QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 30, 2019
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission file number 001-11406
KADANT INC.
(Exact name of registrant as specified in its charter)
Delaware
52-1762325
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
One Technology Park Drive
Westford, Massachusetts
01886
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code: (978) 776-2000
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 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 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 Exchange Act). Yes ¨ No x
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
KAI
New York Stock Exchange
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Kadant Inc. was incorporated in Delaware in November 1991 and currently trades on the New York Stock Exchange under the ticker symbol "KAI." Kadant Inc. (together with its subsidiaries, the Company) is a global supplier of high-value, critical components and engineered systems used in process industries worldwide. The Company has a diverse and large customer base, including most of the world's major paper, lumber and oriented strand board (OSB) manufacturers, and various mining companies across multiple industries. Its products, technologies, and services play an integral role in enhancing process efficiency, optimizing energy utilization, and maximizing productivity in resource-intensive industries.
The Company's operations include three reportable operating segments, Papermaking Systems, Wood Processing Systems, and Material Handling Systems, and a separate product line, Fiber-based Products. See Note 2 for information regarding the Company's most recent acquisition, which comprises its new Material Handling Systems segment.
Interim Financial Statements
The interim condensed consolidated financial statements and related notes presented have been prepared by the Company, are unaudited, and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair statement of the Company's financial position at March 30, 2019, its results of operations, comprehensive income, cash flows, and stockholders' equity for the three-month periods ended March 30, 2019 and March 31, 2018. Interim results are not necessarily indicative of results for a full year or for any other interim period.
The condensed consolidated balance sheet presented as of December 29, 2018 has been derived from the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2018. The condensed consolidated financial statements and related notes are presented as permitted by the Securities and Exchange Commission (SEC) rules and regulations for Form 10-Q and do not contain certain information included in the annual consolidated financial statements and related notes of the Company. The condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2018, filed with the SEC.
Use of Estimates and Critical Accounting Policies
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Although the Company makes every effort to ensure the accuracy of the estimates and assumptions used in the preparation of its condensed consolidated financial statements or in the application of accounting policies, if business conditions were different, or if the Company were to use different estimates and assumptions, it is possible that materially different amounts could be reported in the Company's condensed consolidated financial statements.
Notes 1 and 3 to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2018 describe the significant accounting estimates and policies used in preparation of the consolidated financial statements. There have been no material changes in the Company’s significant accounting policies during the three months ended March 30, 2019, except for the adoption of Accounting Standards Codification (ASC), Leases (Topic 842) (ASC 842). See Recently Adopted Accounting Pronouncements within this note and Note 8 for further details.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Supplemental Cash Flow Information
See Note 8 for supplemental cash flow information related to the Company's lease obligations.
Three Months Ended
(In thousands)
March 30, 2019
March 31, 2018
Cash Paid for Interest
$
2,782
$
2,459
Cash Paid for Income Taxes, Net of Refunds
$
4,679
$
8,455
Non-Cash Investing Activities:
Post-closing adjustments
$
1,567
$
397
Liabilities assumed of acquired business
$
29,664
$
—
Non-cash additions to property, plant, and equipment
$
193
$
1,816
Non-Cash Financing Activities:
Issuance of Company common stock upon vesting of restricted stock units
$
3,278
$
2,755
Dividends declared but unpaid
$
2,570
$
2,440
Restricted Cash
The Company's restricted cash serves as collateral for bank guarantees primarily associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into in the normal course of business. The majority of the bank guarantees will expire over the next twelve months.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company's condensed consolidated balance sheet that are shown in aggregate in the accompanying condensed consolidated statement of cash flows:
