemical supply chain management services to the commercial aerospace, airline, military, automotive, energy, pharmaceutical and electronics sectors.

Founded in 1953 by the father of our current Chairman of the Board of Directors, we have grown to serve over 7,000 customers, which are primarily in the commercial, military and general aviation sectors, including the leading original equipment manufacturers (OEMs) and their subcontractors, through which we support nearly all major Western aircraft programs, and also sell products to airline-affiliated and independent maintenance, repair and overhaul (MRO) providers. We also service customers in the automotive, energy, health care, industrial, pharmaceutical and space sectors. We have 3,069 employees and operate across 56 locations in 17 countries. The following charts illustrate the composition of our fiscal year 2018 net sales based on our sales data.

businesspiechart2018.jpg

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Our Products and Services

Our Products

We offer more than 563,000 active SKUs, which fall into the following product categories during the year ended September 30, 2018 (dollars in thousands):
 
 
Hardware
 
Chemicals
 
Electronic
Components
 
Bearings
 
Machined Parts and Tooling
Net product sales
 
$732,892
 
$656,959
 
$114,875
 
$36,212
 
$29,512
 
 
 
 
 
 
 
 
 
 
 
% of net product sales
 
46.7%
 
41.8%
 
7.3%
 
2.3%
 
1.9%
 
 
 
 
 
 
 
 
 
 
 
Types of products offered
Blind fasteners
Adhesives Sealants
Connectors
Airframe control
Brackets
 
Panel fasteners
 
and tapes
Relays
 
bearings
Milled parts
 
Bolts and screws
Lubricants
Switches
Rod ends
Shims
 
Clamps
Oil and grease
Circuit breakers
Spherical Bearings
Stampings
 
Hi lok pins and
Paints and coatings
Lighted products
Ball bearing
Turned parts
 
 
collars
Industrial gases
Wire and cable
Needle roller
Welded assemblies
 
Hydraulic fittings
Coolants and
Interconnect
 
bearings
Installation/
 
Inserts
 
metalworking fluids
 
accessories
Bushings
 
removal tooling
 
Lockbolts and
Cleaners and
 
 
Precision bearings
 
 
 
 
collars
 
cleaning solvents
 
 
 
 
 
 
 
Nuts
 
 
 
 
 
 
 
 
 
Rivets
 
 
 
 
 
 
 
 
 
Springs
 
 
 
 
 
 
 
 
 
Valves
 
 
 
 
 
 
 
 
 
Washers
 
 
 
 
 
 
 
 

Hardware

Sales of C-class aerospace hardware represented 47%, 47% and 48% of our fiscal 2018, 2017 and 2016 product sales, respectively. Fasteners, our largest category of hardware products, include a wide range of highly engineered aerospace parts that are designed to hold together two or more components, such as rivets (both blind and solid), bolts (including blind bolts), screws, nuts and washers. Many of these fasteners are designed for use in specific aircraft platforms and others can be used across multiple platforms. Materials used in the manufacture of these fasteners range from standard alloys, such as aluminum, steel or stainless steel, to more advanced materials, such as titanium, Inconel and Waspaloy.

Chemicals

Chemical sales represented 42%, 42% and 41% of our fiscal 2018, 2017 and 2016 product sales, respectively. Our chemical product offerings include adhesives; sealants and tapes; lubricants; oil and grease; paints and coatings; industrial gases; coolants and metalworking fluids; and cleaners and cleaning solvents.

Electronic Components

We offer highly reliable interconnect and electro-mechanical products, including connectors, relays, switches, circuit breakers, lighted products, wire and cable and interconnect accessories. We also offer value-added assembled products including mil-circular and rack and panel connectors and illuminated push button switches. We maintain large quantities of connector components in inventory, which allows us to respond quickly to customer orders. In addition, our lighted switch assembly operation affords customers same day service, including engraving capabilities in multiple languages.

Bearings

Our product offering includes a variety of standard anti-friction products designed to both commercial and military aircraft specifications, such as airframe control bearings, rod ends, spherical bearings, ball bearings, needle roller bearings, bushings and precision bearings.


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Machined Parts and Tooling

Machined parts are designed for a specific customer and are assigned unique OEM-specific SKUs. The machined parts we distribute include laser cut or stamped brackets, milled parts, shims, stampings, turned parts and welded assemblies made of materials ranging from high-grade steel or titanium to nickel based alloys.

We stock a full range of tools needed for the installation and removal of many of our products, including air and hydraulic tools as well as drill motors, and we also offer factory authorized maintenance and repair services for these tools. In addition to selling these tools, we also rent or lease these tools to our customers.

Our Services

In addition to our traditional distribution services, we have developed innovative value-added services, such as quality assurance, kitting, JIT supply chain management, CMS and 3PL/4PL programs for our customers.

Quality Assurance

Our quality assurance (QA) function is a key component of our service offering, with approximately 6% of our employees dedicated to this area. We believe we offer an industry-leading QA function as a result of our rigorous processes, sophisticated testing equipment and dedicated QA staff. Our superior QA performance is demonstrated by a comparison of our customers’ aggregate rejection rate of the products we deliver, which was 0.09% during fiscal 2018, to our rejection rate of the products we receive from our suppliers, which was 2.97% during fiscal 2018.

Our QA department inspects the inventory we purchase to ensure the accuracy and completeness of documentation. For many of our customers, these inspections are conducted at our in-house laboratory, where we operate sophisticated testing equipment. We also maintain an electronic copy of the relevant certifications for the inventory, which can include a manufacturer certificate of conformance, test reports, process certifications, material distributor certifications and raw material mill certifications. Our industry-leading QA capabilities also allow our JIT customers to reduce the number of personnel dedicated to the QA function and reduce the delays caused by the rejection of improperly inspected products.

Kitting

Kitting involves the packaging of an entire bill of materials or a complete “ship-set” of products, which reduces the amount of time workers spend retrieving products from storage locations. Kits can be customized in varying configurations and sizes and can contain up to several hundred different products. All of our kits and components contain fully certified and traceable products and are assembled by our full-service kitting department at our Central Stocking Locations (CSLs), or at our customer sites.

JIT Supply Chain Management and CMS

JIT supply chain management, which includes CMS, involves the delivery of products on an as-needed basis to the point-of-use at a customer’s manufacturing line. JIT programs are designed to prevent excess inventory build-up and shortages and improve manufacturing efficiency. Each JIT contract requires us to maintain an efficient inventory tracking, analysis and replenishment program and is designed to provide high levels of stock availability and on-time delivery. We believe customers that utilize our comprehensive JIT supply chain management services are frequently able to realize significant benefits including:

reduced inventory levels and lower inventory excess and obsolescence (E&O) expense, in part because such customers only purchase what they need, and make more efficient use of their floor space;
increased accuracy in forecasting and planning, resulting in substantially improved on-time delivery, reduced expediting costs and fewer disruptions of production schedules;
improved quality assurance resulting in a substantial reduction in customer product rejection rates; and
reduced administrative and overhead costs relating to procurement, QA, supplier management and stocking functions.

Before signing a JIT contract, our customers typically experience outages of many SKUs and, in some cases, have up to a year’s worth of inventory on hand for other SKU’s. As part of our JIT programs, we generally assume custody of the customer’s existing inventory at the onset of the contract, immediately reducing their management of their physical inventory on-hand with lower costs. Customer inventory is generally assumed on a consignment basis and is entered in our perpetual

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inventory system in a distinct customer-specific “virtual warehouse.” Software protocol in our IT systems requires the system to first “look” to a customer’s consigned inventory when parts replenishment is required. In certain cases, we can sell this consigned inventory to our base of over 7,000 other active customers around the world, gradually drawing down the customer’s inventory. As the consigned inventory for each SKU is exhausted, our stock of Wesco-sourced product is then used for replenishment.

Another key strength of our JIT programs is our ability to utilize highly scalable and customizable point-of-use systems to develop an efficient supply chain management system and automated replenishment solution for any number of SKUs. In order to minimize inventory on hand, certain indicators are used to trigger the replenishment of product, with all replenishment activity done via hand-held scanners that transmit orders to our stocking locations.

In certain circumstances, we also provide our JIT and CMS customers with additional value-added services, including the implementation of process control and usage reduction programs; safety data-sheet management, support for environmental, health and safety compliance (EHS) and reporting; and assistance with the development of waste management strategies.

Customers are also increasingly seeking 3PL or 4PL arrangements to optimize supply chain management by outsourcing either specific logistics and distribution functions or their entire logistics function to a service provider like us.

Aftermarket Sales

We sell products to airline-affiliated, OEM-affiliated and independent MRO providers on both a Contract and ad hoc basis. We have expanded our efforts to increase our presence in both the commercial and military aerospace MRO markets, particularly as a result of our acquisition of Haas in 2014 and through the introduction of our Wesco e-commerce sales platform, which we believe provides us with a cost-effective way to further penetrate the aftermarket. In addition, we have targeted domestic and international airlines and maintenance centers that we believe are assuming an expanded role within the MRO market.

Going forward, we expect commercial MRO providers to benefit from many of the same trends as those impacting the commercial OEM market, including industry passenger volumes and capacity utilization, as well as requirements to maintain aging aircraft and the cost of fuel, which can lead to greater utilization of existing planes. The commercial MRO market may also benefit from directives or notifications announced by international industry regulators and trade associations. Such directives or notifications can serve to bolster required maintenance, and thus the demand for new and existing aerospace products. Furthermore, we expect demand in the military MRO market to be driven by changes in overall fleet size and the level of U.S. military operational activity domestically and overseas. We believe that our presence in this market helps us mitigate the volatility of new military aircraft sales with sales to the aftermarket.

Customer Contracts

We sell products to our customers under two types of arrangements: (1) Contracts, which include JIT supply chain management contracts and LTAs, and (2) ad hoc sales.

Contracts

JIT Contracts.  JIT contracts, which include CMS contracts, are typically three to five years in length and are structured to supply the product requirement for specific SKUs, production lines or facilities. Given our direct involvement with JIT customers, volume requirements and purchasing frequency under these contracts is highly predictable. Under JIT contracts, customers commit to purchase specified products from us at a fixed price or a pass-through price, on an as needed basis, and we are often responsible for maintaining high levels of stock availability of those products. JIT contracts typically contain termination for convenience provisions, which generally allow our customers to terminate their contracts on short notice without meaningful penalties and often provide for us to be reimbursed for the cost of any inventory specifically procured for the customer or inventory that is not commonly sold to our other customers. JIT customers often purchase products from us that are not covered under their contracts on an ad hoc basis. For additional information about our JIT supply chain management services, see “-Our Products and Services-Our Services-JIT Supply Chain Management and CMS.”

LTAs.  Like JIT contracts, LTAs also typically run for three to five years. LTAs are essentially negotiated price lists for customers or individual customer sites that cover a range of pre-determined products, purchased on an as-needed basis. LTAs allow the customer to buy contracted SKUs from us and may obligate us to maintain stock availability for those products. Once an LTA is in place, the customer is then able to place individual purchase orders with us for any of the contractually specified products. LTAs typically contain termination for convenience provisions, which generally allow for our customers to terminate

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their contracts on short notice without meaningful penalties and often provide that we are reimbursed for the cost of any inventory specifically procured for the customer or inventory that is not commonly sold to other customers. LTA customers also frequently purchase products from us on an ad hoc basis, which are not captured under the contractual pricing arrangement.

Ad Hoc Sales

Ad hoc sales represent products purchased from us on an as-needed basis and are generally supplied out of our existing inventory. Typically, ad hoc orders are for smaller quantities of products than those ordered under Contracts, and are often urgent in nature. Given our breadth and volume of inventory, it is not uncommon for even our competitors to purchase products from us on an ad hoc basis when their own stocks prove to be inadequate. In an environment of increasing aircraft production and oftentimes relatively long supplier lead-times, product shortages can become increasingly common for OEMs, subcontractors, MRO providers and distributors with less sophisticated forecasting abilities and procurement organizations.

Under each of the sales arrangements described above we typically warrant that the products we sell conform to the drawings and specifications that are in effect at the time of delivery in the applicable contract, and that we will replace defective or non-conforming products for a period of time that varies from contract to contract. We, in turn, look to the product manufacturer to indemnify us for liabilities resulting from defective or non-conforming products. We do not accrue for warranty expenses as our claims related to defective and non-conforming products have been nominal.

Backlog

We believe that sales backlog is not a relevant measure of our business, given the long-term nature of our Contracts with our customers.

Customers

We sell to over 7,000 active customers worldwide. During fiscal 2018, Lockheed Martin represented approximately 11% of our total net sales, consisting of multiple contracts across multiple independent programs such that no individual contract is material. Our top 10 customers collectively accounted for 49% of our total net sales during fiscal 2018.

During fiscal 2018, 76% of our net sales were derived from major OEMs, such as Airbus, Boeing, BAE Systems, Bell Helicopter, Bombardier, Cessna, Embraer, Gulfstream, Lockheed Martin, Northrop Grumman and Raytheon, and many of their subcontractors. Government sales comprised 14% of our net sales during fiscal 2018 and were derived from various military parts procurement agencies such as the U.S. Defense Logistics Agency, or from defense contractors buying on their behalf. Aftermarket sales to airline-affiliated or independent MRO providers made up 5% of our fiscal 2018 net sales. The remaining 5% of our net sales were to other distributors.

During fiscal 2018, 55% of our net sales were derived from customers supporting commercial programs and 45% of our net sales were derived from customers supporting military programs. We also service international customers in markets that include Australia, Canada, China, France, Germany, India, Ireland, Israel, Italy, Malaysia, Mexico, Philippines, Poland, Saudi Arabia, Singapore, South Korea, Turkey and the United Kingdom. For additional information about our net sales and long-lived assets by geographic area, see Note 20 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

Procurement

We source our inventory from over 6,000 suppliers globally, including Amphenol, Arconic, Consolidated Aerospace Manufacturing (CAM), Esterline, Henkel, Lisi Aerospace, PRC Desoto, Precision Castparts Corp., TriMas, and 3M. During fiscal 2018, Precision Castparts Corp. and Arconic supplied 12% and 8%, respectively, of the products we purchased. Suppliers typically prefer to deal with a relatively small number of large and sophisticated distributors in order to improve production efficiency; reduce finished goods inventory and related obsolescence costs; maintain pricing discipline; improve performance in meeting on-time-delivery targets to the end customers; and consolidate customer accounts, which can reduce administrative and overhead costs relating to sales and marketing, customer service and other functions. As a result of our size and our long-standing relationships with many of our suppliers, we are often able to take advantage of significant volume-based discounts when purchasing inventory. Given our industry position and close cooperation with suppliers, we believe that we are in an excellent position to become a distributor for new product lines as they become available.

Our management analyzes supply, demand, cost and pricing factors to make inventory investment decisions, which are facilitated by our highly customized IT systems, and we maintain close relationships with the leading suppliers in the industry.

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Our strong understanding of the global aerospace industry is derived from our long-term relationships with major OEMs, subcontractors and suppliers. In addition, our direct insight into our customers’ production rates often allows us to detect industry trends. Furthermore, our ability to forecast demand, share inventory and usage information, and place purchase orders with our suppliers well in advance of our customer requirements can provide us with a distinct advantage in an industry where inventory availability is critical for customers that need specific products within a stipulated timeframe to meet their own production and delivery commitments. However, despite our expertise in this area, effective inventory management is an ongoing challenge, and we continue to take steps to enhance the effectiveness of our procurement practices and mitigate the negative impact of inventory builds on our cash flow. For additional information about the impact of inventory on our business, including our cash flows, see Part I, Item 1A. “Risk Factors-Risks Related to Our Business and Industry-We may be unable to effectively manage our inventory, which could have a material adverse effect on our business, financial condition and results of operations,” Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Other Factors Affecting Our Financial Results-Fluctuations in Cash Flow,” and Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates-Inventories.”

Information Technology Systems

We have invested to build integrated, highly customized IT systems that enable our purchasing and sales organizations to make more informed decisions, our inventory management system to operate in an efficient manner and certain of our customers to make online purchases directly from us. Our primary scalable IT infrastructure is based on IBM and Oracle hardware and applications including the Oracle JD Edwards EnterpriseOne (JDE) enterprise resource planning (ERP) system and our proprietary chemical supply chain management system, tcmIS®, which was developed on the Oracle Enterprise database. These customized IT systems provide us visibility into quantities, stocking locations and purchases across our customer base by individual inventory item, enabling us to accurately fill an average of 16,000 orders per day and provide an exceptional level of customer service. These systems are fully capable of interfacing with external enterprise business systems. Additionally, we have developed functionality for JIT delivery, which can integrate directly into our customers’ manufacturing process. This functionality includes recognition of signals and actions to fill customer bins from hand-held scanners, min/max data or proprietary signals from a customer’s ERP system. JDE and tcmIS® also support our EDI functionality, which allows our system to interface with customers and suppliers, regardless of technology, data format or connectivity. tcmIS® also supports additional chemical-specific functionality, such as product labeling and Global Harmonized System compliance. We also continue to invest in our infrastructure and cyber-defense capabilities to enhance both availability and data protection.

For our shipping logistics and export compliance support, we employ Precision Software’s TRA/X. TRA/X enables us to ship globally while maintaining tracking numbers and rating information for each customer shipment. In addition, at several of our distribution facilities, we use Minerva’s AIMS inventory management system to provide the best possible warehouse flow and cycle times. AIMS is tailored to fit our global warehouse operational needs and allows us to provide an expandable warehouse management system that can also incorporate transaction processing, work-in-progress and other manufacturing operations. AIMS interfaces with a broad range of material handling equipment, including horizontal and vertical carousels, conveyors, sorting equipment, pick systems and cranes.

Going forward, we will continue to evaluate our IT infrastructure and expect to undertake efforts to modernize our capabilities, particularly through investments in additional state of the art software and hardware that is designed to improve our ability to service our customers.

Seasonality

Our net sales may fluctuate quarterly based on the number of production days at our customers' facilities, which is driven by holidays and planned production shutdowns, particularly the winter holidays during our first fiscal quarter and the summer months during our fourth fiscal quarter.

Competition

The industry in which we operate is highly competitive and fragmented. We believe the principal competitive factors in our industry include the ability to provide superior customer service and support, on-time delivery, sufficient inventory availability, competitive pricing and an effective QA program. Our competitors include both U.S. and foreign companies, including divisions of larger companies and certain of our suppliers, some of which have significantly greater financial resources than we do, and therefore may be able to adapt more quickly to changes in customer requirements than we can. In addition to facing competition for Contract customers from our primary competitors, Contract customers or potential Contract customers may also determine that it is more cost effective to establish or re-establish an in-house supply chain management

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capability. Under these circumstances, we may be unable to sufficiently reduce our costs to provide competitive pricing while also maintaining acceptable operating margins.

Employees

As of September 30, 2018, we employed 3,069 personnel worldwide, 1,035 of whom were located at customer sites. We have 839 employees located outside of North America. We are not a party to any collective bargaining agreements with our employees.