(In thousands)
March 30, 2019
March 31, 2018
December 29, 2018
December 30, 2017
Cash and cash equivalents
$
56,478
$
72,210
$
45,830
$
75,425
Restricted cash
697
1,532
287
1,421
Total Cash, Cash Equivalents, and Restricted Cash
$
57,175
$
73,742
$
46,117
$
76,846
Banker's Acceptance Drafts included in Accounts Receivable
The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for their trade accounts receivable. The drafts are noninterest-bearing obligations of the issuing bank and mature within six months of the origination date. The Company's subsidiaries may sell the drafts at a discount to a third-party financial institution or transfer the drafts to vendors in settlement of current accounts payable prior to the scheduled maturity date. These drafts, which totaled $7,772,000 at March 30, 2019 and $7,976,000 at December 29, 2018, are included in accounts receivable in the accompanying condensed consolidated balance sheet until the subsidiary sells the drafts to a bank and receives a discounted amount, transfers the banker's acceptance drafts in settlement of current accounts payable prior to maturity, or obtains cash payment on the scheduled maturity date.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Inventories
The components of inventories are as follows:
March 30, 2019
December 29, 2018
(In thousands)
Raw Materials
$
46,684
$
44,522
Work in Process
20,239
15,876
Finished Goods
36,106
25,975
$
103,029
$
86,373
Intangible Assets, Net
Acquired intangible assets by major asset class are as follows:
(In thousands)
Gross
Accumulated Amortization
Currency Translation
Net
March 30, 2019
Definite-Lived
Customer relationships
$
166,183
$
(41,222
)
$
(4,498
)
$
120,463
Product technology
57,001
(24,619
)
(1,761
)
30,621
Tradenames
5,227
(2,090
)
(419
)
2,718
Other
17,784
(12,581
)
(576
)
4,627
246,195
(80,512
)
(7,254
)
158,429
Indefinite-Lived
Tradenames
26,300
—
(133
)
26,167
Acquired Intangible Assets
$
272,495
$
(80,512
)
$
(7,387
)
$
184,596
December 29, 2018
Definite-Lived
Customer relationships
$
113,283
$
(38,160
)
$
(4,520
)
$
70,603
Product technology
46,501
(23,563
)
(1,677
)
21,261
Tradenames
5,227
(1,980
)
(390
)
2,857
Other
13,744
(11,476
)
(127
)
2,141
178,755
(75,179
)
(6,714
)
96,862
Indefinite-Lived
Tradenames
16,600
—
(115
)
16,485
Acquired Intangible Assets
$
195,355
$
(75,179
)
$
(6,829
)
$
113,347
Intangible assets are initially recorded at fair value at the date of acquisition. Definite-lived intangible assets are stated net of accumulated amortization and currency translation in the accompanying condensed consolidated balance sheet. The Company amortizes definite-lived intangible assets over lives that have been determined based on the anticipated cash flow benefits of the intangible asset.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Goodwill
The changes in the carrying amount of goodwill by segment are as follows:
(In thousands)
Papermaking Systems
Wood Processing Systems
Material Handling Systems
Total
Balance at December 29, 2018
Gross balance
$
241,912
$
101,771
$
—
$
343,683
Accumulated impairment losses
(85,509
)
—
—
(85,509
)
Net balance
156,403
101,771
—
258,174
2019 Adjustments
Acquisition (Note 2)
—
—
86,502
86,502
Currency translation
(1,031
)
123
—
(908
)
Total 2019 adjustments
(1,031
)
123
86,502
85,594
Balance at March 30, 2019
Gross balance
240,881
101,894
86,502
429,277
Accumulated impairment losses
(85,509
)
—
—
(85,509
)
Net balance
$
155,372
$
101,894
$
86,502
$
343,768
Warranty Obligations
The Company's contracts covering the sale of its products include warranty provisions that provide assurance to its customers that the products will comply with agreed-upon specifications. The Company negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications.
The changes in the carrying amount of accrued warranty costs included in other current liabilities in the accompanying condensed consolidated balance sheet are as follows:
Three Months Ended
(In thousands)
March 30, 2019
March 31, 2018
Balance at Beginning of Year
$
5,726
$
5,498
Provision charged to expense
1,076
715
Usage
(925
)
(364
)
Acquisition
295
—
Currency translation
(3
)
61
Balance at End of Period
$
6,169
$
5,910
Revenue Recognition
The Company recognizes revenue under ASC 606, Revenue from Contracts with Customers. Most of the Company’s revenue is recognized at a point in time for each performance obligation under the contract when the customer obtains control of the goods or service. The majority of the Company’s parts and consumables products and capital products with minimal customization are accounted for at a point in time. The Company has made a policy election not to treat the obligation to ship as a separate performance obligation under the contract and, as a result, the associated shipping costs are accrued when revenue is recognized.
The remaining portion of the Company’s revenue is recognized on an over time basis based on an input method that compares the costs incurred to date to the total expected costs required to satisfy the performance obligation. Contracts are accounted for on an over time basis when they include products which have no alternative use and an enforceable right to payment over time. Contracts recognized on an over time basis are typically for large capital projects which are highly customized for the customer and, as a result, would include a significant cost to rework in the event of cancellation.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
The following table presents revenue by revenue recognition method:
Three Months Ended
March 30,
March 31,
(In thousands)
2019
2018
Point in time
$
148,276
$
142,005
Over time
23,040
7,188
$
171,316
$
149,193
The transaction price is typically based on the amount billed to the customer and includes estimated variable consideration where applicable. Such variable consideration relates to certain performance guarantees and rights to return the product. The Company estimates variable consideration as the most likely amount to which it expects to be entitled based on the terms of the contracts with customers and historical experience, where relevant. For contracts with multiple performance obligations, the transaction price is allocated to each performance obligation based on the relative stand-alone selling price.
The following table presents the disaggregation of revenues by product type and geography:
Three Months Ended
March 30,
March 31,
(In thousands)
2019
2018
Revenues by Product Type:
Parts and Consumables
$
112,850
$
95,985
Capital
58,466
53,208
$
171,316
$
149,193
Revenues by Geography:
North America
$
100,876
$
77,616
Europe
38,985
41,493
Asia
17,078
20,148
Rest of World
14,377
9,936
$
171,316
$
149,193
See Note 12, Business Segment Information, for further details on the disaggregation of revenues by segment and product line.
The following table presents balances from contracts with customers:
March 30, 2019
December 29, 2018
(In thousands)
Accounts receivable
$
104,120
$
92,624
Contract assets
$
16,996
$
15,741
Contract liabilities
$
38,950
$
34,774
Contract assets represent unbilled revenues associated with revenue recognized on contracts accounted for on an over time basis, which will be billed in future periods based on the contract terms. Contract liabilities consist of customer deposits, advanced billings, and deferred revenue. Deferred revenue is included in other current liabilities in the accompanying condensed consolidated balance sheet. Contract liabilities will be recognized as revenue in future periods once the revenue recognition criteria are met. The majority of the contract liabilities relate to advanced payments on contracts accounted for at a point in time. These advance payments will be recognized as revenue when the Company's performance obligations have been satisfied, which typically occurs when the product has shipped and control of the asset has transferred to the customer. The Company recognized revenue of $19,095,000 in the first three months of 2019 and $27,325,000 in the first three months of 2018 that was included in the contract liabilities balance at the beginning of 2019 and 2018, respectively.
Customers in China will often settle their accounts receivable with a banker's acceptance draft, in which case cash settlement will be delayed until the banker's acceptance draft matures or is settled prior to maturity. For customers outside of
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
China, final payment for the majority of the Company's products is received in the quarter following the product shipment. Certain of the Company's contracts include a longer period before final payment is due, which is typically within one year of final shipment or transfer of control to the customer.
Recently Adopted Accounting Pronouncements
Leases (Topic 842). In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, which requires a lessee to recognize a right-of-use (ROU) asset and a corresponding lease liability for operating leases, initially measured at the present value of the future lease payments, on its balance sheet. This ASU also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. The Company adopted this ASU as of the beginning of fiscal 2019 using the cumulative-effect adjustment method. As a result, prior period amounts were not restated and continue to be under Topic 840, Leases, which did not require the recognition of operating leases on the balance sheet and is not comparative. As permitted under ASC 842, the Company elected the package of practical expedients for expired or existing contracts, which does not require the reassessment of prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected practical expedients relating to its ongoing accounting, including a short-term lease recognition exemption allowing lessees not to recognize ROU assets and liabilities with a term of 12 months or less and an election not to separate lease and non-lease components for all leases except vehicle leases.
The adoption of this standard as of the beginning of fiscal 2019 resulted in increases of 2.3% to total assets and 4.8% to total liabilities and an immaterial decrease to retained earnings. In addition, the adoption of this ASU did not have a material impact on the Company’s condensed consolidated statements of income or cash flows. See Note 8, Leases, for required lease accounting disclosures.