Regulatory Matters

Governmental agencies throughout the world, including the U.S. Federal Aviation Administration (FAA), prescribe standards for aircraft components, including virtually all commercial airline and general aviation products, as well as regulations regarding the repair and overhaul of airframes and engines. Specific regulations vary from country to country, although compliance with FAA requirements generally satisfies regulatory requirements in other countries. In addition, the products we distribute must also be certified by aircraft and engine OEMs. If any of the material authorizations or approvals that allow us to supply products is revoked or suspended, then the sale of the related products would be prohibited by law, which would have an adverse effect on our business, financial condition and results of operations.

From time to time, the FAA or equivalent regulatory agencies in other countries propose new regulations or changes to existing regulations, which are usually more stringent than existing regulations. If these proposed regulations are adopted and enacted, we could incur significant additional costs to achieve compliance, which could have a material adverse effect on our business, financial condition and results of operations.

We are also subject to government rules and regulations that include the U.S. Foreign Corrupt Practices Act (FCPA), the Bribery Act 2010 (Bribery Act), the International Traffic in Arms Regulations (ITAR), the Export Administration Regulations (EAR), economic sanctions and the False Claims Act. See “Risk Factors-Risks Related to Our Business and Industry-We are subject to unique business risks as a result of supplying equipment and services to the U.S. government directly and as a subcontractor, which could lead to a reduction in our net sales from, or the profitability of our supply arrangements with, the U.S. government” and “-Our international operations require us to comply with numerous applicable anti-corruption and trade control laws and regulations, including those of the U.S. government and various other jurisdictions, and our failure to comply with these laws and regulations could adversely affect our reputation, business, financial condition and results of operations.”

Environmental Matters

We are subject to extensive federal, state, local and foreign laws, regulations, rules and ordinances relating to pollution, protection of the environment and human health and safety, and the handling, transportation, storage, treatment, disposal and remediation of hazardous substances, including potentially with respect to historical chemical blending and other activities that pre-dated our purchase of Haas. Actual or alleged violations of EHS laws or permit requirements could result in restrictions or prohibitions on operations and substantial civil or criminal sanctions, as well as, under some EHS laws, the assessment of strict liability and/or joint and several liability.

Furthermore, we may be liable for the costs of investigating and cleaning up environmental contamination on or from our operations or at off-site locations, including potentially with respect to historical chemical blending and other activities that pre-dated our purchase of our businesses. We may therefore incur additional costs and expenditures beyond those currently anticipated to address all such known and unknown situations under existing and future EHS laws.

In addition, governmental, regulatory and societal demands for increasing levels of product safety and environmental protection are resulting in increased pressure for more stringent regulatory control with respect to the chemical industry. The European Union’s Registration, Evaluation, Authorization and Restriction of Chemicals (REACH) regulations enacted in 2009 have been a continuing source of compliance obligations and restrictions on certain chemicals, and REACH-like regimes have now been adopted in several other countries. In the United States, the core provisions of the Toxic Substances Control Act (TSCA) were amended in June 2016 for the first time in nearly 40 years. Among the more significant changes are that these amendments mandate safety reviews of existing “high priority” chemicals and regulatory action to control any “unreasonable risks” identified as result of such reviews. The Environmental Protection Agency (EPA) also now must make a no “unreasonable risk” finding before a new chemical can be fully commercialized. These new mandates create uncertainty about whether existing chemicals of importance to our business may be designated for restriction and whether the new chemical approval process may become more difficult and costly to comply with. These types of changes in the Company’s regulatory

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environment, particularly, but not limited to, in the United States, the European Union, Canada and China, could lead to heightened regulatory scrutiny and could adversely impact our ability to supply certain products and provide supply chain management services to our customers. Such changes also could result in compliance obligations for us directly or as part of our supply chain management services to customers, fines, ongoing monitoring and other future business activity restrictions, which could have a material adverse effect on the Company’s liquidity, financial position and results of operations. Finally, we have in the past sold products containing per-and polyfluoroalkyl substances (PFAS), including perfluorooctanoic acid (PFOA). Certain PFAS, including PFOA, have been targeted for risk assessment, restriction, and high priority remediation and have been the subject of ongoing and substantial litigation in the both the U.S. and European Union. We have not received any claims or enforcement actions from governments or third parties relating to PFOA or any other PFAS.

Available Information

We file annual, quarterly and current reports and other information with the SEC. The SEC maintains an Internet website (www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC, including us. You may also access, free of charge, our reports filed with the SEC (for example, our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K and any amendments to those forms) through the “Investor Relations” portion of our website (www.wescoair.com). We also make available on our website our (1) Corporate Governance Guidelines, (2) Code of Business Conduct and Ethics, which applies to our directors, officers and employees, (3) Whistleblower Policy and (4) the charters of the Audit, Compensation and Nominating and Corporate Governance Committees. Reports filed with or furnished to the SEC will be available as soon as reasonably practicable after they are filed with or furnished to the SEC. Our website is included in this Annual Report as an inactive textual reference only. The information found on our website is not part of this or any other report filed with or furnished to the SEC.

ITEM 1A.  RISK FACTORS

You should consider and read carefully all of the risks and uncertainties described below, as well as other information included in this Annual Report, including our consolidated financial statements and related notes. The risks described below are not the only ones facing us. The occurrence of any of the following risks or additional risks and uncertainties not presently known to us or that we currently believe to be immaterial could materially and adversely affect our business, financial condition or results of operations. This Annual Report also contains forward-looking statements and estimates that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of specific factors, including the risks and uncertainties described below.

Risks Related to Our Business and Industry

We are directly dependent upon the condition of the aerospace industry, which is closely tied to global economic conditions, and if the aerospace industry or the U.S. or global economy were to experience a recession, our business, financial condition and results of operations could be negatively impacted.

Demand for the products and services we offer are directly tied to the delivery of new aircraft, aircraft utilization, and repair of existing aircraft, which, in turn, are impacted by global economic conditions. For example, 2009 revenue passenger miles (RPMs) on commercial aircraft declined due to the global recession. During the same period, the industry experienced declines in large commercial, regional and business jet deliveries. A slowdown in the global economy, or a return to a recession, would negatively impact the aerospace industry, and could negatively impact our business, financial condition and results of operations.

Military spending, including spending on the products we sell, is dependent upon national defense budgets, and a reduction in military spending could have a material adverse effect on our business, financial condition and results of operations.

During the year ended September 30, 2018, 45% of our net sales were related to military aircraft. The military market is significantly dependent upon government budget trends, particularly the U.S. Department of Defense (DoD) budget. Future DoD budgets could be negatively impacted by several factors, including, but not limited to, a change in defense spending policy by the current and future presidential administrations and Congress, the U.S. government’s budget deficits, spending priorities, the cost of sustaining the U.S. military presence in overseas operations and possible political pressure to reduce U.S. Government military spending, each of which could cause the DoD budget to decline. A decline in U.S. military expenditures could result in a reduction in military aircraft production, which could have a material adverse effect on our business, financial condition and results of operations.


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In particular, military spending may be negatively impacted by the Budget Control Act of 2011 (the Budget Control Act), which was passed in August 2011. The Budget Control Act established limits on U.S. government discretionary spending, including a reduction of defense spending by approximately $490 billion between the 2012 and 2021 U.S. government fiscal years, and also provided that the defense budget would face “sequestration” cuts of up to an additional $500 billion during that same period to the extent that discretionary spending limits were exceeded. The impact of sequestration was reduced with respect to the government’s 2014 and 2015 fiscal years, in exchange for extending sequestration into fiscal years 2022 and 2023, following the enactment of the Bipartisan Budget Act of 2013 in December 2013. The impact of sequestration was further reduced with respect to the government’s 2016 and 2017 fiscal years, following the enactment of the Bipartisan Budget Act of 2015 in November 2015 and with respect to the government’s 2018 and 2019 fiscal years, following the enactment of the Bipartisan Budget Act of 2018 in February 2018. Sequestration is currently scheduled to resume in the government’s 2020 fiscal year. We are unable to predict the impact that the cuts associated with sequestration will ultimately have on funding for the military programs which we support. However, such cuts could result in reductions, delays or cancellations of these programs, which could have a material adverse effect on our business, financial condition and results of operations.

We are subject to unique business risks as a result of supplying equipment and services to the U.S. government directly and as a subcontractor, which could lead to a reduction in our net sales from, or the profitability of our supply arrangements with, the U.S. government.

Companies engaged in supplying defense-related equipment and services to U.S. government agencies are subject to business risks specific to the defense industry. We contract directly with the U.S. government and are also a subcontractor to customers contracting with the U.S. government. Accordingly, the U.S. government may unilaterally suspend or prohibit us from receiving new contracts pending resolution of alleged violations of procurement laws or regulations, revoke required security clearance, reduce the value of existing contracts or audit our contract-related costs and fees. In addition, most of our U.S. government contracts and subcontracts can be terminated by the U.S. government or the contracting party, as applicable, at its convenience. Termination for convenience provisions provide only for our recovery of costs incurred or committed, settlement expenses and profit on the work completed prior to termination.

In addition, we are subject to U.S. government inquiries and investigations, including periodic audits of costs that we determine are reimbursable under government contracts. U.S. government agencies routinely audit government contractors to review performance under contracts, cost structure and compliance with applicable laws, regulations, and standards, as well as the adequacy of and compliance with internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation and management information systems. Any costs found to be misclassified or inaccurately allocated to a specific contract are not reimbursable, and to the extent already reimbursed, must be refunded. Also, any inadequacies in our systems and policies could result in payments being withheld, penalties and reduced future business.

Government rules require contracting officers to impose contractual withholdings at no less than certain minimum levels if a contracting officer determines that one or more of a contractor’s business systems have one or more significant deficiencies. If a contracting officer were to impose such a withholding on us or even one of our prime contractors, it would increase the risk that we would not be paid in full or paid timely. If future audit adjustments exceed our estimates, our profitability could be adversely affected.

If a government inquiry or investigation uncovers improper or illegal activities, we could be subject to civil or criminal penalties or administrative sanctions, including contract termination, fines, forfeiture of fees, suspension of payment and suspension or debarment from doing business with U.S. government agencies, any of which could materially adversely affect our reputation, business, financial condition and results of operations.

We are also subject to the federal False Claims Act, which provides for substantial civil penalties and treble damages where a contractor presents a false or fraudulent claim to the government for payment. Actions under the False Claims Act may be brought by the government or by other persons on behalf of the government (who may then share in any recovery).

If we lose significant customers, significant customers materially reduce their purchase orders or significant programs on which we rely are delayed, scaled back or eliminated, our business, financial condition and results of operations may be adversely affected.

Our top ten customers for the year ended September 30, 2018 accounted for 49% of our net sales. A reduction in purchasing by or loss of one of our larger customers for any reason, including changes in manufacturing or procurement practices, loss of a customer as a result of the acquisition of such customer by a purchaser who does not fully utilize a distribution model or uses a competitor, in-sourcing by customers, a transfer of business to a competitor, an economic

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downturn, failure to adequately service our clients or to manage the implementation of new customer sites, decreased production or a strike, could have a material adverse effect on our business, financial condition and results of operations.

As an example of changes in manufacturing practices that could impact us, OEMs such as Boeing and Airbus have incorporated a higher proportion of composite materials in some of the aircraft they manufacture. Aircraft utilizing composite materials generally require the use of significantly fewer C-class aerospace parts than new aircraft made of more traditional non-composite materials, although the parts used are generally higher priced than C-class aerospace parts used in non-composite aircraft structures. To the extent Boeing, Airbus and other customers increase their reliance on composite materials, they may materially reduce their purchase orders from us.

As an example of the potential loss of business due to customer in-sourcing, a major OEM is undertaking an initiative to cause its first and second tier suppliers to source certain OEM-specific materials, including fasteners, directly from the OEM itself, rather than through distributors such as us. If such initiative is broadly implemented by the OEM, or if other OEMs pursue similar initiatives, a portion of our sales to their suppliers, and consequently our business, financial condition and results of operations, could be adversely affected.

In addition, major OEMs have recently indicated that they are pursuing initiatives to increase the services portion of their business. These initiatives could lead to greater in-sourcing on the part of the OEMs, which could adversely affect a portion of our sales to the OEMs and their suppliers.

We expect to derive a significant portion of our net sales from certain aerospace programs in their early production stages. Our future growth will be dependent, in part, upon our sales to various OEMs and subcontractors as related to such programs. If production of any of the programs we support is terminated or delayed, or if our sales to customers affiliated with these programs are reduced or eliminated, our business, financial condition and results of operations could be adversely affected.

We operate in a highly competitive market and our failure to compete effectively may negatively impact our results of operations.

We operate in a highly competitive global industry and compete against a number of companies, including divisions of larger companies and certain of our suppliers, some of which may have significantly greater financial resources than we do and therefore may be able to adapt more quickly to changes in customer requirements than we can. Our competitors consist of both U.S. and foreign companies and range in size from divisions of large public corporations to small privately held entities. We believe that our ability to compete depends on superior customer service and support, on-time delivery, sufficient inventory availability, competitive pricing and effective quality assurance programs. To remain competitive, we may have to adjust the prices of some of the products and services we sell and continue investing in our procurement, supply-chain management and sales and marketing functions, the costs of which could negatively impact our results of operations.

In addition, we face competition for our Contract customers from both competitors in our industry (including OEMs who are increasing the services portion of their business) and the in-sourcing of supply-chain management by our customers themselves. If any of our Contract customers decides to in-source the services we provide or switches to one of our competitors, we would be adversely affected.

We do not have guaranteed future sales of the products we sell and when we enter into Contracts with our customers we generally take the risk of certain cost increases, and our business, financial condition, results of operations and operating margins may be negatively affected if we purchase more products than our customers require, product costs increase unexpectedly, we experience high start-up costs on new Contracts or our Contracts are terminated.

A majority of our Contracts are long-term, fixed-price agreements with no guarantee of future sales volumes, and they may be terminated for convenience on short notice by our customers, often without meaningful penalties, and often provide that we are reimbursed for the cost of any inventory specifically procured for the customer or inventory that is not commonly sold to our other customers. In addition, we purchase inventory based on our forecasts of anticipated future customer demand. As a result, we may take the risk of having excess inventory if our customers do not place orders consistent with our forecasts, particularly with respect to inventory that has a more limited shelf-life. Also, even though we often enter into long-term pricing agreements with our suppliers, we do run the risk of not being able to pass along or otherwise recover unexpected increases in our product costs, including as a result of commodity price increases and tariffs, which may increase above our established prices at the time we entered into the Contract and established prices for products we provide. When we are awarded new Contracts, particularly JIT contracts, we may incur high costs, including salary and overtime costs, to hire and train on-site personnel, in the start-up phase of our performance. In the event that we purchase more products than our customers require,

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product costs increase unexpectedly, we experience high start-up costs on new Contracts or our Contracts are terminated, our business, financial condition, results of operations and operating margins could be negatively affected.

We may be unable to effectively manage our inventory, which could have a material adverse effect on our business, financial condition and results of operations.

Due to the lead times required by many of our suppliers, we typically order products, particularly hardware products, in advance of expected sales, and the volume of such orders may be significant. Lead times generally range from several weeks up to two years, depending on industry conditions, which makes it difficult to successfully manage our inventory as we plan for future demand. In addition, demand for our products can fluctuate significantly, which can also negatively impact our cash flows and inventory level. For example, in the three months ended September 30, 2015, we determined that inventory previously purchased in connection with a specific program that was subsequently terminated had no alternative use, and we recorded a provision to write-down such inventory by $33.0 million.

If suppliers are unable to supply us with the products we sell in a timely manner, inadequate quantities and/or at a reasonable cost, while also meeting our customers' quality standards, we may be unable to meet the demands of our customers, which could have a material adverse effect on our business, financial condition and results of operations.

Our inventory is primarily sourced directly from producers and manufacturing firms, and we depend on the availability of large supplies of the products we sell, which must also meet our customers' quality standards. Our largest suppliers for the year ended September 30, 2018 were Precision Castparts Corp. and Arconic. During fiscal 2018, 12% of the products we purchased were from Precision Castparts Corp. and 8% were purchased from Arconic. In addition, our ten largest suppliers during fiscal 2018 accounted for 40% of our purchases. These manufacturers and producers may experience capacity constraints that result in their being unable to supply us with products in a timely manner, in adequate quantities and/or at a reasonable cost. Contributing factors to manufacturer capacity constraints include, among other things, industry or customer demands in excess of manufacturing capacity, labor shortages and changes in raw material flows. In addition, changes in trade policies, such as the imposition of additional tariffs on certain products imported into the United States, could result in increased procurement costs. Any significant interruption in the supply of these products or termination of our relationship with any of our suppliers could result in us being unable to meet the demands of our customers, which would have a material adverse effect on our business, financial condition and results of operations.

Our business is highly dependent on complex information technology and our business and operations could suffer in the event of cyber-security breaches.

The provision and application of IT is an increasingly critical aspect of our business. Among other things, our IT systems must frequently interact with those of our customers, suppliers and logistics providers. Our future success will depend on our continued ability to employ IT systems that drive operational efficiency and meet our customers’ demands. The failure or disruption of the hardware or software that supports our IT systems, including redundancy systems, could significantly harm our ability to service our customers and cause economic losses for which we could be held liable and which could damage our reputation. In addition, we are subject to the risk of cyber-security attacks, which includes, but is not limited to, malicious software, ransomware or terrorists attacks, unauthorized attempts to gain access to sensitive, confidential or otherwise protected information related to us, our customers and our suppliers and other cyber-security breaches. A cyber-related attack could cause a loss of data and interruptions or delays in our business (particularly with respect to our tcmIS® operating system), cause us to incur remediation costs, subject us to claims and damage our reputation. In addition, the failure or disruption of our IT systems, communications or utilities, or those of third parties on which we rely, could cause us to interrupt or suspend our operations or otherwise adversely affect our business. Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of any system or operational failure or disruption which could have a material adverse effect on our business, results of operations and financial condition. In addition, system improvements and other IT-related upgrades could require us to accelerate the depreciation of certain assets, which could have a material adverse effect on our operating results.

Our competitors may have or may develop IT systems that permit them to be more cost effective and otherwise better able to meet customer demands than we are able to with IT systems we are able to acquire or develop. Larger competitors may be able to develop or license IT systems more cost effectively than we can by spreading the cost across a larger revenue base, and competitors with greater financial resources may be able to acquire or develop IT systems that we cannot afford. If we fail to meet the demands of our customers or protect against disruptions of our IT systems, we may lose customers, which could seriously harm our business and adversely affect our operating results and operating cash flow.


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Our implementation of a new WMS could adversely affect our business, financial condition and results of operations or the effectiveness of our financial reporting processes, including our internal controls over financial reporting.