Derivatives and Hedging (Topic 815), Targeted Improvements in Accounting for Hedging Activity. In August 2017, the FASB issued ASU No. 2017-12, which revises hedge accounting to better portray the economic results of an entity’s risk management activities, simplifies hedge accounting guidance, and improves disclosures of hedge accounting arrangements. The Company adopted this ASU on a prospective basis at the beginning of fiscal 2019. The adoption of this ASU did not have a material effect on the Company's condensed consolidated financial statements.
Recent Accounting Pronouncements Not Yet Adopted
Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. In June 2016, the FASB issued ASU No. 2016-13, which significantly changes the way entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses expected to occur over their remaining lives. This new guidance is effective for the Company in fiscal 2020 with early adoption permitted beginning in fiscal 2019. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.
Compensation-Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20), Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. In August 2018, the FASB issued ASU 2018-14, which removes, adds and clarifies several disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. This new guidance is effective on a retrospective basis for the Company in fiscal 2021. Early adoption is permitted. The Company does not believe that the adoption of this ASU will have a material effect on its condensed consolidated financial statements.
2. Acquisition
The Company’s acquisitions have been accounted for using the purchase method of accounting and its results are included in its condensed consolidated financial statements from the date of acquisition. Historically, the Company’s acquisitions have been made at prices above the fair value of identifiable net assets, resulting in goodwill. Acquisition transaction costs are included in selling, general, and administrative expenses (SG&A) in the accompanying condensed consolidated statement of income as incurred. The Company recorded acquisition transaction costs of $843,000 in the first three months of 2019 relating to its recent acquisition described below.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
2. Acquisition (continued)
On January 2, 2019, the Company acquired, directly and indirectly, all the outstanding equity interests of Syntron Material Handling Group, LLC and certain of its affiliates (SMH) pursuant to an equity purchase agreement, dated December 9, 2018, for approximately $176,855,000, net of cash acquired, which includes a post-closing adjustment of $1,567,000 that was paid by the Company in April 2019. The Company funded the acquisition through borrowings under its revolving credit facility.
SMH, which comprises the Company's new Material Handling Systems segment, has manufacturing operations in Mississippi, United States and in China. SMH is a leading provider of material handling equipment and systems to various process industries, including mining, aggregates, food processing, packaging, and pulp and paper. Revenues for SMH were approximately $89,365,000 for the trailing twelve months ended October 31, 2018. The Company expects several synergies in connection with this acquisition, including expansion of product sales into new markets by leveraging SMH's existing presence, strengthening of SMH's relationships in the pulp and paper industry, and sourcing efficiencies. Goodwill from the SMH acquisition was $86,502,000, of which $64,438,000 is expected to be deductible for tax purposes over 15 years. In addition, intangible assets acquired were $77,140,000, of which $66,725,000 is expected to be deductible for tax purposes over 15 years. For the quarter ended March 30, 2019, the Company recorded revenues of $20,584,000 and an operating loss of $1,353,000 for SMH from the date of acquisition, including amortization expense of $3,308,000 associated with acquired profit in inventory and backlog, and $843,000 of acquisition transaction costs.
The following table summarizes the estimated fair values of assets acquired and liabilities assumed and the purchase price for SMH. The final purchase accounting and purchase price allocation remain subject to change as the Company continues to refine its preliminary valuation of certain acquired assets and the valuation of acquired intangibles.
(In thousands)
Net Assets Acquired:
Cash, Cash Equivalents, and Restricted Cash
$
2,431
Accounts Receivable
10,271
Inventory
12,982
Other Current Assets
900
Property, Plant, and Equipment
7,730
Other Assets
10,994
Definite-Lived Intangible Assets
Customer relationships
52,900
Product technology
10,500
Other
4,040
Indefinite-Lived Intangible Assets
Tradenames
9,700
Goodwill
86,502
Total assets acquired
208,950
Accounts Payable
4,663
Customer Deposits
2,919
Other Current Liabilities
3,724
Long-Term Lease Liabilities
15,244
Long-Term Deferred Income Taxes
3,114
Total liabilities assumed
29,664
Net assets acquired
$
179,286
Purchase Price:
Cash Paid to Seller Borrowed Under Revolving Credit Facility
$
177,719
Post-Closing Adjustment to be Paid to Seller
1,567
Total Purchase Price
$
179,286
The weighted-average amortization period for definite-lived intangible assets is 14 years, including weighted-average amortization periods of 15 years for customer relationships, 14 years for product technology, and 8 years for other intangible assets.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
2. Acquisition (continued)
Unaudited Supplemental Pro Forma Information
Had the acquisition of SMH been completed as of the beginning of 2018, the Company’s pro forma results of operations for the three months ended March 30, 2019 and March 31, 2018 would have been as follows:
Three Months Ended
(In thousands, except per share amounts)
March 30, 2019
March 31, 2018
Revenues
$
171,316
$
170,532
Net Income Attributable to Kadant
$
14,112
$
8,475
Earnings per Share Attributable to Kadant:
Basic
$
1.27
$
0.77
Diluted
$
1.24
$
0.75
Pro forma results include the following non-recurring pro forma adjustments that were directly attributable to the business combination:
•
Pre-tax charge to SG&A expenses of $843,000 in 2018 and reversal in 2019, for acquisition transaction costs.
•
Estimated pre-tax charge to cost of revenues of $2,310,000 in 2018 and reversal in 2019, for the sale of SMH inventory revalued at the date of acquisition.
•
Estimated pre-tax charge to SG&A expenses of $998,000 in 2018 and reversal in 2019, for intangible asset amortization related to acquired backlog.
These pro forma results of operations have been prepared for comparative purposes only, and they do not purport to be indicative of the results of operations that would have resulted had the acquisition of SMH occurred as of the beginning of 2018, or that may result in the future.
3. Earnings per Share
Basic and diluted earnings per share (EPS) are calculated as follows:
Three Months Ended
March 30, 2019
March 31, 2018
(In thousands, except per share amounts)
Amounts Attributable to Kadant:
Net Income
$
10,900
$
10,858
Basic Weighted Average Shares
11,133
11,042
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan Shares
252
300
Diluted Weighted Average Shares
11,385
11,342
Basic Earnings per Share
$
0.98
$
0.98
Diluted Earnings per Share
$
0.96
$
0.96
The dilutive effect of the outstanding and unvested restricted stock units (RSUs) of the Company's common stock totaling 44,000 shares in the first three months of 2019 and 30,000 in the first three months of 2018, was not included in the computation of diluted EPS for the respective periods as the effect would have been antidilutive or, for unvested performance-based RSUs, the performance conditions had not been met as of the end of the reporting periods.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Provision for Income Taxes
The provision for income taxes was $3,963,000 in the first three months of 2019 and $3,861,000 in the first three months of 2018. The effective tax rate of 26% in the first three months of 2019 was higher than the Company's statutory rate of 21% primarily due to nondeductible expenses, the distribution of the Company’s worldwide earnings, state taxes, and tax expense associated with the Global Intangible Low-Taxed Income (GILTI) provisions of the Tax Cuts and Jobs Act of 2017 (2017 Tax Act). This incremental tax expense was offset in part by a decrease in tax related to the net excess income tax benefits from stock-based compensation arrangements. The effective tax rate of 26% in the first three months of 2018 was higher than the Company's statutory tax rate of 21% primarily due to a true-up to the federal provisional net income tax expense initially recorded in 2017 for the 2017 Tax Act, the U.S. tax cost of foreign operations, including the GILTI provisions of the 2017 Tax Act, and the distribution of the Company's worldwide earnings. This incremental tax expense was offset in part by a decrease in tax related to the net excess income tax benefits from stock-based compensation arrangements, the reversal of tax reserves associated with uncertain tax positions, and a favorable impact to state taxes primarily related to the true-up to the provisional net income tax expense initially recorded in 2017 for the 2017 Tax Act.