We are currently implementing a new WMS, which we expect will provide our business with enhanced warehouse transaction management capabilities and improved labor efficiency around the globe.  Such an implementation is a major undertaking, both financially and from a management and personnel perspective.  Even if successfully implemented, we may not realize the anticipated productivity improvements or cost efficiencies from the WMS.  In addition, any disruptions, delays or deficiencies in the design and implementation of the WMS could adversely affect our ability to manage our inventory, process orders, ship products in a timely manner or provide services and customer support, and could also result in loss of information, diminished management reporting capabilities, harm to our control environment, diminished employee productivity and unanticipated increases in costs.  If we do not effectively implement the WMS or if the WMS does not operate as intended, it could adversely affect our business, financial condition and results of operations and the effectiveness of our financial reporting processes, including our internal controls over financial reporting.

If we are unable to successfully execute and realize the expected financial benefits from our Wesco 2020 initiative, our business and financial results could be adversely affected. 

In May 2018, we announced the launch of our “Wesco 2020” initiative, which is designed to broaden and institutionalize improvements already made to our business during fiscal 2018 and further improve the Company’s service excellence, inventory management, productivity and profitability.  The Company expects “Wesco 2020” to deliver significant operational and financial benefits through footprint alignment, organizational refinement, productivity gains and investment in critical capabilities to serve customers better.  However, we may be unable to effectively execute certain of these improvement initiatives, which could limit our realization of expected costs savings, anticipated synergies and efficiencies and customer service improvements.  Moreover, the expenses associated with these initiatives can be difficult to predict, and we may incur substantial additional expenses in connection with the execution of “Wesco 2020” in excess of what is currently expected, particularly if any of these initiatives are unsuccessful or prove unsustainable, which may require us to incur additional costs. Furthermore, improvement initiatives of this sort are a complex and time-consuming process that can place substantial demands on management, which could divert attention from other business priorities or disrupt our daily operations. Any of these failures could, in turn, materially adversely affect our business, financial condition, results of operations and cash flows, and could negatively impact our ability to achieve our other strategic goals and business plans. 

We may be unable to retain personnel who are key to our operations.

Our success, among other things, is dependent on our ability to attract, develop and retain highly qualified senior management and other key personnel. Competition for key personnel is intense, and our ability to attract and retain key personnel is dependent on a number of factors, including prevailing market conditions and compensation packages offered by companies competing for the same talent. The inability to hire, develop and retain these key employees may adversely affect our operations.

There are risks inherent in international operations that could have a material adverse effect on our business, financial condition and results of operations.

While the majority of our operations are based in the United States, we have significant international operations, with facilities in Australia, Canada, China, France, Germany, India, Israel, Italy, Mexico, Singapore and the United Kingdom, and customers throughout North America, Latin America, Europe, Asia and the Middle East. For the years ended September 30, 2018 and 2017, 33% and 35%, respectively, of our net sales were derived from customers located outside the United States.

Our international operations are subject to, without limitation, the following risks:
    
the burden of complying with multiple and possibly conflicting laws and any unexpected changes in regulatory requirements;
    
political risks, including risks of loss due to civil disturbances, acts of terrorism, acts of war, guerilla activities and insurrection;

unstable economic, financial and market conditions and increased expenses due to inflation, or higher interest rates;
   

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difficulties in enforcement of third-party contractual obligations and collecting receivables through foreign legal systems;

changes in global trade policies;
   
increasingly complex laws and regulations concerning privacy, data protection and data security, including the European Union’s General Data Protection Regulation;
    
difficulties in staffing and managing international operations and the application of foreign labor regulations;
    
differing local product preferences and product requirements; and
    
potentially adverse tax consequences from changes in tax laws, requirements relating to withholding taxes on remittances and other payments by subsidiaries and restrictions on our ability to repatriate dividends from our subsidiaries.

In addition, fluctuations in the value of foreign currencies affect the dollar value of our net investment in foreign subsidiaries, with these fluctuations being included in a separate component of stockholders’ equity. At September 30, 2018, we reported a cumulative foreign currency translation adjustment loss of $84.4 million in stockholders’ equity, and we may incur additional adjustments in future periods. In addition, operating results of certain of our foreign subsidiaries are translated into U.S. dollars for purposes of our statements of comprehensive income at average monthly exchange rates. Moreover, to the extent that our net sales are not denominated in the same currency as our expenses, our net earnings could be materially adversely affected. For example, a portion of labor, material and overhead costs for our facilities in the United Kingdom, Germany, France and Italy are incurred in British pounds or euros, but in certain cases the related net sales are denominated in U.S. dollars. Changes in the value of the U.S. dollar or other currencies could result in material fluctuations in foreign currency translation amounts or the U.S. dollar value of transactions and, as a result, our net earnings could be materially adversely affected. At times we engage in hedging transactions to manage or reduce our foreign currency exchange risk, but these transactions may not be successful and, as a result, our business, financial condition and results of operations could be materially adversely affected. During fiscal 2018 and 2017, fluctuations in foreign currency translation had a positive impact on net sales of $1.1 million and a negative impact of $22.9 million, respectively.

Our international operations require us to comply with numerous applicable anti-corruption and trade control laws and regulations, including those of the U.S. government and various other jurisdictions, and our failure to comply with these laws and regulations could adversely affect our reputation, business, financial condition and results of operations.

Doing business on a worldwide basis requires us to comply with the laws and regulations of the U.S. government and various other jurisdictions, and our failure to successfully comply with these rules and regulations may expose us to liabilities. These laws and regulations can apply to companies, individual directors, officers, employees and agents, and may restrict our operations, trade practices, investment decisions and partnering activities. Our risk of violating anti-corruption laws is increased because some of the international locations in which we operate lack a highly developed legal system and have elevated levels of corruption, and because our industry is highly regulated.

In particular, our international operations are subject to U.S. and foreign anti-corruption laws and regulations, such as the FCPA, the Bribery Act and other applicable anti-corruption regimes. These laws generally prohibit us from corruptly providing anything of value, directly or indirectly, to foreign government officials for the purposes of improperly influencing official decisions, improperly obtaining or retaining business, or otherwise obtaining favorable treatment. As part of our business, we may deal with governments and state-owned business enterprises, the employees and representatives of which may be considered government officials for purposes of the FCPA, the Bribery Act or other applicable anti-corruption laws. Some anti-corruption laws, such as the Bribery Act, also prohibit commercial bribery and the acceptance of bribes. In addition, the FCPA further requires publicly traded companies to maintain adequate record-keeping that accurately reflects the transactions of the company, as well as a system of internal accounting controls.

As an exporter, we must comply with various laws and regulations relating to the export of products, services and technology from the United States and other countries having jurisdiction over our operations. In the U.S., these laws include, among others, the EAR administered by the U.S. Department of Commerce’s Bureau of Industry and Security, the ITAR administered by the U.S. Department of State’s Directorate of Defense Trade Controls, and trade sanctions, regulations and embargoes administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control. These laws and regulations may require us to obtain individual validated licenses from the relevant agency to export, re-export, or transfer commodities, software, technology, or services to certain jurisdictions, individuals, or entities. We cannot be certain that our applications for

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export licenses or other authorizations will be granted or approved. Furthermore, the export license and export authorization process is often time-consuming.

Violations of these legal requirements can be punishable by criminal fines and imprisonment, civil penalties, disgorgement of profits, injunctions, debarment from government contracts, seizure and forfeiture of unlawful attempted exports, and/or denial of export privileges, as well as other remedial measures. We have established policies and procedures designed to assist us, our personnel and our agents to comply with applicable U.S. and international laws and regulations. However, there can be no guarantee that our policies and procedures will effectively prevent us, our employees and our agents from violating these regulations in every transaction in which we may engage, and violations, allegations or investigations of such violations could materially adversely affect our reputation, business, financial condition and results of operations.

Changes in trade policies, including the imposition of additional tariffs, could negatively impact our business, financial condition and results of operations.

The current United States administration has signaled support for, and in some instances has taken action with respect to, major changes to certain trade policies, such as the imposition of additional tariffs on imported products and the withdrawal from or renegotiation of certain trade agreements, including the North American Free Trade Agreement. Such changes could also result in retaliatory actions by the United States’ trade partners. For example, the United States has increased tariffs on certain imports from China, as well as on steel and aluminum products imported from various countries. In response, China, the European Union, and several other countries have imposed or proposed additional tariffs on certain exports from the United States.

We procure certain of the products we sell directly or indirectly from outside of the United States, including from China. The imposition of tariffs and other potential changes in United States trade policy could increase the cost or limit the availability of such products, which could hurt our competitive position and adversely impact our business, financial condition and results of operations. In addition, we sell a significant proportion of our products to customers outside of the United States. Retaliatory actions by other countries could result in increases in the price of our products, which could limit demand for such products, hurt our global competitive position and have a material adverse effect on our business, financial condition and results of operations.

Our total assets include substantial intangible assets, and the write-off of a significant portion of our intangible assets would negatively affect our financial results.

Our total assets reflect substantial intangible assets. At September 30, 2018, goodwill and intangible assets, net represented 24.0% of our total assets. Goodwill represents the excess of the purchase price of acquired businesses over the fair value of the assets acquired and liabilities assumed resulting from acquisitions, including the acquisition of our Company by affiliates of The Carlyle Group (Carlyle) and the acquisition of Haas. Intangible assets represent trademarks, backlogs, non-compete agreements, technology and customer relationships. On at least an annual basis, we assess whether there has been impairment in the value of goodwill and indefinite-lived intangible assets. If our testing identifies impairment under generally accepted accounting principles in the United States (GAAP), the impairment charge we calculate would result in a charge to income from operations. For example, during the three months ended June 30, 2017, we recorded a non-cash goodwill impairment of $311.1 million. Any future determination requiring the write-off of a significant portion of goodwill and unamortized identified intangible assets would negatively affect our results of operations and total capitalization, which could be material. For additional information, see “Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates-Goodwill and Indefinite-Lived Intangible Assets.”

Changes in U.S. tax law have affected and may continue to affect our business, financial condition and results of operations.

On December 22, 2017, the Tax Act was signed into law. As a fiscal year taxpayer, certain provisions of the Tax Act have impacted the Company for our fiscal year ended September 30, 2018, while other provisions of the Tax Act will impact the Company for our fiscal year beginning October 1, 2018 and beyond. We are still evaluating the full impact of the Tax Act on our liability for U.S. corporate tax and the related impact on our business, financial condition and results of operations, and based on our current estimates, we believe these changes will be material (see Note 15 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K). For example, we believe that the following changes included in the Tax Act, among others, will or could have a material impact on our liability for U.S. corporate tax: (i) the transition to a territorial tax system that generally allows for the repatriation of foreign earnings without additional U.S. corporate income tax while maintaining and expanding existing rules regarding the taxation of foreign earnings prior to their repatriation to the U.S. and (ii) the limitations on the deductibility of interest expense, entertainment expense and certain

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executive compensation. However, our estimates regarding the impact of the Tax Act may change, possibly materially, following management’s review of historical records, refinement of calculations, modifications of assumptions and further interpretation of the Tax Act based on U.S. Treasury regulations and guidance from the Internal Revenue Service and state tax authorities.

If any of our customers were to become insolvent or experience substantial financial difficulties, our business, financial condition and results of operations may be adversely affected.

If any of the customers with whom we do business becomes insolvent or experiences substantial financial difficulties we may be unable to timely collect amounts owed to us by such customers and may not be able to sell the inventory we have purchased for such customers, which could have a material adverse effect on our business, financial condition and results of operations.

We or our suppliers or customers may experience damage to or disruptions at our or their facilities caused by natural disasters and other factors, which may result in our business, financial condition and results of operations being adversely affected.

Several of our facilities or those of our suppliers and customers could be subject to a catastrophic loss caused by earthquakes, tornadoes, floods, hurricanes, fire, power loss, telecommunication and information systems failure or other similar events. Should insurance be insufficient to recover all such losses or should we be unable to reestablish our operations, or if our customers or suppliers were to experience material disruptions in their operations as a result of such events, our business, financial condition and results of operations could be adversely affected.

We are dependent on access to and the performance of third-party package delivery companies.

Our ability to provide efficient distribution of the products we sell to our customers is an integral component of our overall business strategy. We do not maintain our own delivery networks, and instead rely on third-party package delivery companies. We cannot assure you that we will always be able to ensure access to preferred delivery companies or that these companies will continue to meet our needs or provide reasonable pricing terms. In addition, if the package delivery companies on which we rely experience delays resulting from inclement weather or other disruptions, we may be unable to maintain products in inventory and deliver products to our customers on a timely basis, which may adversely affect our business, financial condition and results of operations.

A significant labor dispute involving us or one or more of our customers or suppliers, or a labor dispute that otherwise affects our operations, could reduce our net sales and harm our profitability.

Labor disputes involving us or one or more of our customers or suppliers could affect our operations. If our customers or suppliers are unable to negotiate new labor agreements and our customers’ or suppliers’ plants experience slowdowns or closures as a result, our net sales and profitability could be negatively impacted.

While our employees are not currently unionized, they may attempt to form unions in the future, and the employees of our customers, suppliers and other service providers may be, or may in the future be, unionized. We cannot assure you that there will not be any strike, lock out or material labor dispute with respect to our business or those of our customers or suppliers in the future that materially affects our business, financial condition and results of operations.

We may be materially adversely affected by high fuel prices.

Fluctuations in the global supply of crude oil and the possibility of changes in government policies on the production, transportation and marketing of jet fuel make it impossible to predict the future availability and price of jet fuel. In the event there is an outbreak or escalation of hostilities or other conflicts or significant disruptions in oil production or delivery in oil-producing areas or elsewhere, there could be reductions in the production or importation of crude oil and significant increases in the cost of jet fuel. If there were major reductions in the availability of jet fuel or significant increases in its cost, commercial airlines would face increased operating costs. Due to the competitive nature of the airline industry, airlines are often unable to pass on increases in fuel prices to customers by increasing fares. As a result, an increase in jet fuel could result in a decrease in net income from either lower margins or, if airlines increase ticket fares, lower net sales from reduced airline travel. Decreases in airline profitability could decrease the demand for new commercial aircraft, resulting in delays of or reductions in deliveries of commercial aircraft that utilize the products we sell, and, as a result, our business, financial condition and results of operations could be materially adversely affected.


18



Our financial results may fluctuate from period-to-period, making quarter-to-quarter comparisons of our business, financial condition and results of operations less reliable indicators of our future performance.

There are many factors, such as the cyclical nature of the aerospace industry, fluctuations in our ad hoc sales, delays in major aircraft programs, planned production shutdowns, downward pressure on sales prices and changes in the volume of our customers’ orders that could cause our financial results to fluctuate from period-to-period. For example, during the year ended September 30, 2018, 24% of our net sales were derived from ad hoc sales. The prices we charge for ad hoc sales are typically higher than the prices under our Contract sales. However, customers may not continue to purchase the same amount of products from us on an ad hoc basic as they have in the past, so it cannot be assured that in any given year we will be able to generate similar levels of ad hoc net sales as we did in the past. We are also actively working to transition customers from ad hoc purchases to Contracts, which may also result in a reduction in our ad hoc net sales. In addition, our acquisition of Haas has contributed to lower our ad hoc sales as a percentage of total net sales. A significant diminution in our ad hoc sales in any given period could result in fluctuations in our financial results and operating margins. As a result of these factors, we believe that quarter-to-quarter comparisons of our financial results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance.

We will continue to incur significant costs as a result of operating as a publicly traded company, and our management is required to devote substantial time to public company compliance requirements and investor needs.

As a publicly traded company, we will continue to incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act) and the rules of the SEC and the New York Stock Exchange have imposed various requirements on public companies. Our management and other personnel will continue to devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations will continue to result in increased legal and financial compliance costs compared to a private company and make some activities more time-consuming and costly. For example, we believe these rules and regulations make it more difficult and more expensive for us to maintain appropriate levels of director and officer liability insurance.

We are subject to health, safety and environmental laws and regulations, any violation of which could subject us to significant liabilities and penalties.

We are subject to extensive federal, state, local and foreign laws, regulations, rules and ordinances relating to pollution, protection of the environment and human health and safety, and the handling, transportation, storage, treatment, disposal and remediation of hazardous substances, including potentially with respect to historical chemical blending and other activities that pre-dated the purchase of the Haas business by us. Actual or alleged violations of EHS laws, or permit requirements could result in restrictions or prohibitions on operations and substantial civil or criminal sanctions, as well as, under some EHS laws, the assessment of strict liability and/or joint and several liability.

Furthermore, we may be liable for the costs of investigating and cleaning up environmental contamination on or from our operations or at off-site locations, including potentially with respect to historical chemical blending and other activities that pre-dated the purchase of the Haas business by us. We may therefore incur additional costs and expenditures beyond those currently anticipated to address all such known and unknown situations under existing and future EHS laws.

Governmental, regulatory and societal demands for increasing levels of product safety and environmental protection are resulting in increased pressure for more stringent regulatory control with respect to the chemical industry. The European Union’s REACH regulations enacted in 2009 have been a continuing source of compliance obligations and restrictions on certain chemicals, and REACH-like regimes have now been adopted in several other countries. In the United States, the core provisions of the TSCA were amended in June 2016 for the first time in nearly 40 years. Among the more significant changes are that these amendments mandate safety reviews of existing “high priority” chemicals and regulatory action to control any “unreasonable risks” identified as result of such reviews. The EPA also now must make a no “unreasonable risk” finding before a new chemical can be fully commercialized. These new mandates create uncertainty about whether existing chemicals of importance to our business may be designated for restriction and whether the new chemical approval process may become more difficult and costly.
These types of changes in the Company’s regulatory environment, particularly, but not limited to, in the United States, the European Union, Canada and China, could lead to heightened regulatory scrutiny and could adversely impact our ability to supply certain products and provide supply chain management services to our customers. Such changes also could result in compliance obligations for us directly or as part of our supply chain management services to customers, fines, ongoing monitoring and other future business activity restrictions, which could have a material adverse effect on our business, financial condition and results of operations. Finally, we have in the past sold products containing PFAS, including PFOA. Certain

19



PFAS, including PFOA, have been targeted for risk assessment, restriction, and high priority remediation and have been the subject of ongoing and substantial litigation in the both the U.S. and European Union. We have not received any claims or enforcement actions from governments or third parties relating to PFOA or any other PFAS.
In addition, these concerns could influence public perceptions regarding our operations and our ability to attract and retain customers and employees. Moreover, changes in EHS regulations could inhibit or interrupt our operations, or require us to modify our facilities or operations. Accordingly, environmental or regulatory matters may cause us to incur significant unanticipated losses, costs, capital expenditures or liabilities, which could reduce our profitability. Such losses, costs, capital expenditures or liabilities will be subject to evolving regulatory requirements and will depend on the timing of the promulgation and enforcement of specific standards which impose requirements on our operations. As a result, these losses, costs, capital expenditures or liabilities may be more than currently anticipated.

Our operations involve risks associated with the handling, transportation, storage and disposal of chemical products that may increase our operating costs and reduce our profitability.