5. Long-Term Obligations
Long-term obligations are as follows:
March 30, 2019
December 29, 2018
(In thousands)
Revolving Credit Facility, due 2023
$
324,720
$
141,106
Commercial Real Estate Loan, due 2019 to 2028
20,213
20,475
Senior Promissory Notes, due 2023 to 2028
10,000
10,000
Finance Leases, due 2019 to 2024
1,921
—
Other Borrowings, due 2019 to 2023
4,206
4,388
Unamortized Debt Issuance Costs
(143
)
(148
)
Total
360,917
175,821
Less: Current Maturities of Long-Term Obligations
(2,631
)
(1,668
)
Long-Term Obligations
$
358,286
$
174,153
See Note 11 for the fair value information related to the Company's long-term obligations.
Revolving Credit Facility
In 2018, the Company entered into a second amendment (Second Amendment) to its existing amended and restated five-year, unsecured multi-currency revolving credit facility, dated as of March 1, 2017 (as amended, the Credit Agreement). Pursuant to the Second Amendment, the Company has a borrowing capacity of $400,000,000, with an uncommitted unsecured incremental borrowing facility of $150,000,000 under its Credit Agreement, and a maturity date of December 14, 2023. Interest on borrowings outstanding accrues and is payable quarterly in arrears and is calculated at one of the following rates selected by the Company: (i) the Base Rate, calculated as the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate as published by Citizens Bank, N.A., and (c) the thirty-day London Inter-Bank Offered Rate (LIBOR) rate, as defined, plus 0.50%; or (ii) the LIBOR rate (with a zero percent floor), as defined, plus an applicable margin of 1% to 2.25%. The applicable margin is determined based upon the ratio of the Company's total debt, net of unrestricted cash up to $30,000,000 and certain debt obligations, to earnings before interest, taxes, depreciation, and amortization (EBITDA) as defined in the Credit Agreement.
The obligations of the Company under the Credit Agreement may be accelerated upon the occurrence of an event of default, which includes customary events of default under such financing arrangements. In addition, as amended by the Second Amendment, the Credit Agreement contains negative covenants applicable to the Company and its subsidiaries, including financial covenants requiring the Company to maintain a maximum consolidated leverage ratio of 3.75 to 1.00, or for the quarter during which a material acquisition occurs and for the three fiscal quarters thereafter, 4.00 to 1.00, and limitations on making certain restricted payments (including dividends and stock repurchases).
Loans under the Credit Agreement are guaranteed by certain domestic subsidiaries of the Company. In addition, one of the Company’s foreign subsidiaries entered into a separate guarantee agreement limited to certain obligations of two foreign subsidiary borrowers.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
5. Long-Term Obligations (continued)
As of March 30, 2019, the outstanding balance under the Credit Agreement was $324,720,000, and included $39,863,000 of Canadian dollar-denominated borrowings and $15,857,000 of euro-denominated borrowings. As of March 30, 2019, the Company had $75,344,000 of borrowing capacity available under its Credit Agreement, which was calculated by translating its foreign-denominated borrowings using borrowing date foreign exchange rates.
See Note 10, Derivatives, under the heading Interest Rate Swap Agreements, for information relating to the swap agreements used to hedge the Company’s exposure to movements in the three-month LIBOR rate on its U.S. dollar-denominated debt borrowed under the Credit Agreement.
The weighted average interest rate for the outstanding balance under the Credit Agreement was 3.64% as of March 30, 2019.
Commercial Real Estate Loan
In 2018, the Company and certain domestic subsidiaries borrowed $21,000,000 under a promissory note (Real Estate Loan) which is repayable in quarterly principal installments of $262,500 over a ten-year period with the remaining principal balance of $10,500,000 due upon maturity. Interest accrues and is payable quarterly in arrears at a fixed rate of 4.45% per annum. The Company is not permitted to prepay any amount before July 6, 2019. Any voluntary prepayments are subject to a 2% prepayment fee if paid in the twelve months following July 6, 2019 and are subject to a 1% prepayment fee if paid in the twelve months following July 6, 2020. Thereafter, no prepayment fee will be applied to voluntary prepayment by the Company.