Our business is subject to hazards inherent in the handling, transportation, storage and disposal of chemical products. These hazards include: chemical spills, storage tank leaks, discharges or releases of toxic or hazardous substances or gases and other hazards incident to the handling, transportation, storage and disposal of dangerous chemicals. We are also potentially subject to other hazards, including natural disasters and severe weather; explosions and fires; transportation problems, including interruptions, spills and leaks; mechanical failures; unscheduled downtimes; labor difficulties; and other risks. Many potential hazards can cause bodily injury and loss of life, severe damage to or destruction of property and equipment and environmental damage, and may result in suspension of our own or our customers’ operations and the imposition of civil or criminal penalties and liabilities. Furthermore, we are subject to present and future claims with respect to our employees when working within our own operations or when supplying chemicals to and/or providing chemical management services at our customer’s operations, other persons, including potentially our customers and their employees, workers’ compensation and other matters.

We maintain property, business interruption, products liability and casualty insurance policies which we believe are in accordance with customary industry practices, as well as insurance policies covering other types of risks, including pollution legal liability insurance, but we are not fully insured against all potential hazards and risks incident to our business. Each of these insurance policies is subject to customary exclusions, deductibles and coverage limits, in accordance with industry standards and practices. As a result of market conditions, premiums and deductibles for certain insurance policies can increase substantially and, in some instances, certain insurance may become unavailable or available only for reduced amounts of coverage. If we were to incur a significant liability for which we were not fully insured, it could have a material adverse effect on our business, results of operations, financial condition and liquidity.

If the temperature control systems on which we rely fail, certain of the chemical products we sell may become “non-conforming” while in storage or in transit, and as a result, we may be responsible for providing replacement products to our customers, which could have a material adverse effect on our business, financial condition and results of operations.

Many of the chemical products we sell are sensitive to temperature. Our storage facilities and the vehicles maintained by the third-party delivery companies on whom we rely utilize sophisticated temperature control systems to ensure safe storage and handling of these products. If these temperature control systems fail, products that are sensitive to temperature may become
non-conforming to the customer’s specifications, and we may be responsible for providing replacement products, which could have a material adverse effect on our business, financial condition and results of operations.

Our reputation and/or our business, financial condition and results of operations could be adversely affected if one of the products we sell causes an aircraft to crash.

We may be exposed to liabilities for personal injury, death or property damage due to the failure of a product we have sold. We typically agree to indemnify our customers against certain liabilities resulting from the products we sell, and any third-party indemnification we seek from our suppliers and our liability insurance may not fully cover our indemnification obligations to customers. We also may not be able to maintain insurance coverage in the future at an acceptable cost. Any liability for which third-party indemnification is not available that is not covered by insurance could have a material adverse effect on our business, financial condition and results of operations.

In addition, a crash caused by one of the products we have sold could damage our reputation for selling quality products. We believe our customers consider safety and reliability as key criteria in selecting a provider of aircraft products and believe our reputation for quality assurance is a significant competitive strength. If a crash were to be caused by one of the

20



products we sold, or if we were to otherwise fail to maintain a satisfactory record of safety and reliability, our ability to retain and attract customers may be materially adversely affected.

We sell products to a highly regulated industry and our business may be adversely affected if our suppliers or customers lose government approvals, if more stringent government regulations are enacted or if industry oversight is increased.

The aerospace industry is highly regulated in the United States and in other countries. The FAA prescribes standards and other requirements for aircraft components in the U.S. and comparable agencies, such as the European Aviation Safety Agency, the Civil Aviation Administration of China and the Japanese Civil Aviation Bureau, regulate these matters in other countries. Our suppliers and customers must generally be certified by the FAA, the DoD and similar agencies in foreign countries. If any of our suppliers’ government certifications are revoked, we would be less likely to buy such supplier’s products, and, as a result, would need to locate a suitable alternate supply of such products, which we may be unable to accomplish on commercially reasonable terms or at all. If any of our customers’ government certifications are revoked, their demand for the products we sell would decline. In each case, our business, financial condition and results of operations may be adversely affected.

In addition, if new and more stringent government regulations are adopted or if industry oversight increases, our suppliers and customers may incur significant expenses to comply with such new regulations or heightened industry oversight. In the case of our suppliers, these expenses may be passed on to us in the form of price increases, which we may be unable to pass along to our customers. In the case of our customers, these expenses may limit their ability to purchase products from us. In each case, our business, financial condition and results of operations may be adversely affected.

We may be unable to successfully consummate or integrate future acquisitions, which could negatively impact our business, financial condition and results of operations.

We may consider future acquisitions, some of which could be material to us. Depending upon the acquisition opportunities available, we may need to raise additional funds through the capital markets or arrange for additional debt financing to consummate such acquisitions. We may be unable to raise the capital required for future acquisitions on satisfactory terms or at all, which could adversely affect our business, financial condition and results of operations. Economics related to acquisitions including valuation, purchase price, synergies and competitive advantage may rely on our ability to efficiently integrate an acquired business with our existing enterprise, which we may not be able to execute successfully.

The results of the United Kingdom’s referendum on withdrawal from the European Union may have a negative effect on global economic conditions, financial markets and our business, which could reduce the price of our common stock.

We have material business operations in both the United Kingdom and the broader European Union. In June 2016, a majority of voters in the United Kingdom elected to withdraw from the European Union in a national referendum. The terms of the withdrawal are subject to a negotiation period that could last until or beyond March 2019, two years after the government of the United Kingdom formally initiated the withdrawal process in March 2017. This has created significant uncertainty about the future relationship between the United Kingdom and the European Union, and has given rise to calls for the governments of other European Union member states to consider withdrawal.

These developments, or the perception that any of them could occur, have had and may continue to have a material adverse effect on global economic conditions and the stability of global financial markets, and could significantly reduce global market liquidity and restrict the ability of key market participants to operate in certain financial markets. Asset valuations, currency exchange rates and credit ratings may be especially subject to increased market volatility. Lack of clarity about future United Kingdom laws and regulations as the United Kingdom determines which European Union laws to replace or replicate in the event of a withdrawal, including financial laws and regulations, tax and free trade agreements, intellectual property rights, supply chain logistics, environmental, health and safety laws and regulations, immigration laws and employment laws, could decrease foreign direct investment in the United Kingdom, increase costs, depress economic activity and restrict our access to capital. If the United Kingdom and the European Union are unable to negotiate acceptable withdrawal terms or if other European Union member states pursue withdrawal, barrier-free access between the United Kingdom and other European Union member states or among the European economic area overall could be diminished or eliminated. Any of these factors could have a direct or indirect impact on our business in the United Kingdom and the broader European Union, on our suppliers and customers in the United Kingdom and the broader European Union and on our business outside the United Kingdom and the broader European Union, which could have a material adverse effect on our business, financial condition and results of operations and reduce the price of our common stock.


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Our substantial indebtedness could adversely affect our financial health and could harm our ability to react to changes to our business.

As of September 30, 2018, our total indebtedness outstanding under our Credit Facilities (as defined in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities”) was $854.6 million, which was 55.2% of our total capitalization.

In addition, we may incur substantial additional indebtedness in the future. Our Credit Facilities contain certain significant qualifications and exceptions that allow us to incur additional indebtedness, and the indebtedness incurred in compliance with these qualifications and exceptions could be substantial. If we incur additional debt, the risks associated with our substantial leverage would increase.

Our substantial indebtedness could have important consequences to investors. For example, it could:
    
increase our vulnerability to general economic downturns and industry conditions;
    
require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate requirements;
    
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
    
place us at a competitive disadvantage compared to competitors that have less debt; and
    
limit, along with the financial and other restrictive covenants contained in the documents governing our indebtedness, among other things, our ability to borrow additional funds, make investments and incur liens.

In addition, all of our debt under the Credit Facilities bears interest at floating rates, causing us to enter into interest rate swap derivative instruments to partially offset our exposure to interest rate fluctuations, which result in additional risks. As of September 30, 2018, we had a current interest rate hedge liability of $0.3 million. For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in Accumulated Other Comprehensive Income and subsequently reclassified into interest expense in the same period(s) during which the hedged transaction affects earnings. Derivatives not qualifying as cash flow hedges will default to a mark-to-market accounting treatment and are recorded directly to the income statement. Our derivatives also expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement, which could negate the intended protection from our hedge instruments. See further discussion on our derivative financial instruments in Note 12 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

Our level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay, when due, the principal of, interest on or other amounts due in respect of our indebtedness. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under the Credit Facilities or otherwise in amounts sufficient to enable us to service our indebtedness. If we cannot service our debt, we will have to take actions such as reducing or delaying capital investments, selling assets, restructuring or refinancing our debt or seeking additional equity capital and cannot assure you that we will be successful in implementing any such actions or that any actions we take will allow us to stay in compliance with the terms of our indebtedness.

The terms of the Credit Facilities and other debt instruments may restrict our current and future operations, particularly our ability to respond to changes or to take certain actions.

The Credit Facilities contain a number of restrictive covenants that impose significant operating and financial restrictions on us and may limit our ability to engage in acts that may be in our long-term best interests. The Credit Facilities include covenants restricting, among other things, our ability to:
    
incur or guarantee additional indebtedness or issue preferred stock;
    
pay distributions on, redeem or repurchase our capital stock;
    
make investments;

22



    
sell assets;
    
enter into agreements that restrict distributions or other payments from our restricted subsidiaries to us;
    
incur or allow liens;
    
consolidate, merge or transfer all or substantially all of our assets;
    
engage in transactions with affiliates;
    
enter into sale leaseback transactions;
    
change fiscal periods;
    
enter into agreements that restrict the granting of liens or the making of subsidiary distributions;

enter into certain hedging arrangements outside of the ordinary course of business;
    
make optional prepayments and modifications of certain debt instruments; and

engage in certain business activities.

In addition, the Credit Facilities contain a maximum leverage ratio covenant. A breach of this financial covenant could result in a default under the Credit Facilities. If any such default occurs, the lenders under the Credit Facilities may elect to declare all outstanding borrowings, together with accrued interest and other amounts payable thereunder, to be immediately due and payable. The lenders under the Credit Facilities also have the right in these circumstances to terminate any commitments to provide further borrowings. In addition, following an event of default under the Credit Facilities, the lenders under those facilities will have the right to proceed against the collateral granted to them to secure the debt, which includes our available cash. If the debt under the Credit Facilities was to be accelerated, we cannot assure you that our assets would be sufficient to repay in full our debt. See Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Credit Facilities” for additional information about the Company’s compliance with the Consolidated Total Leverage Ratio (as defined in the Credit Agreement) maintenance covenant contained in the Credit Agreement.

Risks Related to our Common Stock

The price of our common stock may fluctuate significantly, and you could lose all or part of your investment.
Volatility in the market price of our common stock may prevent you from being able to sell your common stock at or above the price you paid for your common stock. The market price of our common stock could fluctuate significantly for various reasons, including:
our operating and financial performance and prospects;
our quarterly or annual earnings or those of other companies in our industry;
the public’s reaction to our press releases, our other public announcements and our filings with the SEC;
changes in, or failure to meet, earnings estimates or recommendations by research analysts who track our common stock or the stock of other companies in our industry;
the failure of securities analysts to cover our common stock or changes in analyst recommendations;
credit ratings downgrades or other negative actions by ratings agencies for us or our subsidiaries;
strategic actions by us or our competitors, such as acquisitions or restructurings;
new laws or regulations or new interpretations of existing laws or regulations applicable to our business;
changes in accounting standards, policies, guidance, interpretations or principles;

23



the delay in impact on our profitability caused by the time lag between when we experience cost increases until these increases flow through cost of sales because of our method of accounting for inventory, or the impact from our inability to pass on such cost increases to our customers;
material litigation or government investigations;
changes in general conditions in the United States and global economies or financial markets, including those resulting from war, incidents of terrorism or responses to such events;
changes in key personnel;
sales of common stock by us or members of our management team;
the volume of trading in our common stock; and
the realization of any risks described under “Risk Factors.”
In addition, in recent years, the U.S. stock market has experienced significant price and volume fluctuations. This volatility has significantly impacted the market price of securities issued by many companies, including companies in our industry. The changes have often been unrelated or disproportionate to the operating performance of the affected companies. Hence, the price of our common stock could fluctuate based upon factors that have little or nothing to do with our Company, and these fluctuations could materially reduce our share price and cause you to lose all or part of your investment.
We have no plans to pay regular dividends on our common stock, so you may not receive funds without selling your common stock.
We have no plans to pay regular dividends on our common stock. We generally intend to invest our future earnings, if any, to fund our growth and reduce debt. Any payment of future dividends will be at the discretion of our Board of Directors and will depend on, among other things, our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends and other considerations that our Board of Directors deems relevant. The Credit Facilities also effectively limit our ability to pay dividends. Accordingly, you may have to sell some or all of your common stock in order to generate cash flow from your investment. You may not record a gain on your investment when you sell your common stock and you may lose the entire amount of the investment.
Provisions of our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law might discourage, delay or prevent a change of control of our Company or changes in our management and, as a result, depress the trading price of our common stock.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could discourage, delay or prevent a change in control of our Company or changes in our management that the stockholders of our Company may deem advantageous. These provisions:
establish a classified Board of Directors, with three classes of directors;
authorize the issuance of blank check preferred stock that our Board of Directors could issue to increase the number of outstanding shares and to discourage a takeover attempt;
limit the ability of stockholders to remove directors;
prohibit our stockholders from calling a special meeting of stockholders;
prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of stockholders;
provide that our Board of Directors is expressly authorized to amend, or to alter or repeal our bylaws; and
establish advance notice requirements for nominations for election to our Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
These anti-takeover defenses could discourage, delay or prevent a transaction involving a change in control of our Company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing, which could result in us taking corporate actions other than those you desire.

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Future sales of our common stock in the public market could lower our share price, and any additional capital raised by us through the sale of equity or convertible debt securities may dilute your ownership in our Company and may adversely affect the market price of our common stock.
We and our existing stockholders may sell additional shares of common stock in subsequent public offerings. We may also issue additional shares of common stock or convertible debt securities to finance future investments including acquisitions. As of September 30, 2018, we had 950,000,000 shares of common stock authorized and 99,557,885 shares of common stock outstanding. In addition, we have 2,041,586 shares of common stock issuable upon the exercise of options outstanding as of September 30, 2018 and 2,341,594 available shares of common stock reserved for issuance under the Wesco Aircraft Holdings, Inc. 2014 Incentive Award Plan (the 2014 Plan).

We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of our common stock will have on the market price of our common stock. Sales of substantial amounts of our common stock (including sales pursuant to Carlyle’s registration rights and shares issued in connection with an acquisition), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock. 

ITEM 1B.  UNRESOLVED STAFF COMMENTS
 
None.

ITEM 2.  PROPERTIES
 
Our global headquarters is located at 24911 Avenue Stanford, Valencia, California 91355. As of September 30, 2018, we have a total of 56 administrative, sales and/or stocking facilities, all of which are either leased or located at a customer site, except for our global headquarters, which is owned by us. These facilities, including facilities in Northlake, Texas; McDonough, Georgia; Wichita, Kansas; Austin, Texas; Mississauga, Ontario; Cleckheaton, United Kingdom and Clayton West, United Kingdom, are located in 17 countries, including the U.S., Australia, Canada, China, France, Germany, India, Israel, Italy, Mexico, Singapore and the United Kingdom.

Our warehouse operations are divided between CSLs and Forward Stocking Locations (FSLs). Our CSLs serve as the primary supply warehouses for most of our net sales and also house our procurement, customer service, document control, IT, material support and quality assurance functions. Our CSLs are supported by sales offices throughout the U.S., Australia, Canada, China, France, Germany, India, Israel, Italy, Mexico, Singapore and the United Kingdom.

Complementing our CSLs and sales offices are FSLs. An FSL is a specialized stocking point for one or more Contracts located within a geographic region. FSLs are typically located either near or within a customer facility and are established to support large Contracts. In certain instances, FSLs initially established to service a single customer are expanded to service other regional customers.

We believe that our existing facilities, including both owned and leased, are in good condition and suitable for the conduct of our business. For additional information regarding obligations under operating leases, see Note 17 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

ITEM 3.  LEGAL PROCEEDINGS

We are involved in various legal matters that arise in the ordinary course of our business. We believe that the ultimate outcome of such matters will not have a material adverse effect on our business, financial condition or results of operations. However, there can be no assurance that such actions will not be material or adversely affect our business, financial condition or results of operations. For more information see Note 4 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

ITEM 4.  MINE SAFETY DISCLOSURES
 
Not applicable.


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PART II

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Stockholders and Market Information About Our Common Stock
 
Our common stock began trading on the New York Stock Exchange under the symbol “WAIR” on July 28, 2011. As of November 8, 2018, we had approximately 63 holders of record of our common stock and the closing price reported on the New York Stock Exchange of our common stock was $11.13 per share.
 
Dividends
 
We have not paid dividends in the past and we do not intend to pay any cash dividends for the foreseeable future. We intend to retain earnings, if any, for the future operation and expansion of our business and the repayment of debt. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon our results of operations, cash requirements, financial condition, contractual restrictions, restrictions imposed by applicable laws and other factors that our Board of Directors may deem relevant. Our existing indebtedness effectively limits our ability to pay dividends and make distributions to our stockholders.
 
Recent Sales of Unregistered Securities
 
None.

Issuer Purchases of Equity Securities
 
During the quarter ended September 30, 2018, we repurchased 108,433 shares of common stock in connection with shares surrendered to satisfy statutory minimum tax withholding obligations in connection with the vesting of restricted stock awards under the 2014 Plan. We expended approximately $1,220,000 to repurchase these shares.

Period
 
Total
Number of
Shares
Purchased
 
 
Average
Price
Paid per
Share
 
 
Total Number
of Shares
Purchased
as Part of Publicly
Announced
Plans or
Programs
 
 
Approximate
Dollar Value
of Shares that
May Yet Be
Purchased Under
the Plans or
Programs
(in millions)
 
July 1, 2018 - July 31, 2018
 
 

 
 
$

 
 
 

 
 
$

 
August 1, 2018 - August 31, 2018
 
 

 
 
 

 
 
 

 
 
 

 
September 1, 2018 - September 30, 2018
 
 
108,433

 
 
 
11.25

 
 
 

 
 
 

 
Total
 
 
 
 
108,433

 
 
$
11.25

 
 
 

 
 
$

 


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Performance
 
The graph set forth below compares the cumulative total shareholder return on our common stock between September 30, 2013 and September 30, 2018 to (1) the cumulative total return of U.S. companies listed on the New York Stock Exchange and (2) the cumulative total return of a peer group selected by the Company (Esterline Technologies Corporation (ESL), Fastenal Company (FAST), HEICO Corporation (HEI), KLX Inc. (KLXI), MSC Industrial Direct Co., Inc. (MSM), Transdigm Group Incorporated (TDG) and W.W. Grainger, Inc. (GWW)) over the same period. The peer group reflects a mix of companies that we believe is reflective of our broader industry and line-of-business. This graph assumes an initial investment of $100 on September 30, 2013, in our common stock, the market index and the peer group and assumes the reinvestment of dividends, if any. The historical information set forth below is not necessarily indicative of future price performance.

performancegraph2018.jpg
Company/Market/Peer Group
 
9/30/2013
 
9/30/2014
 
9/30/2015
 
9/30/2016
 
9/30/2017
 
9/30/2018
Wesco Aircraft Holdings, Inc.
 
$100.00
 
$83.13
 
$58.29
 
$64.17
 
$44.91
 
$53.75
New York Stock Exchange (U.S. Companies)
 
100.00
 
116.24
 
111.81
 
127.92
 
149.01
 
168.75
Peer Group
 
100.00
 
105.76
 
94.98
 
113.84
 
122.76
 
184.82


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ITEM 6.  SELECTED FINANCIAL DATA

The selected income statement and other data for each of the years ended September 30, 2018, 2017 and 2016 and the selected balance sheet data as of September 30, 2018 and 2017 have been derived from our audited consolidated financial statements that are included in this Annual Report. The selected income statement and other data for the years ended September 30, 2015, and 2014 and the selected balance sheet data as of September 30, 2016, 2015 and 2014 have been derived from audited consolidated financial statements that are not included in this Annual Report on Form 10-K.

The financial data set forth below are not necessarily indicative of future results of operations. This data should be read in conjunction with, and is qualified in its entirety by reference to, Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto included elsewhere in this Annual Report.
 
Years Ended September 30,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(in thousands except per share data)
Consolidated statements of income data:
 
 
 
 
 
 
 
 
 
Net sales (1)
$
1,570,450

 
$
1,429,429

 
$
1,477,366

 
$
1,497,615

 
$
1,355,877

 
 
 
 
 
 
 
 
 
 
Income (loss) from operations (1)
$
109,468

 
$
(208,795
)
 
$
158,750

 
$
(206,365
)
 
$
183,934

Interest expense, net (1)
(48,880
)
 
(39,821
)
 
(36,901
)
 
(37,092
)
 
(29,225
)
Other income, net
24

 
369

 
3,741

 
1,841

 
2,199

Income (loss) before income taxes
60,612

 
(248,247
)
 
125,590

 
(241,616
)
 
156,908

Income tax (provision) benefit
(27,958
)
 
10,901

 
(34,212
)
 
86,872

 
(54,806
)
Net income (loss)
$
32,654

 
$
(237,346
)
 
$
91,378

 
$
(154,744
)
 
$
102,102

 
 
 
 
 
 
 
 
 
 
Per share data:
 
 
 
 
 
 
 
 
 
Net income (loss) per share
 
 
 
 
 
 
 
 
 
Basic
$
0.33

 
$
(2.40
)
 
$
0.94

 
$
(1.60
)
 
$
1.06

Diluted
$
0.33

 
$
(2.40
)
 
$
0.93

 
$
(1.60
)
 
$
1.05

Weighted average shares outstanding
 
 
 
 
 
 
 
 
 
Basic
99,157

 
98,701

 
97,634

 
96,955

 
95,951

Diluted
99,500

 
9,701

 
98,166

 
96,955

 
97,606

 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
46,222

 
$
61,625

 
$
77,061

 
$
82,866

 
$
104,775

Total assets (4)
1,789,476

 
1,754,107

 
1,948,578

 
2,020,973

 
2,412,274

Long-term debt and capital lease obligations (2) (3)
774,106

 
790,854

 
835,989

 
954,730

 
1,081,825

Total stockholders’ equity
692,469

 
649,731

 
882,915

 
817,573

 
992,290

 

(1)
We acquired Haas in February 2014.
(2)
Total long-term debt and capital lease obligations excludes current portion.
(3)
Total long-term debt related to term loan A and term loan B as of September 30, 2018, 2017 and 2016 was reduced by deferred debt issuance costs of $8.8 million, $11.7 million and $7.6 million, respectively, as required by ASC 2015-03 which we adopted on October 1, 2016. Total long-term debt was not retroactively recast to include deferred debt issuance costs as of September 30, 2015 and 2014.
(4)
Total assets as of September 30, 2016 was retroactively recast to reflect the reclassification of $7.6 million of deferred debt issuance costs related to term loan A and term loan B from long-term assets to long-term debt as required by ASC 2015-03. Total assets was not retroactively recast to exclude deferred debt issuance costs as of September 30, 2015 and 2014.


28



ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, liquidity and capital resources. You should read this discussion in conjunction with our consolidated financial statements and the related notes contained elsewhere in this Annual Report on Form 10-K.

The statements in this discussion regarding industry trends, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in Part I, Item 1A. “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements.

Industry Trends Affecting Our Business

We rely on demand for new commercial and military aircraft for a significant portion of our sales. Commercial aircraft demand is driven by many factors, including the global economy, industry passenger volumes and capacity utilization, airline profitability, introduction of new models and the lifecycle of current fleets. Demand for business jets is closely correlated to regional economic conditions and corporate profits, but also influenced by new models and changes in ownership dynamics. Military aircraft demand is primarily driven by government spending, the timing of orders and evolving U.S. Department of Defense strategies and policies.

Aftermarket demand is affected by many of the same trends as those in OEM channels, as well as requirements to maintain aging aircraft and the cost of fuel, which can lead to greater utilization of existing planes. Demand in the military aftermarket is further driven by changes in overall fleet size and the level of U.S. military operational activity domestically and overseas.

Supply chain service providers and distributors have been aided by these trends along with an increase in outsourcing activities, as OEMs and their suppliers focus on reducing their capital commitments and operating costs.

Commercial Aerospace Market

Over the past three years, major airlines have ordered new aircraft at a robust pace, aided by strong profits and increasing passenger volumes. At the same time, volatile fuel prices have led to greater demand for fuel-efficient models and new engine options for existing aircraft designs. The rise of emerging markets has added to the growth in overall demand at a stronger pace than seen historically. Large commercial OEMs have indicated that they expect a high level of deliveries, primarily due to continued demand and their unprecedented level of backlogs.

Business aviation has lagged the larger commercial market, reflecting a deeper downturn in the last recession, changes in corporate spending patterns and an uncertain economic outlook. While overall business aviation production levels remain below their pre-recession peak, recent indicators point to improved market conditions. Production has increased for new models, and the number of pre-owned aircraft relative to the total business aviation in-service fleet has fallen to multiyear lows. Whether these improved conditions lead to increased deliveries in the future remains uncertain.

Military Aerospace Market

Military production has fluctuated for many aircraft programs in the past few years. Increases in the U.S. Department of Defense budget for fiscal years 2018 and 2019 have supported greater production of certain military programs. In particular, we believe the services we provide the Joint Strike Fighter program will benefit our business as production for that program increases. We believe increased sales from other established programs that directly benefit from these changes also will benefit our business.

U.S. Department of Defense spending continues to be uncertain for fiscal years 2020 through 2023, given that the limits imposed upon U.S. government discretionary spending by the Budget Control Act and the Bipartisan Budget Act of 2013 remain in effect for these fiscal years, unless Congress acts to raise the spending limits or repeal or suspend the provisions of these laws. Future budget cuts or changes in spending priorities could result in existing program delays, changes or cancellations.


29



Other Factors Affecting Our Financial Results
 
Fluctuations in Revenue
 
 There are many factors, such as changes in customer aircraft build rates, customer plant shut downs, variation in customer working days, changes in selling prices, the amount of new customers’ consigned inventory and increases or decreases in customer inventory levels, that can cause fluctuations in our financial results from quarter to quarter. To normalize for short-term fluctuations, we tend to look at our performance over several quarters or years of activity rather than discrete short-term periods. As such, it can be difficult to determine longer-term trends in our business based on quarterly comparisons. Ad hoc business tends to vary based on the amount of disruption in the market due to changes in aircraft build rates, new aircraft introduction, customer or site consolidations, and other factors. Fluctuations in our ad hoc business tend to be partially offset by our Contract business as most of our ad hoc revenue comes from our Contract customers.

 We will continue our strategy of seeking to expand our relationships with existing ad hoc customers by transitioning them to Contracts, as well as expanding relationships with our existing Contract customers to include additional customer sites, additional SKUs and additional levels of service. New Contract customers and expansion of existing Contract customers to additional sites and SKUs sometimes leads to a corresponding decrease in ad hoc sales as a portion of the SKUs sold under Contracts were previously sold to the same customer as ad hoc sales. We believe this strategy serves to mitigate some of the fluctuations in our net sales. Our sales to Contract customers may fail to meet our expectations for a variety of reasons, in particular if industry build rates are lower than expected or, for certain newer JIT customers, if their consigned inventory, which must be exhausted before corresponding products are purchased directly from us, is greater than we expected.

 If any of our customers are acquired or controlled by a company that elects not to utilize our services, or attempt to implement in-sourcing initiatives, it could have a negative effect on our strategy to mitigate fluctuations in our net sales. Additionally, although we derive a significant portion of our net sales from the building of new commercial and military aircraft, we have not typically experienced extreme fluctuations in our net sales when sales for an individual aircraft program decrease, which we believe is attributable to our diverse base of customers and programs.
 
Fluctuations in Margins
 
 Our gross margins are impacted by changes in product mix. Generally, our hardware products have higher gross profit margins than chemicals and electronic components.

 We also believe that our strategy of growing our Contract sales and converting ad hoc customers into Contract customers could negatively affect our gross profit margins, as gross profit margins tend to be higher on ad hoc sales than they are on Contract-related sales. However, we believe any potential adverse impact on our gross profit margins would be outweighed by the benefits of a more stable long-term revenue stream attributable to Contract customers. 
 
Our Contracts generally provide for fixed prices, which can expose us to risks if prices we pay to our suppliers rise due to increased raw material or other costs. However, we believe our expansive product offerings and inventories, our ad hoc sales and, where possible, our longer-term agreements with suppliers have enabled us to mitigate this risk. Some of our Contracts are denominated in foreign currencies and fixed prices in these Contracts can expose us to fluctuations in foreign currency exchange rates with the U.S. dollar.

Fluctuations in Cash Flow
 
Our cash flows are affected by fluctuations in our inventory. When we are awarded new programs, we generally increase our inventory to prepare for expected sales related to the new programs, which often take time to materialize, and to achieve minimum stock requirements, if any. As a result, if certain programs for which we have procured inventory are delayed or if certain newer JIT customers’ consigned inventory is larger than we expected, we may experience a more sustained inventory increase.
 
Inventory fluctuations may also be attributable to general industry trends. Factors that may contribute to fluctuations in inventory levels in the future could include (1) purchases to take advantage of favorable pricing, (2) purchases to acquire high-volume products that are typically difficult to obtain in sufficient quantities; (3) changes in supplier lead times and the timing of inventory deliveries; (4) purchases made in anticipation of future growth; and (5) purchases made in connection with new customer Contracts or the expansion of existing Contracts. While effective inventory management is an ongoing challenge, we continue to take steps to enhance the sophistication of our procurement practices to mitigate the negative impact of inventory buildups on our cash flow.

30



 
Our accounts receivable balance as a percentage of net sales may fluctuate from quarter to quarter. These fluctuations are primarily driven by changes, from quarter to quarter, in the timing of sales within the quarter and variation in the time required to collect the payments. The completion of customer Contracts with accelerated payment terms can also contribute to these quarter-to-quarter fluctuations. Similarly, our accounts payable may fluctuate from quarter to quarter, which is primarily driven by the timing of purchases or payments made to our suppliers.

 Segment Presentation
 
We conduct our business through three reportable segments: the Americas, EMEA (Europe, Middle East and Africa) and APAC (Asia Pacific). We evaluate segment performance based primarily on segment income or loss from operations. Each segment reports its results of operations and makes requests for capital expenditures and working capital needs to our chief operating decision maker (CODM). Our Chief Executive Officer serves as our CODM. 

Key Components of Our Results of Operations
 
The following is a discussion of the key line items included in our financial statements for the periods presented below under the heading “Results of Operations.” These are the measures that management utilizes to assess our results of operations, anticipate future trends and evaluate risks in our business.

Net Sales
 
Our net sales include sales of hardware, chemicals, electronic components, bearings, tools and machined parts, and eliminate all intercompany sales. We also provide certain services to our customers, including quality assurance, kitting, JIT delivery, CMS, 3PL or 4PL programs and point-of-use inventory management. However, these services are provided by us contemporaneously with the delivery of the product, and as such, once the product is delivered, we do not have a post-delivery obligation to provide services to the customer. Accordingly, the price of such services is generally included in the price of the products delivered to the customer, and revenue is recognized upon delivery of the product, at which point, we have satisfied our obligations to the customer. We do not account for these services as a separate element, as the services generally do not have stand-alone value and cannot be separated from the product element of the arrangement.
 
We serve our customers under Contracts, which include JIT contracts and LTAs, and with ad hoc sales. Under JIT contracts, customers typically commit to purchase specified products from us at a fixed price, on an as needed basis, and we are responsible for maintaining stock availability of those products. LTAs are typically negotiated price lists for customers or individual customer sites that cover a range of pre-determined products, purchased on an as-needed basis. Ad hoc purchases are made by customers on an as-needed basis and are generally supplied out of our existing inventory. Contract customers often purchase products that are not captured under their Contract on an ad hoc basis.
 
Income (Loss) from Operations
 
Income (loss) from operations is the result of subtracting the cost of sales and selling, general, and administrative expenses from net sales, and is used primarily to evaluate our performance and profitability.
 
The principal component of our cost of sales is product cost, which was 94.4% of our total cost of sales for the year ended September 30, 2018. The remaining components are freight and expediting fees, import duties, tooling repair charges, packaging supplies and inventory adjustment charges, which collectively were 5.6% of our total cost of sales for the year ended September 30, 2018.
 
Product cost is determined by the current weighted average cost of each inventory item, except for chemical parts for which the first-in, first-out method is used, and the provision, if any, for excess and obsolete inventory (E&O). The inventory provision is calculated to write-down the value of excess and obsolete inventory to its net realizable value. We review inventory for excess quantities and obsolescence quarterly. For a description of our E&O provision policy, see “—Critical Accounting Policies and Estimates—Inventories.” Charges to cost of sales for the E&O provision and related items of $16.8 million, $12.9 million and $14.6 million were recorded during the years ended September 30, 2018, 2017 and 2016, respectively. We believe that these amounts appropriately reflect the risk of E&O inventory inherent in our business and the proper net realizable value of inventories. For a more detailed description of the E&O provision, see Note 5 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
 

31



The principal components of our selling, general and administrative expenses are salaries, wages, benefits and bonuses paid to our employees; stock-based compensation; commissions paid to outside sales representatives; travel and other business expenses; training and recruitment costs; marketing, advertising and promotional event costs; rent; bad debt expense; professional services fees (including legal, audit and tax); and ordinary day-to-day business expenses. Depreciation and amortization expense is also included in selling, general and administrative expenses, and consists primarily of scheduled depreciation for leasehold improvements, machinery and equipment, vehicles, computers, software and furniture and fixtures. Depreciation and amortization also includes intangible asset amortization expense.
 
Other Expenses
 
Interest Expense, Net.  Interest expense, net consists of the interest we pay on our long-term debt, interest and fees on our revolving facility (as defined below under “—Liquidity and Capital Resources—Credit Facilities”) and our line-of-credit and deferred debt issuance costs, net of interest income.

Other Income, Net.  Other income, net is primarily comprised of foreign exchange gain or loss associated with transactions denominated in currencies other than the respective functional currency of the reporting subsidiary.
 
Critical Accounting Policies and Estimates
 
The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and judgments on an on-going basis and may revise our estimates and judgments as circumstances change. Actual results may materially differ from what we anticipate, and different assumptions or estimates about the future could materially change our reported results. We believe the following accounting policies are the most critical in that they significantly affect our financial statements, and they require our most significant estimates and complex judgments.
 
Inventories
 
Our inventory is comprised solely of finished goods. Inventories are stated at the lower of cost or net realizable value (LCNRV). The method by which amounts are removed from inventory are weighted average cost for all inventory, except for chemical parts for which the first-in, first-out method is used.
 
We charge cost of sales for inventory provisions to write down our inventory to the LCNRV. Most of our inventory provisions relate to the write-down of excess quantities of products, based on our inventory levels compared to assumptions about future demand and market conditions. Once inventory has been written-down, it creates a new cost basis for the inventory that is not subsequently written-up. The process for evaluating E&O inventory often requires us to make subjective judgments and estimates concerning forecasted demand, including quantities and prices at which such inventories will be able to be sold in the normal course of business.
 
The components of our inventory are subject to different risks of excess quantities or obsolescence. Our hardware inventory, which does not expire or have a pre-determined shelf life, bears a higher risk of our having excess quantities than risk of becoming obsolete due to spoilage. However, our chemical inventory becomes obsolete when it has aged past its shelf-life, cannot be recertified and is no longer usable or able to be sold, or the inventory has been damaged on-site or in-transit. In such instances, a full write-down is taken against such inventory.
 
Demand for our products can fluctuate significantly. Our estimates of future product demand and selling prices may prove to be inaccurate, in which case we may have understated or overstated the write-down required for E&O inventories. In the future, if our inventories are determined to be valued higher than LCNRV, we will be required to reduce the value of such inventories to LCNRV and recognize the differences in our cost of goods sold at the time of such determination. Conversely, if our inventories are determined to be valued below LCNRV, we may have over-reported our costs of goods sold in previous periods and will be required to defer the recognition of such additional operating income until those inventories are sold. Charges to cost of sales for E&O provisions and related items were $16.8 million, $12.9 million and $14.6 million in the years ended September 30, 2018, 2017 and 2016, respectively. We believe that these amounts appropriately reflect the valuation risk of E&O inventory inherent in our business.


32



Goodwill and Indefinite-Lived Intangible Assets
 
Goodwill represents the excess of the consideration paid over the fair value of the net assets acquired in a business combination. Goodwill and indefinite-lived intangible assets acquired in a business combination are not amortized, but instead tested for impairment at least annually or more frequently should an event occur or circumstances indicate that the carrying amount may be impaired. Such events or circumstances may be a significant change in business climate, economic and industry trends, legal factors, negative operating performance indicators, significant competition, changes in strategy, or disposition of a reporting unit or a portion thereof. Goodwill and indefinite lived intangibles impairment testing is performed at the reporting unit level on July 1 of each year, as well as when circumstances change that might indicate impairment.
 
We test goodwill for impairment by performing a qualitative assessment process, or using a two-step quantitative assessment process. If we choose to perform a qualitative assessment process and determine it is more likely than not (that is, a likelihood of more than 50 percent) that the carrying value of the net assets is more than the fair value of the reporting unit, the two-step quantitative assessment process is then performed; otherwise, no further testing is required. Factors utilized in the qualitative assessment include the following: macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; Wesco entity specific operating results and other relevant Wesco entity specific events. We may elect not to perform the qualitative assessment process and, instead, proceed directly to the two-step quantitative assessment process.
 
The first step identifies potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. The estimates of fair value of a reporting unit are determined based on a discounted cash flow analysis and market earnings multiples. A discounted cash flow analysis requires us to make various judgmental assumptions, including assumptions related to discount rates, revenue growth rates, projected operating margins, terminal values and working capital. The assumptions about revenue growth rates, projected operating margins and terminal values are based on the forecast and long-term business plans of each reporting unit. Discount rate and working capital level assumptions are based on an assessment of the risk inherent in the discounted cash flows of the respective reporting units. If the fair value exceeds the carrying value of a reporting unit, goodwill is not considered impaired and the second step of the test is unnecessary. If the carrying amount of a reporting unit’s goodwill exceeds the fair value of a reporting unit, the second step measures the impairment loss, if any.
 
The second step compares the implied fair value of goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. The implied fair value of the reporting unit’s goodwill is calculated by creating a hypothetical balance sheet as if the reporting unit had just been acquired. This balance sheet contains all assets and liabilities recorded at fair value (including any intangible assets that may not have any corresponding carrying value in our balance sheet). The implied value of the reporting unit’s goodwill is calculated by subtracting the fair value of the net assets from the fair value of the reporting unit. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

The preparation of our internal forecasts requires significant judgments, including the estimation of the long-term rate of revenue growth for our business, future product costs, cost containment activities, changes in working capital, interest rates, discount rates, and other factors. Changes in these factors could significantly change our internal forecasts, which could significantly change the amount of impairment recorded, if any.

As of July 1, 2018, we performed our annual Step 1 goodwill impairment tests on our three reporting units, Americas, EMEA and APAC. The results of these tests indicated that the estimated fair values of our reporting units exceeded their carrying values.

As previously disclosed, as of June 30, 2017, we performed a two-step quantitative assessment on goodwill impairment on all our reporting units, which was triggered by events identified in our quarterly qualitative assessment. As a result, we recognized a total impairment charge of $311.1 million. We also performed our fiscal year 2017 annual goodwill impairment test as of July 1, 2017, concurrent with our restructuring of our reporting units, which indicated no impairment for any of the three new reporting units, Americas, EMEA and APAC. Out of the $311.1 million goodwill impairment charge, $308.4 million was assigned to the Americas reporting unit and $2.7 million was assigned to the APAC reporting unit based on their relative fair value as of July 1, 2018. See Note 8 of the Notes to Consolidated Financial Statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended September 30, 2017 for additional information.


33



Revenue Recognition
 
We recognize product and service revenue when (1) persuasive evidence of an arrangement exists, (2) title transfers to the customer, (3) the sales price charged is fixed or determinable and (4) collection is reasonably assured. In instances where title does not pass to the customer upon shipment, we recognize revenue upon delivery or customer acceptance, depending on the terms of the sales contract.
 
We report revenue on a gross or net basis based on management’s assessment of whether we act as a principal or agent in the transaction. We assess whether we act as a principal in the transaction or as an agent acting on behalf of others by considering such factors as to whether or not we obtain control of the product, the form of consideration we receive, our ability to influence pricing, and our performance obligations. Based upon these criteria, if we are the principal in the transaction and have the risks and rewards of ownership, the transactions are recorded as gross in the consolidated statements of comprehensive income. If we do not act as a principal in the transaction, the transactions are recorded on a net basis in the consolidated statements of comprehensive income. The majority of our revenue is recorded on a gross basis with the exception of certain gas, energy and chemical management service contracts that are recorded as net revenue.
 
We also enter into sales rebate and profit sharing arrangements with our customers. Such customer incentives are accounted for as a reduction to gross sales and recorded based upon estimates at the time products are sold. These estimates are based upon historical experience for similar programs and products. We review such rebates and profit-sharing arrangements on an ongoing basis and accruals are adjusted, if necessary, as additional information becomes available.

Management provides allowances for credits and returns, based on historic experience, and adjusts such allowances as considered necessary. To date, such provisions have been within the range of management’s expectations and the allowance established.
 
Income Taxes
 
We recognize deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. A valuation allowance is established, when necessary, to reduce net deferred tax assets to the amount expected to be realized. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which temporary differences become deductible or includible in taxable income. We consider projected future taxable income and tax planning strategies in our assessment. Our foreign subsidiaries are taxed in local jurisdictions at local statutory rates. The Company includes interest and penalties related to income taxes, including unrecognized tax benefits, within income tax expense.

We determine whether it is more likely than not that some or all of the deferred tax assets will not be realized.  We have recorded valuation allowances of $37.9 million and $18.6 million as of September 30, 2018 and 2017, respectively, against certain deferred tax assets, which consist primarily of foreign tax credits and foreign net operating losses. The valuation allowances are based on our estimates of taxable income by jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable. If actual results differ from these estimates or if we revise these estimates in future periods, we may need to adjust the valuation allowances which could materially impact our financial position and results of operations.
 
Stock-Based Compensation
 
We account for all stock-based compensation awards to employees and members of our Board of Directors based upon their fair values as of the date of grant using a fair value method and recognize the fair value of each award as an expense over the requisite service period using the graded vesting method for awards with performance conditions and the straight-line method for awards with service conditions only.
 
For purposes of calculating stock-based compensation, we estimate the fair value of stock options using a Black-Scholes option pricing model, which requires the use of certain subjective assumptions including expected term, volatility, expected dividend, risk-free interest rate, and the fair value of our common stock. These assumptions generally require significant judgment.
 

34



We estimate the expected term of employee options using the average of the time-to-vesting and the contractual term. We derive our expected volatility from the historical volatilities of the price of our common stock over the expected term of the options. Our expected dividend rate is zero, as we have never paid any dividends on our common stock and do not anticipate any dividends in the foreseeable future. We base the risk-free interest rate on the U.S. Treasury yield in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to each grant’s expected life.

We estimate the fair value of restricted stock units and awards based on the market price of the shares underlying the awards on the grant date. Fair value for performance-based awards reflects the estimated probability that the performance condition will be met. Fair value for awards with total stockholder return performance metrics reflects the fair value calculated using the Monte Carlo simulation model, which incorporates stock price correlation and other variables over the time horizons matching the performance periods.

Management estimates a forfeiture rate for each grant of awards based on its judgment and expectations of employee turnover behavior and other factors. Quarterly actual forfeiture could have a significant effect on reported stock-based compensation expense, as the cumulative effect of adjusting the amortization of stock-based compensation expense is recognized in the period when the forfeiture occurs.

The following table summarizes the amount of stock-based compensation expense recognized in our consolidated statements of comprehensive income (in thousands):
 
 
 
2018
 
2017
 
2016
Stock-based compensation expense
 
$
9,252

 
$
7,335

 
$
8,490

 
If any of the factors change and/or we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there is a difference between the assumptions used in determining stock-based compensation expense and the actual factors that become known over time, we may change the input factors used in determining stock-based compensation costs for future grants. Additionally, we may change the estimates that the performance obligations may be met. These changes, if any, may materially impact our results of operations in the period such changes are made. We expect to continue to grant stock options in the future, and to the extent that we do, our actual stock-based compensation expense recognized in future periods will likely increase.

Results of Operations
 
Consolidated
 
 
 
Years Ended September 30,
Consolidated Result of Operations
 
2018
 
2017
 
2016
 
 
(dollars in thousands)
Net sales
 
$
1,570,450

 
$
1,429,429

 
$
1,477,366

 
 
 
 


 


Gross profit
 
$
403,156

 
$
361,907

 
$
393,692

Selling, general & administrative expenses
 
293,688

 
259,588

 
234,942

Goodwill impairment charge
 

 
311,114

 

Income (loss) from operations
 
109,468

 
(208,795
)
 
158,750

Interest expense, net
 
(48,880
)
 
(39,821
)
 
(36,901
)
Other income, net
 
24

 
369

 
3,741

Income (loss) before income taxes
 
60,612

 
(248,247
)
 
125,590

(Provision) benefit for income taxes
 
(27,958
)
 
10,901

 
(34,212
)
Net income (loss)
 
$
32,654

 
$
(237,346
)
 
$
91,378

 

35



 
 
(as a percentage of net sales, numbers rounded)
Gross profit
 
25.7
 %
 
25.3
 %
 
26.6
 %
Selling, general & administrative expenses
 
18.7
 %
 
18.2
 %
 
15.9
 %
Goodwill impairment charge
 
 %
 
21.7
 %
 
 %
Income (loss) from operations
 
7.0
 %
 
(14.6
)%
 
10.7
 %
Interest expense, net
 
(3.1
)%
 
(2.8
)%
 
(2.5
)%
Other income, net
 
 %
 
 %
 
0.3
 %
Income (loss) before income taxes
 
3.9
 %
 
(17.4
)%
 
8.5
 %
(Provision) benefit for income taxes
 
(1.8
)%
 
0.8
 %
 
(2.3
)%
Net income (loss)
 
2.1
 %
 
(16.6
)%
 
6.2
 %
 
Year ended September 30, 2018 compared with the year ended September 30, 2017
 
Net Sales

Consolidated net sales increased $141.0 million, or 9.9%, to $1,570.5 million for the year ended September 30, 2018 compared with $1,429.4 million for the year ended September 30, 2017. The $141.0 million increase reflects growth in chemical product sales, ad hoc sales and hardware Contract sales. Chemical product sales and hardware Contract sales together added $91.4 million of net sales and reflect both new business and a net increase for existing Contracts, partially offset by declines from Contract expirations. Ad hoc sales were also higher, increasing $49.6 million when compared with the prior year, reflecting growth at several key customers. Ad hoc and Contract sales as a percentage of net sales represented 24% and 76%, respectively, for 2018, which was unchanged from the prior year. The $141.0 million increase in net sales included one-time sales of $16.9 million related to contract claims.

Income (loss) from Operations
 
Consolidated income from operations was $109.5 million for the year ended September 30, 2018 compared with a $208.8 million loss from operations for the year ended September 30, 2017. The increase in income from operations resulted primarily from a prior year non-cash goodwill impairment charge of $311.1 million recorded in the three months ended June 30, 2017. Excluding the goodwill impairment charge, income from operations increased $7.1 million compared with the prior year. The $7.1 million increase is comprised of higher gross profit of $41.2 million which was partially offset by an increase in SG&A expenses of $34.1 million. Excluding the prior year goodwill impairment charge, income from operations as a percentage of net sales was 7.0% for the year ended September 30, 2018 compared to 7.2% for the prior year.

The increase in gross profit was primarily driven by the revenue growth described above. Average gross margins increased 0.4 percentage points, primarily due to higher margins on ad hoc sales and a stronger sales mix, partially offset by lower margins on chemical product sales, compared with the prior year.

The $34.1 million increase in SG&A expenses largely reflected increases in payroll and other personnel related costs of $15.5 million and professional fees of $15.9 million. The higher payroll and other personnel related costs were due in part to increased staffing in the second half of fiscal 2017 to implement new Contracts and to improve overall service to customers. Higher professional fees primarily reflect costs for outside consultants supporting the execution of the Company's "Wesco 2020" initiative. Higher SG&A costs are reflected in a 0.5 percentage points increase in SG&A measured as a percent of net sales.
 
Interest Expense, Net
 
Interest expense, net was $48.9 million for the year ended September 30, 2018, which increased $9.1 million, compared to the year ended September 30, 2017. The increase was primarily due to both higher short-term borrowings and interest rates, partially offset by a lower amortization of deferred debt issuance costs when compared with the prior year which included a $2.3 million write off of deferred debt issuance costs.
 

36



Provision (Benefit) for Income Taxes
 
The income tax provision was $28.0 million for the year ended September 30, 2018, compared to the income tax benefit of $10.9 million for the year ended September 30, 2017. For the year ended September 30, 2017, we recorded a consolidated pre-tax loss of $248.2 million which resulted in an income tax benefit yielding an effective tax rate of 4.4%. For the year ended September 30, 2018, our effective tax rate was 46.1%. The 41.7 percentage point change of the effective tax rate compared to the same period in the prior year resulted primarily from (i) a $311.1 million goodwill impairment charge, a portion of which is permanently not deductible for tax purposes resulting in a lower income tax benefit and (ii) the establishment of a $15.1 million valuation allowance with respect to deferred tax assets for foreign tax credits resulting in a lower income tax benefit, both of which occurred during the year ended September 30, 2017 as well as (iii) an unfavorable provisional tax adjustment related to the enactment of the Tax Act which occurred during the year ended September 30, 2018. The difference in effective tax rates between years was partially offset in the current year by a decrease of the U.S. federal statutory tax rate from 35% to 21% related to the enactment of the Tax Act. The tax rate change became effective as of January 1, 2018 and therefore favorably impacts only a portion of our fiscal year ending September 30, 2018.
 
Net Income (Loss)

We reported net income of $32.7 million for the year ended September 30, 2018, compared to a net loss of $237.3 million for the year ended September 30, 2017. The increase in net income primarily reflects the goodwill impairment charge of $311.1 million in 2017, as well as a current year increase in gross profit of $41.2 million, partially offset by current year increases in SG&A expenses of $34.1 million, interest expense of $9.1 million and the provision for income taxes, as discussed above.
 
Year ended September 30, 2017 compared with the year ended September 30, 2016

Net Sales

 Consolidated net sales decreased $48.0 million, or 3.2%, to $1,429.4 million for the year ended September 30, 2017 compared with $1,477.4 million for the year ended September 30, 2016. Foreign currency translation impacts reduced sales by $22.9 million. Excluding foreign currency translation impacts, net sales for the year ended September 30, 2017 decreased $25.1 million compared to the same period in the prior year. The $25.1 million decrease was due to a decrease in ad hoc sales of $27.7 million, partially offset by an increase in Contract sales of $2.6 million. The decline in ad hoc sales was primarily due to production schedule changes and customer service issues. Contract sales for the year ended September 30, 2016 included $9.8 million related to a large commercial hardware contract that ended on March 31, 2015. Excluding this $9.8 million, which did not repeat in the corresponding 2017 period, Contract sales increased $12.4 million due to significant new Contracts partially offset by lost Contracts and declines on existing and renewed Contracts. The reduction in customer production days and customer service issues also affected Contract sales; however, other increases in Contract sales more than offset this impact. Ad hoc and Contract sales as a percentage of net sales represented 24% and 76%, respectively, for the year ended September 30, 2017 as compared to 25% and 75%, respectively, for the same period in the prior year.

Income (loss) from Operations
 
Consolidated loss from operations was $208.8 million for the year ended September 30, 2017 due to the non-cash goodwill impairment charge of $311.1 million partially offset by $102.3 million in income from operations. Income from operations excluding the goodwill impairment charge decreased $56.5 million, or 35.5%, compared with $158.8 million income from operations for the year ended September 30, 2016. Loss from operations was 14.6% of net sales for the year ended September 30, 2017. Excluding the goodwill impairment, income from operations as a percentage of net sales was 7.2% compared to an income from operations of 10.7% of net sales for the year ended September 30, 2016, a decrease of 3.5 percentage points. Average gross margins decreased 1.3 percentage points and SG&A as a percent of net sales increased by 2.3 percentage points.

The $56.5 million decrease in income from operations excluding the goodwill impairment charge was comprised of a decrease in gross profit of $31.8 million and an increase in SG&A expenses of $24.7 million. Foreign currency translation had a $7.2 million negative impact on gross profit. The remaining $24.6 million decrease in gross profit was primarily driven by the decrease in sales on a constant currency basis and decline in gross margins. The 1.3 percentage point decline in gross margins was due primarily to changes in product mix, a decrease in ad hoc margins and an increase in provisions for customer claims compared to the same period of the prior year.


37



The $29.0 million increase in SG&A expenses, excluding a benefit of $4.3 million related to the impact of foreign currency translation, largely reflected increases in payroll and other personnel related costs of $25.3 million, IT related costs of $2.5 million, travel expenses of $1.9 million, rent expense of $1.7 million, depreciation expense of $1.3 million, repair and maintenance costs of $1.0 million and bad debt expenses of $1.0 million. The increase in payroll and other personnel related costs was due in part to increased staffing required to begin implementing new contracts, and, to a lesser extent, to other headcount increases, wage increases, and higher incentive compensation than in fiscal 2016. These increases were partially offset by decreases in professional fees of $2.9 million, commissions of $1.2 million, non-cash stock-based compensation of $1.1 million and property and liability insurance of $1.0 million.

Changes in unallocated corporate costs are included above, which were $0.2 million lower than the prior year, primarily driven by decreases in non-cash stock-based compensation of $1.8 million and professional fees of $1.7 million, partially offset by an increase in payroll and other personnel related costs of $3.4 million including $1.7 million of severance costs.
 
Interest Expense, Net
 
Interest expense, net was $39.8 million for the year ended September 30, 2017, which increased $2.9 million, or 7.9%, compared to the year ended September 30, 2016. The increase was primarily due to $2.3 million of deferred debt issuance costs written off in the year ended September 30, 2017 as debt extinguishment loss related to the Credit Agreement (as defined and described in Note 11 of Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K), as well as additional interest expense from our borrowing against the revolving facility, partially offset by a lower interest expense due to a reduction of the term loans compared to the same period of the prior year.
 
Other Income, Net
 
Other income, net was $0.4 million for the year ended September 30, 2017, which decreased by $3.4 million compared to the year ended September 30, 2016. The decline was primarily related to a decrease in foreign currency exchange gain associated with transactions denominated in currencies other than the respective functional currency of the reporting subsidiary.

Provision (Benefit) for Income Taxes
 
The income tax benefit was $10.9 million for the year ended September 30, 2017, compared to the income tax provision of $34.2 million for the year ended September 30, 2016. Our effective tax rate was 4.4% and 27.2% for the years ended September 30, 2017 and 2016, respectively. The decrease in our effective tax rate resulted primarily from (1) the $311.1 million goodwill impairment charge, a portion of which is permanently not deductible for tax purposes, (2) the recording of $37.5 million of U.S. taxes on certain previously undistributed foreign earnings, and (3) the establishment of a $15.1 million valuation allowance with respect to a deferred tax asset for foreign tax credits. Refer to Note 15 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for additional information about our benefit for income taxes for the year ended September 30, 2017. Management’s decision to record a $37.5 million U.S. tax charge on certain undistributed foreign earnings will allow for the future repatriation of up to $126.5 million of foreign earnings to the U.S. without an expected incremental U.S. tax provision impact.
 
Net Income (loss)

We reported a net loss of $237.3 million for the year ended September 30, 2017, compared to a net income of $91.4 million for the year ended September 30, 2016. Net loss was 16.6% of net sales for the year ended September 30, 2017, as compared to net income of 6.2% of net sales for the year ended September 30, 2016. This decrease in net income was primarily driven by a non-cash goodwill impairment charge of $311.1 million, a decrease in gross profit of $31.8 million and an increase in SG&A expenses of $24.7 million, partially offset by a benefit for income taxes, as discussed above.


38



Americas Segment
 
 
 
Years Ended September 30,
Americas Results of Operations
 
2018
 
2017
 
2016
 
 
(dollars in thousands)
Net sales
 
$
1,271,893

 
$
1,142,366

 
$
1,177,496

 
 
 
 
 
 
 
Gross profit
 
329,828

 
284,285

 
301,706

Selling, general & administrative expenses
 
200,920

 
189,383

 
167,547

Goodwill impairment charge
 

 
308,403

 

Income (loss) from operations
 
$
128,908

 
$
(213,501
)
 
$
134,159

 
 
(as a percentage of net sales, numbers rounded)
Gross profit
 
25.9
%
 
24.9
 %
 
25.6
%
Selling, general & administrative expenses
 
15.8
%
 
16.6
 %
 
14.2
%
Goodwill impairment charge
 
%
 
27.0
 %
 
%
Income (loss) from operations
 
10.1
%
 
(18.7
)%
 
11.4
%
 
Year ended September 30, 2018 compared with the year ended September 30, 2017
 
Net Sales
 
Net sales for our Americas segment increased $129.5 million, or 11.3%, to $1,271.9 million for the year ended September 30, 2018, compared with $1,142.4 million for the year ended September 30, 2017. The $129.5 million increase was due primarily to an increase in ad hoc sales, chemical product sales and hardware Contract sales, and one-time sales of $16.9 million in 2018 related to customer contract related claims.

Income (Loss) from Operations
 
Income from operations for our Americas segment for the year ended September 30, 2018 was $128.9 million compared with a $213.5 million loss from operations for the year ended September 30, 2017. The increase in income from operations reflects primarily a prior year non-cash goodwill impairment charge of $308.4 million. Excluding the prior year goodwill impairment charge, income from operations increased $34.0 million compared with the prior year. The $34.0 million increase is comprised of higher gross profit of $45.5 million which was partially offset by an increase in SG&A expenses of $11.5 million. Income from operations as a percentage of net sales was 10.1% for the year ended September 30, 2018, compared with 8.3% for the year ended September 30, 2017 excluding the goodwill impairment charge.

The $45.5 million increase in gross profit was primarily driven by increases in ad hoc, hardware Contract and chemical product sales compared with the prior year. Average gross margins increased 1.0 percentage point, due primarily to higher margins for ad hoc and hardware Contract sales, offset partially by lower margins for chemical product sales, compared with the same period in the prior year.

The $11.5 million increase in SG&A expenses reflected increases in payroll and other personnel related costs of $11.9 million, bad debt expense of $0.7 million and depreciation expense of $0.7 million. These increases were partially offset by lower stock-based compensation expense of $0.3 million, IT related costs of $0.2 million, integration costs of $0.5 million and marketing and travel costs of $0.5 million. The increase in payroll and other personnel related costs was due in part to increased staffing required to implement new Contracts and improve overall service to customers. SG&A as a percent of net sales declined 0.8 percentage points.

Year ended September 30, 2017 compared with the year ended September 30, 2016
 
Net Sales
 
Net sales for our Americas segment decreased $35.1 million, or 3.0%, to $1,142.4 million for the year ended September 30, 2017, compared with $1,177.5 million for the year ended September 30, 2016. Foreign currency translation

39



impacts reduced sales by $3.3 million. Excluding foreign currency translation impacts, net sales for the year ended September 30, 2017 decreased $31.8 million compared to the same period in the prior year. The $31.8 million decline was due to a decrease in ad hoc sales of $34.9 million, slightly offset by an increase in Contract sales of $3.1 million. The $34.9 million decline in ad hoc sales was primarily due to production schedule changes and customer service issues. Contract sales for the year ended September 30, 2016 included $9.8 million related to a large commercial hardware contract that ended on March 31, 2015. Excluding this $9.8 million, which did not repeat in the corresponding 2017 period, Contract sales increased $12.9 million due to increases in contract volume and new contracts, net of contracts losses.

Income (loss) from Operations
 
Loss from operations for our Americas segment for the year ended September 30, 2017 was $213.5 million due to the non-cash goodwill impairment charge of $308.4 million partially offset by $94.9 million in income from operations. Income from operations excluding goodwill impairment decreased $39.3 million, or 29.3%, compared with $134.2 million of income from operations for the same period in the prior year. Excluding the goodwill impairment charge, income from operations as a percentage of net sales was 8.3% for the year ended September 30, 2017, compared to 11.4% for the year ended September 30, 2016, a decline of 3.1 percentage points. Average gross margins decreased 0.7 percentage points and SG&A as a percent of net sales increased by 2.4 percentage points.

The $39.3 million decrease in income from operations excluding goodwill impairment charge was comprised of a decrease in gross profit of $17.4 million and an increase in SG&A expenses of $21.9 million. The foreign currency translation impact on gross profit was a negative $1.3 million. The remaining $16.1 million decline in gross profit was primarily driven by lower net sales, and a decrease in gross margins caused by changes in sales mix, partially offset by lower write downs of E&O inventory. The 0.7 percentage point decline in gross margins was due primarily to changes in product mix, a decrease in ad hoc margins and an increase in provisions for customer claims compared to the same period of the prior year. The increase in SG&A expenses was $22.8 million after adjusting for the $0.9 million favorable foreign currency translation impact, which was largely driven by increases in payroll and other personnel related costs of $17.5 million, IT related costs of $2.5 million, rent expense of $1.5 million, bad debt expense of $1.3 million, travel expenses of $1.1 million, depreciation expense of $1.1 million, non-cash stock-based compensation of $0.7 million and repair and maintenance cost of $0.7 million. These increases were partially offset by decreases in professional fees of $1.3 million, commission of $1.1 million and property liability insurance of $1.0 million.

EMEA Segment
 
 
 
Years Ended September 30,
EMEA Results of Operations
 
2018
 
2017
 
2016
 
 
(dollars in thousands)
Net sales
 
$
262,087

 
$
258,072

 
$
274,952

 
 
 
 
 
 
 
Gross profit
 
64,499

 
$
70,209

 
86,096

Selling, general & administrative expenses
 
46,573

 
45,071

 
42,215

Income from operations
 
$
17,926

 
$
25,138

 
$
43,881

 
 
(as a percentage of net sales, numbers rounded)
Gross profit
 
24.6
%
 
27.2
%
 
31.3
%
Selling, general & administrative expenses
 
17.8
%
 
17.5
%
 
15.3
%
Income from operations
 
6.8
%
 
9.7
%
 
16.0
%

Year ended September 30, 2018 compared with the year ended September 30, 2017

Net Sales

Net sales for our EMEA segment increased $4.0 million, or 1.6%, to $262.1 million for the year ended September 30, 2018, compared with $258.1 million for the year ended September 30, 2017. The $4.0 million increase reflects higher chemical product sales, partially offset by a decline in Ad hoc sales and hardware Contract sales.
 

40



Income from Operations
 
Income from operations for our EMEA segment declined $7.2 million, or 28.7%, to $17.9 million for the year ended September 30, 2018, compared to $25.1 million for the year ended September 30, 2017. The $7.2 million decline in income from operations was comprised of a decrease in gross profit of $5.7 million and an increase in SG&A expenses of $1.5 million. Income from operations as a percentage of net sales was 6.8% for the year ended September 30, 2018, compared to 9.7% for the year ended September 30, 2017, a decrease of 2.9 percentage points.

The $5.7 million decline in gross profit was primarily driven by lower Contracts sales of hardware products and a weaker sales mix compared with the prior year. Average gross margins declined 2.6 percentage points, due primarily to a weaker sales mix and lower margins for hardware Contract sales and chemical product sales compared with the prior year.

The $1.5 million increase in SG&A expenses primarily reflects a negative $1.8 million impact resulting from strengthening of the British Pound vs. the U.S. dollar. Excluding the exchange rate impact of $1.8 million, SG&A decreased slightly compared to the prior year, primarily driven by decreases in marketing and travel expenses of $0.5 million, bad debt expense of $0.7 million, partially offset by increases in payroll and other people costs of $1.1 million.

Year ended September 30, 2017 compared with the year ended September 30, 2016
 
Net Sales

Net sales for our EMEA segment decreased $16.9 million, or 6.1%, to $258.1 million for the year ended September 30, 2017, compared with $275.0 million for the year ended September 30, 2016. Foreign currency translation impacts reduced sales by $19.5 million. Excluding foreign currency translation impacts, net sales for the year ended September 30, 2017 increased $2.6 million compared to the same period in the prior year. The $2.6 million increase was due to ad hoc sales growth of $7.2 million, partially offset by a decline in Contract sales of $4.6 million. The increase in ad hoc sales was primarily due to increased customer production rates and expanded content. The decrease in Contract sales was driven by a decline in existing contract volumes partially offset by new contracts in excess of lost business.
 
Income from Operations
 
Income from operations for our EMEA segment decreased $18.7 million, or 42.7%, to $25.1 million for the year ended September 30, 2017, compared to $43.9 million for the year ended September 30, 2016. Income from operations as a percentage of net sales was 9.7% for the year ended September 30, 2017, compared to 16.0% for the year ended September 30, 2016, a decrease of 6.3 percentage points. The decrease in income from operations was comprised of a $15.9 million decrease in gross profit and a $2.8 million increase in SG&A expenses. Average gross margins decreased 4.1 percentage points and SG&A as a percent of net sales increased by 2.2 percentage points. The $15.9 million decrease in gross profit was partially due to a $5.9 million decrease due to negative foreign currency translation impact. The remaining $10.0 million decrease in gross profit was primarily driven by lower product margin, higher write downs of E&O inventory, higher freight and expedite costs, partially offset by the increase in sales on a constant currency basis. The 4.1 percentage point decline in gross margins was due primarily to a decrease in chemical margins, a decrease in ad hoc margins due to higher than usual margins in the prior year, an increase in write downs of E&O inventory and changes in product mix compared to the same period of the prior year. Excluding a favorable $3.4 million impact of foreign currency translation, SG&A expenses increased by $6.2 million, largely driven by increases in payroll and other people costs of $3.9 million, travel expenses of $0.6 million, repair and maintenance costs of $0.3 million, rent expense of $0.2 million, warehouse expense of $0.2 million, depreciation expense of $0.2 million and professional fees of $0.2 million.

41



APAC Segment
 
 
Years Ended September 30,
APAC Results of Operations
 
2018
 
2017
 
2016
 
 
(dollars in thousands)
Net sales
 
$
36,470

 
$
28,991

 
$
24,918

 
 
 
 
 
 
 
Gross profit
 
8,829

 
7,413

 
5,890

Selling, general & administrative expenses
 
6,812

 
4,874

 
4,694

Goodwill impairment charge
 

 
2,711

 

Income (loss) from operations
 
$
2,017

 
$
(172
)
 
$
1,196

 
 
(as a percentage of net sales, numbers rounded)
Gross profit
 
24.2
%
 
25.6
 %
 
23.6
%
Selling, general & administrative expenses
 
18.7
%
 
16.8
 %
 
18.8
%
Goodwill impairment charge
 
%
 
9.4
 %
 
%
Income (loss) from operations
 
5.5
%
 
(0.6
)%
 
4.8
%

Year ended September 30, 2018 compared with the year ended September 30, 2017

Net Sales

Net sales for our APAC segment increased $7.5 million, or 25.8%, to $36.5 million for the year ended September 30, 2018, compared with $29.0 million for the year ended September 30, 2017. The increase primarily reflects increases in ad hoc sales, hardware Contract sales and chemical product sales.
 
Income (Loss) from Operations
 
Income from operations of our APAC segment for the year ended September 30, 2018 was $2.0 million compared with a $0.2 million of loss from operations for the same period in the prior year. The $2.2 million increase in income from operations primarily resulted from a non-cash goodwill impairment charge of $2.7 million recorded for the three months ended June 30, 2017. Excluding the prior year's goodwill impairment charge of $2.7 million, income from operations declined $0.5 million when compared with the prior year. Gross profit increased $1.4 million, which was more than offset by an increase in SG&A expenses of $1.9 million. Excluding the prior year's goodwill impairment charge, income from operations as a percentage of net sales declined 3.3 percentage points compared with the prior year.

The $1.4 million increase in gross profit was primarily driven by increases in ad hoc sales and hardware Contract sales and a lower E&O provision, partially offset by lower chemical product sales compared with the prior year. Average gross margins declined 1.4 percentage points due primarily to lower gross margins in ad hoc sales, hardware Contract sales and chemical product sales, offset partially by a stronger sales mix and a lower E&O provision, compared with the prior year.

The $1.9 million increase in SG&A expenses was due primarily to increases in payroll and other personnel related costs of $1.1 million and building and equipment related expenses of $0.6 million as part of our growth in the APAC region. SG&A as a percent of net sales increased 1.9 percentage points.

Year ended September 30, 2017 compared with the year ended September 30, 2016
 
Net Sales

Net sales for our APAC segment increased $4.1 million, or 16.3%, to $29.0 million for the year ended September 30, 2017, compared with $24.9 million for the year ended September 30, 2016. Foreign currency translation impacts reduced sales by $0.2 million. Excluding foreign currency translation impacts, net sales for the year ended September 30, 2017 increased $4.3 million compared to the same period in the prior year. The $4.3 million increase was due to Contract sales growth of $4.1 million and ad hoc sales growth of $0.2 million. The increase in Contract sales was primarily due to increased customer production rates and new contracts.

42



 
Income (loss) from Operations
 
Loss from operations of our APAC segment for the year ended September 30, 2017 was $0.2 million due to the non-cash goodwill impairment charge of $2.7 million partially offset by $2.5 million in income from operations. Income from operations excluding the goodwill impairment increased $1.3 million, or 112.2%, compared with $1.2 million of income from operations for the same period in the prior year. Excluding the goodwill impairment, income from operations as a percentage of net sales was 8.8% for the year ended September 30, 2017, compared to 4.8% for the year ended September 30, 2016, an increase of 4.0 percentage points. The $1.3 million increase in income from operations was comprised of an increase in gross profit of $1.5 million, partially offset by an increase in SG&A expenses of $0.2 million. Average gross margins increased 2.0 percentage points and SG&A as a percent of net sales decreased by 2.0 percentage points. The increase in gross profit was primarily driven by higher net sales and lower write downs of E&O inventory. The 2.0 percentage point increase in gross margins was primarily driven by lower write downs of E&O inventory. The higher SG&A expenses was driven by an increase in payroll and other personnel related costs of $0.5 million, partially offset by a decrease in bad debt expense of $0.2 million.

Unallocated Corporate Costs
 
 
Selling, General and Administrative Expenses
Years Ended September 30,
 
Americas
 
EMEA
 
APAC
 
Unallocated Corporate Costs
 
Consolidated
2018
 
$
200,920

 
$
46,573

 
$
6,812

 
$
39,383

 
$
293,688

2017
 
189,383

 
45,071

 
4,874

 
20,260

 
259,588

2016
 
167,547

 
42,215

 
4,694

 
20,486

 
234,942


SG&A expenses for the Americas, EMEA and APAC segments are discussed previously. Following are discussions on SG&A expenses not allocated to the three segments.

Year ended September 30, 2018 compared with the year ended September 30, 2017

Unallocated corporate costs were $19.1 million higher than the prior year, primarily driven by increases in professional fees of $15.9 million mainly reflecting costs for outside consultants assisting with the Company's "Wesco 2020" initiative, stock-based compensation expense of $2.3 million, and payroll and other personnel related costs of $0.3 million.

Year ended September 30, 2017 compared with the year ended September 30, 2016

Unallocated corporate costs were $0.2 million lower than the prior year, primarily driven by decreases in non-cash stock-based compensation of $1.8 million and professional fees of $1.7 million, partially offset by an increase in payroll and other personnel related costs of $3.4 million including $1.7 million of severance costs.
                                                                          
Liquidity and Capital Resources
 
Overview
 
Our primary sources of liquidity are cash flow from operations and available borrowings under our revolving facility. We have historically funded our operations, debt payments, capital expenditures and discretionary funding needs from our cash from operations. We had total available cash and cash equivalents of $46.2 million and $61.6 million as of September 30, 2018 and 2017, respectively, of which $21.3 million, or 46.1%, and $48.7 million, or 79.0%, was held by our foreign subsidiaries as of September 30, 2018 and 2017, respectively. None of our cash and cash equivalents consisted of restricted cash and cash equivalents as of September 30, 2018 or 2017. All of our foreign cash and cash equivalents are readily convertible into U.S. dollars or other foreign currencies.

As previously disclosed, during the three months ended September 30, 2017, we reassessed the potential need to repatriate foreign earnings based on our current long-range outlook, the current imbalance between cash generated and used in the U.S. and the increase in the percentage of excess cash that must be used to repay debt under the Credit Agreement. We determined it was likely that we would, in the future, repatriate approximately $126.5 million of previously earned and undistributed earnings. Accordingly, we recognized a $38.7 million deferred tax liability for U.S. taxes that would become due upon such repatriation net of foreign tax credits estimated to be available in the years when we expected to repatriate the previously undistributed earnings. With the enactment of the Tax Act, we reduced the deferred tax liability by $37.7 million to

43



$1.0 million during the three months ended December 31, 2017, and further reduced the deferred tax liability by $0.5 million to $0.5 million during the three months ended September 30, 2018 (see Note 15 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion about the transition tax provision for our foreign earnings under the Tax Act).

Our primary uses of cash currently are for:
 
operating expenses;

working capital requirements to fund the growth of our business;

capital expenditures that primarily relate to IT equipment, software development and implementation and our warehouse operations; and

debt service requirements for borrowings under the Credit Facilities (as defined below under “—Credit Facilities”).

Due to fluctuations in our cash flows, including for investment in working capital to fund growth in our operations, it is necessary from time to time to borrow under our revolving facility to meet cash demands. Provided we are in compliance with applicable covenants, we can borrow up to $180.0 million on our revolving credit facility of which $54.0 million was outstanding as of September 30, 2018. We anticipate that cash provided by operating activities, cash and cash equivalents and borrowing capacity under our revolving facility will be sufficient to meet our cash requirements for the next twelve months. As of September 30, 2018, we did not have any material capital expenditure commitments.
 
Cash Flows
 
Our cash and cash equivalents decreased by $15.4 million during the year ended September 30, 2018. The decrease primarily reflects our focus to reduce cash balances while we have borrowings under our revolving facility.

A summary of our operating, investing and financing activities are shown in the following table (in thousands):
 
Years Ended September 30,
Consolidated statements of cash flows data:
2018
 
2017
 
2016
Net Income (loss)
$
32,654

 
$
(237,346
)
 
$
91,378

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
69,753

 
346,433

 
64,012

Subtotal
102,407

 
109,087

 
155,390

Changes in working capital assets and liabilities
(84,539
)
 
(136,015
)
 
(37,935
)
Net cash provided by (used in) operating activities
17,868

 
(26,928
)
 
117,455

 
 
 
 
 
 
Net cash used in investing activities
(5,666
)
 
(8,923
)
 
(11,992
)
 
 
 
 
 
 
Net cash (used in) provided by financing activities
(27,144
)
 
20,645

 
(108,121
)
 
 
 
 
 
 
Effect of foreign currency exchange rate on cash and cash equivalents
(461
)
 
(230
)
 
(3,147
)
Net decrease in cash and cash equivalents
$
(15,403
)
 
$
(15,436
)
 
$
(5,805
)

44




Operating Activities

Our cash flows from operations fluctuates based on the level of profitability during the period as well as the timing of investments in inventory, collections of cash from our customers, payments of cash to our suppliers, and the timing of cash payments or receipts associated with other working capital accounts such as changes in our prepaid expenses and accrued liabilities or the timing of our tax payments.
 
Year ended September 30, 2018 compared with the year ended September 30, 2017

Our operating activities generated $17.9 million of cash in the year ended September 30, 2018, an increase of $44.8 million as compared to the year ended September 30, 2017.  The increase in operating cash flow of $44.8 million reflects a $6.7 million decline in cash provided from net income excluding non-cash items, which was more than offset by a series of year-over-year differences reflected in balance sheet changes reducing cash used for operations by $51.5 million. Comparing 2018 to 2017, the key balance sheet changes include:

Favorable changes totaling $77.0 million:
a smaller inventory increase of $56.7 million due to lower incremental investment based upon tighter inventory management,
a net $6.5 million favorable change in income taxes payable and income taxes receivable including a provisional tax provided for repatriation of our foreign earnings (the “Transition Tax”), and
a $13.8 million favorable difference in the change for remaining working capital assets and liabilities for the year ended September 30, 2018.

Unfavorable changes totaling $25.5 million:
a $19.9 million increase in the accounts receivable balance largely driven by higher overall sales, and
a $5.6 million decline in the accounts payable balance principally reflecting differences in timing of payments around the cutoff of each fiscal year.

See Note 15 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion about the transition tax provision for our foreign earnings under the Tax Act.

Year ended September 30, 2017 compared with the year ended September 30, 2016

Our operating activities used $26.9 million of cash in the year ended September 30, 2017, a decrease of $144.4 million as compared to the year ended September 30, 2016.  The decrease in operating cash flow of $144.4 million was primarily due to cash used for inventory purchases of $129.8 million during fiscal 2017 as compared to cash used for inventory purchases of $41.8 million during fiscal 2016, and to a lesser extent, a $46.3 million decrease in net (loss) income adjusted for non-cash items. The remaining decrease of $10.1 million represents cash used for other working capital changes. The $88.0 million increase of cash used for inventory purchases was to support new contracts, multi-year inventory purchases to support long-term contracts, and increased stocking to support our MRO and ad hoc business objectives. During the year ended September 30, 2017, net loss adjusted for non-cash items provided cash of $109.1 million, while net income adjusted for non-cash items provided cash of $155.4 million in the prior year. The decrease of $46.3 million of cash provided from results of operations was due to lower sales volumes, a decline in gross margins and higher spending for SG&A expenses.

Investing Activities
 
Our investing activities used $5.7 million, $8.9 million and $12.0 million of cash in the years ended September 30, 2018, 2017 and 2016, respectively. Investing activities consist primarily of software development and software implementation projects and the purchase of property and equipment for our warehouses and distribution locations.
 
Financing Activities
 
Our financing activities used $27.1 million of cash in the year ended September 30, 2018, which consisted of $68.5 million and $20.0 million for repayments of our borrowings under our revolving facility and long-term debt, respectively, $3.0 million for repayments of our capital lease obligations, a $1.9 million payment for debt issuance costs and a $1.3 million settlement for restricted stock tax withholding, partially offset by $67.5 million of short-term borrowings.
 

45



Our financing activities generated $20.6 million of cash in the year ended September 30, 2017, which consisted primarily of $55.0 million of short-term borrowings and $3.0 million of proceeds received in connection with the exercise of stock options, partially offset by $21.3 million for repayments of our long-term debt, $2.1 million for repayments of our capital lease obligations and a $12.8 million payment for debt issuance costs.
 
Our financing activities used $108.1 million of cash in the year ended September 30, 2016, which consisted primarily of $111.0 million for repayments of our long-term debt, $1.3 million for repayments of capital lease obligations, and a $2.1 million payment for debt issuance costs, partially offset by $6.1 million of proceeds received in connection with the exercise of stock options.

Credit Facilities
 
The credit agreement, dated as of December 7, 2012 (as amended, the Credit Agreement), by and among the Company, Wesco Aircraft Hardware Corp. and the lenders and agents party thereto, which governs our senior secured credit facilities, provides for (1) a $400.0 million senior secured term loan A facility (the term loan A facility), (2) a $180.0 million revolving facility (the revolving facility) and (3) a $525.0 million senior secured term loan B facility (the term loan B facility). We refer to the term loan A facility, the revolving facility and the term loan B facility, together, as the “Credit Facilities.” See Note 11 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for a summary of the Credit Facilities and the Credit Agreement.

As of September 30, 2018, our outstanding indebtedness under our Credit Facilities was $854.6 million, which consisted of (1) $360.0 million of indebtedness under the term loan A facility, (2) $54.0 million of indebtedness under the revolving facility, and (3) $440.6 million of indebtedness under the term loan B facility. As of September 30, 2018, $126.0 million was available for borrowing under the revolving facility to fund our operating and investing activities under the terms and any covenants contained in the Credit Agreement.

As disclosed in Note 11 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K, our borrowings under the Credit Facilities are subject to a financial covenant based upon our Consolidated Total Leverage Ratio, with the maximum ratio set at 6.00 for the quarter ended September 30, 2018. In addition, the Excess Cash Flow Percentage (as such term is defined in the Credit Agreement) is 75%, provided that the Excess Cash Flow Percentage shall be reduced to (i) 50%, if the Consolidated Total Leverage Ratio is less than 4.00 but greater than or equal to 3.00, (ii) 25%, if the Consolidated Total Leverage Ratio is less than 3.00 but greater than or equal to 2.50, and (iii) 0%, if the Consolidated Total Leverage Ratio is less than 2.50.
 
The Credit Agreement also contains customary negative covenants, including restrictions on our and our restricted subsidiaries’ ability to merge and consolidate with other companies, incur indebtedness, grant liens or security interests on assets, make acquisitions, loans, advances or investments, pay dividends, sell or otherwise transfer assets, optionally prepay or modify terms of any junior indebtedness or enter into transactions with affiliates. As of September 30, 2018, we were in compliance with all of the foregoing covenants, and our Consolidated Total Leverage Ratio was 4.18.

A breach of the Consolidated Total Leverage Ratio covenant or any of other covenants contained in the Credit Agreement could result in an event of default in which case the lenders may elect to declare all outstanding amounts to be immediately due and payable. If the debt under the Credit Facilities were to be accelerated, our available cash would not be sufficient to repay our debt in full.


46



Contractual Obligations
 
The following table is a summary of contractual cash obligations at September 30, 2018 (in thousands):
 
 
 
Payments Due by Period
 
Total
 
< 1 Year
 
1 - 3 Years
 
3 - 5 Years
 
> 5 Years
Long-term debt obligations (1)
$
891,189

 
$
59,980

 
$
831,209

 
$

 
$

Borrowings under the revolving facility (2)
57,462

 
56,608

 
854

 

 

Capital lease obligations
4,534

 
2,211

 
1,673

 
585

 
65

Operating lease obligations
50,785

 
12,439

 
17,435

 
12,481

 
8,430

Transition tax payable (3)
9,277

 
742

 
1,484

 
1,484

 
5,567

Total by period
1,013,247

 
$
131,980

 
$
852,655

 
$
14,550

 
$
14,062

Other long-term liabilities (uncertainty in the timing of future payments) (4)
9,771

 
 
 
 
 
 
 
 
Total (5)
$
1,023,018

 
 
 
 
 
 
 
 
 

(1)
Includes both principal and estimated variable interest expense payments. The interest rate used to calculate the estimated future variable interest expense is based on the actual interest rate applicable to the Company’s indebtedness as of September 30, 2018, which was 5.25% for the term loan A facility and 4.75% for the term loan B facility. The actual variable interest expense paid by the Company in the future may vary from what is presented above. Investors should refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities” and “Quantitative and Qualitative Disclosures About Market Risk—Interest Rate Risk” for additional information.

(2)
Includes both principal, estimated variable interest expense payments and estimated undrawn fees. The interest rate used to calculate the estimated future variable interest expense is based on the weighted-average actual interest rate of 5.15% applicable to the Company’s borrowings under the revolving facility as of September 30, 2018. The actual variable interest expense paid by the Company in the future may vary from what is presented above. Investors should refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities” and “Quantitative and Qualitative Disclosures About Market Risk—Interest Rate Risk” for additional information.

(3)
Includes our U.S. tax payable for the Transition Tax for repatriation of our foreign earnings.

(4)
Other long-term liabilities primarily include non-current income taxes payable and non-current deferred tax liabilities. Due to the uncertainty in the timing of future payments, uncertain tax positions of approximately $7.0 million and non-current deferred tax liabilities of approximately $2.8 million were presented as one aggregated amount in the total column on a separate line in this table.

(5)
In addition to the contractual obligations noted in the table below, the Company may issue purchase orders to suppliers in the ordinary course of business to purchase inventory in advance of expected delivery at lead-times that vary based on a variety of factors specific to individual suppliers and circumstances. As of September 30, 2018, the Company had approximately $401.2 million of these open purchase orders that are not included in the table below. In most cases, open purchase orders for products that have not yet entered the supplier’s production process can be cancelled without incurring significant termination fees or other penalties. For industry standard products, once production has begun, cancellation of an open purchase order may require payment of a termination fee or other adjustments to the pricing of the uncancelled portion of the applicable order which generally are insignificant in amount and typically subject to negotiation. For proprietary products, a cancellation fee may apply or we may be required to pay up to the full purchase price for the cancelled product if we cancel after the start of the production process. However, in many cases, our customers are contractually obligated to pay the costs associated with the cancellation of such proprietary parts.

Off-Balance Sheet Arrangements
 
We are not a party to any off-balance sheet arrangements.
 

47



Recently Issued and Adopted Accounting Pronouncements
 
See Note 3 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for a summary of recently issued and adopted accounting pronouncements.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
 
Our exposure to market risk consists of foreign currency exchange rate fluctuations, changes in interest rates and fluctuations in fuel prices.
 
Foreign Currency Exposure
 
We operate on an international basis with a portion of our revenue and expenses transacted in currencies other than the U.S. dollar. During the years ended September 30, 2018 and 2017, 28% and 29%, respectively, of our net sales were made by our foreign subsidiaries, and our total net sales to customers outside the U.S. represented 33% and 35%, respectively, of our total net sales. The majority of our foreign sales are denominated in U.S. dollars and our major foreign subsidiaries have U.S. dollar functional currencies. We are exposed to three types of foreign currency exposure: economic exposure (which could impact our operating margins where the proportions of revenue and expenses denominated in a foreign currency are different), transactional exposure (which could result in foreign currency transaction gains or losses) and translation impacts (which could impact the amount of revenues, expenses, assets and liabilities reported in U.S. dollars).

Wesco Aircraft EMEA’s revenues and product costs are predominately denominated in U.S. dollars while its operating expenses are predominately denominated in British pounds. When our subsidiaries have revenues or expenses denominated in currencies other than their functional currencies, exchange rate movements can impact the operating margins reported by the subsidiaries. Due to the relative size of its operations, Wesco Aircraft EMEA represents our primary economic exposure with respect to foreign currency fluctuations. A hypothetical 10% weakening of the U.S. dollar against the British pound would have decreased our operating profit by $2.3 million and a hypothetical 10% weakening of the U.S. dollar against the euro would have decreased our operating profit by $1.9 million.

Certain assets, including certain bank accounts and accounts receivables of some of our business units, and certain liabilities, including accounts payable, exist in currencies other than the functional currency of the related business units. As a result, these assets and liabilities are affected by foreign currency exchange rate fluctuations. These balances are principally denominated in U.S. dollars, British pounds, euros, Canadian dollars, and Mexican pesos. When these transactions are entered into, outstanding or settled in a currency other than the functional currency, we may recognize a foreign currency transaction gain or loss. We attempt to limit this exposure by seeking to maintain a low net asset or net liability exposure to each currency.

The results of operations of our foreign subsidiaries are translated into U.S. dollars at the average foreign currency exchange rate for each relevant period. This impact is sometimes partially offset by the economic impact when the underlying sale or expense is denominated in U.S. dollars making the net exposure difficult to quantify, predict, or mitigate. Any adjustments resulting from the translation are recorded in accumulated other comprehensive loss on our statements of changes in stockholders’ equity.

From time to time, we enter into currency forward and option contracts to limit exposure to foreign currency exchange rate changes and will continue to monitor our exposure to foreign currency exchange rate changes. As of September 30, 2018, we had no outstanding currency forward and option contracts. We do not enter into currency forward and option contracts for trading or speculative purposes.

Interest Rate Risk
 
Our principal interest rate exposure relates to our Credit Facilities, which bear interest at a variable rate. See Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities.” If interest rates rise, our debt service obligations on the borrowings under the Credit Facilities would increase even though the amount borrowed remained the same, which would affect our results of operations, financial condition and liquidity. If variable interest rates were to increase by 1.0%, our interest expense would increase $8.5 million per year, without taking into account the effect of any hedging instruments.
 
We periodically enter into interest rate swap agreements to manage interest rate risk on our borrowing activities. On September 30, 2018, we had three interest rate swap agreements, one of which effectively fixed our interest rate on variable rate debt of $275.0 million to 2.2625% plus the applicable margin and two of which effectively fixed our interest rate on

48



variable rate debt of $160.8 million to 2.7900% plus the applicable margin. See further discussion on our derivative financial instruments in Note 12 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
 
We do not hold or issue derivative financial instruments for trading or speculative purposes.
 
Fuel Price Risk
 
Our principal direct exposure to increases in fuel prices is as a result of potential increased freight costs caused by fuel surcharges or other fuel cost-driven price increases implemented by the third-party package delivery companies on which we rely. Our annual freight costs (which consists of in-bound and out-bound freight-related costs, net of freight revenue) during the years ended September 30, 2018 and 2017 were $29.7 million and $26.9 million, respectively, and as a result, we do not believe the impact of these potential fuel surcharges or fuel cost-driven price increases would have a material impact on our business, financial condition and results of operations. However, increases in fuel prices may have an indirect material adverse effect on our business, financial condition and results of operations, as such increases may contribute to decreased airline profitability and, as a result, decreased demand for new commercial aircraft that utilize the products we sell. See Part I, Item 1A. “Risk Factors—We may be materially adversely affected by high fuel prices.” We do not use derivatives to manage our exposure to fuel prices.


49



ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



50



Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Wesco Aircraft Holdings, Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Wesco Aircraft Holdings, Inc. and its subsidiaries as of September 30, 2018 and 2017, and the related consolidated statements of comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended September 30, 2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of September 30, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Basis for Opinions

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.


51



Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP
Los Angeles, California
November 15, 2018

We have served as the Company's auditor since 2006.

52



Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
(dollars in thousands, except share and per share data)
 
 
As of September 30,
 
2018
 
2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
46,222

 
$
61,625

Accounts receivable, net of allowance for doubtful accounts of $2,877 and $3,109 at September 30, 2018 and 2017, respectively
283,775

 
256,301

Inventories
884,212

 
827,870

Prepaid expenses and other current assets
15,291

 
13,733

Income taxes receivable
2,017

 
3,617

Total current assets
1,231,517

 
1,163,146

Property and equipment, net
44,205

 
50,355

Deferred debt issuance costs, net
2,827

 
3,676

Goodwill
266,644

 
266,644

Intangible assets, net
163,438

 
178,292

Deferred tax assets
65,135

 
76,038

Other assets
15,710

 
15,956

Total assets
$
1,789,476

 
$
1,754,107

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
180,494

 
$
184,273

Accrued expenses and other current liabilities
42,767

 
35,329

Income taxes payable
2,295

 
3,290

Capital lease obligations, current portion
2,205

 
2,952

Short-term borrowings and current portion of long-term debt
74,000

 
75,000

Total current liabilities
301,761

 
300,844

Capital lease obligations, less current portion
2,329

 
2,013

Long-term debt, less current portion
771,777

 
788,838

Deferred income taxes
2,803

 
3,197

Other liabilities
18,337

 
9,484

Total liabilities
1,097,007

 
1,104,376

Commitments and contingencies


 


Stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value per share: 50,000,000 shares authorized; no shares issued and outstanding

 

Common stock, class A, $0.001 par value, 950,000,000 shares authorized, 99,557,885 and 99,450,902 shares issued and outstanding at September 30, 2018 and 2017, respectively
99

 
99

Additional paid-in capital
444,531

 
436,522

Accumulated other comprehensive loss
(82,980
)
 
(84,626
)
Retained earnings
330,819

 
297,736

Total stockholders’ equity
692,469

 
649,731

Total liabilities and stockholders’ equity
$
1,789,476

 
$
1,754,107


See the accompanying notes to the consolidated financial statements.

53



Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
(in thousands, except per share data)

 
Years Ended September 30,
 
2018
 
2017
 
2016
Net sales
$
1,570,450

 
$
1,429,429

 
$
1,477,366

Cost of sales
1,167,294

 
1,067,522

 
1,083,674

Gross profit
403,156

 
361,907

 
393,692

Selling, general and administrative expenses
293,688

 
259,588

 
234,942

Goodwill impairment charge

 
311,114

 

Income (loss) from operations
109,468

 
(208,795
)
 
158,750

Interest expense, net
(48,880
)
 
(39,821
)
 
(36,901
)
Other income, net
24

 
369

 
3,741

Income (loss) before income taxes
60,612

 
(248,247
)
 
125,590

(Provision) benefit for income taxes
(27,958
)
 
10,901

 
(34,212
)
Net income (loss)
32,654

 
(237,346
)
 
91,378

Other comprehensive loss, net of income taxes:
 
 
 
 
 
Change in net foreign currency translation adjustment
(1,862
)
 
(7,138
)
 
(39,211
)
Change in net unrealized holding losses on derivatives
3,937

 
2,073

 
(1,629
)
Other comprehensive income (loss), net of income taxes
2,075

 
(5,065
)
 
(40,840
)
Comprehensive income (loss)
$
34,729

 
$
(242,411
)
 
$
50,538

 
 
 
 
 
 
Net income (loss) per share:
 
 
 
 
 
Basic
$
0.33

 
$
(2.40
)
 
$
0.94

Diluted
$
0.33

 
$
(2.40
)
 
$
0.93

 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
Basic
99,156,998

 
98,700,879

 
97,634,155

Diluted
99,500,477

 
98,700,879

 
98,165,856


See the accompanying notes to the consolidated financial statements.


54



Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
(dollars in thousands)

 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Loss
 
Retained Earnings
 
Total Shareholders'
Equity
 
Shares
 
Amount
 
 
 
 
Balance at September 30, 2015
97,538,124

 
$
98

 
$
412,492

 
$
(38,721
)
 
$
443,704

 
$
817,573

Issuance of common stock
1,076,784

 
1

 
6,072

 

 

 
6,073

Settlement on restricted stock tax withholding

 

 
(857
)
 

 

 
(857
)
Excess tax benefit related to restricted stock units and stock options exercised

 

 
1,098

 

 

 
1,098

Stock-based compensation expense

 

 
8,490

 

 

 
8,490

Net income

 

 

 

 
91,378

 
91,378

Other comprehensive loss

 

 

 
(40,840
)