The Real Estate Loan is secured by real estate and related personal property of the Company and certain of its domestic subsidiaries, pursuant to the mortgage and security agreements dated July 6, 2018 (Mortgage and Security Agreements). The obligations of the Company under the Real Estate Loan may be accelerated upon the occurrence of an event of default under the Real Estate Loan and the Mortgage and Security Agreements, which includes customary events of default for financings of this type. In addition, a default under the Credit Agreement or any successor credit facility would be an event of default under the Real Estate Loan. The effective interest rate for the Real Estate Loan, including amortization of debt issuance costs, was 4.60% as of March 30, 2019.
Senior Promissory Notes
In 2018, the Company entered into an uncommitted, unsecured Multi-Currency Note Purchase and Private Shelf Agreement (Note Purchase Agreement). Simultaneous with the execution of the Note Purchase Agreement, the Company issued senior promissory notes (Initial Notes) in an aggregate principal amount of $10,000,000, with a per annum interest rate of 4.90% payable semiannually, and a maturity date of December 14, 2028. The Company is required to prepay a portion of the principal of the Initial Notes beginning on December 14, 2023 and each year thereafter, and may optionally prepay the principal on the Initial Notes, together with any prepayment premium, at any time (in a minimum amount of $1,000,000, or the foreign currency equivalent thereof, if applicable) in accordance with the Note Purchase Agreement. The obligations of Initial Notes may be accelerated upon an event of default as defined in the Note Purchase Agreement, which includes customary events of default under such financing arrangements.
In accordance with the Note Purchase Agreement, the Company may also issue additional senior promissory notes (together with the Initial Notes, the Senior Promissory Notes) up to an additional $115,000,000 until the earlier of December 14, 2021 or the thirtieth day after written notice to terminate the issuance and sale of additional notes pursuant to the Note Purchase Agreement. The Senior Promissory Notes are pari passu with the Company’s indebtedness under the Credit Agreement, and any other senior debt of the Company, subject to certain specified exceptions, and participate in a sharing agreement with respect to the obligations of the Company and its subsidiaries under the Credit Agreement. The Senior Promissory Notes are guaranteed by certain of the Company’s domestic subsidiaries.
Debt Compliance
As of March 30, 2019, the Company was in compliance with the covenants related to its debt obligations.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
5. Long-Term Obligations (continued)
Finance Leases
The Company's finance leases primarily relate to contracts for its fleet of vehicles. See Note 8 for further information relating to the Company's finance leases.
Other Borrowings
Other borrowings include a sale-leaseback financing arrangement for a manufacturing facility in Germany. Under this arrangement, the quarterly lease payment includes principal, interest, and a payment to the landlord toward a loan receivable. The interest rate on the outstanding obligation is 1.79%. The secured loan receivable, which is included in other assets in the accompanying condensed consolidated balance sheet, was $736,000 at March 30, 2019. The lease arrangement provides for a fixed price purchase option, net of the projected loan receivable, of $1,494,000 at the end of the lease term in 2022. If the Company does not exercise the purchase option for the facility, the Company will receive cash from the landlord to settle the loan receivable. As of March 30, 2019, $3,941,000 was outstanding under this obligation.
6. Stock-Based Compensation
The Company recognized stock-based compensation expense of $1,553,000 in the first three months of 2019 and $1,464,000 in the first three months of 2018 within SG&A expenses in the accompanying condensed consolidated statement of income. The Company recognizes compensation expense for all stock-based awards granted to employees and directors based on the grant date estimate of fair value for those awards. The fair value of RSUs is based on the grant date price of the Company's common stock, reduced by the present value of estimated dividends foregone during the requisite service period. For time-based RSUs, compensation expense is recognized ratably over the requisite service period for the entire award based on the grant date fair value, and net of actual forfeitures recorded when they occur. For performance-based RSUs, compensation expense is recognized ratably over the requisite service period for each separately-vesting portion of the award based on the grant date fair value, net of actual forfeitures recorded when they occur, and remeasured each reporting period until the total number of RSUs to be issued is known. Unrecognized compensation expense related to stock-based compensation totaled approximately $9,388,000 at March 30, 2019, and will be recognized over a weighted average period of 2.0 years.
On March 4, 2019, the Company granted to certain of its officers performance-based RSUs, which represented, in aggregate, the right to receive 27,422 shares (the target RSU amount), with an aggregate grant date fair value of $2,364,000. The RSUs are subject to adjustment based on the achievement of the performance measure selected for the 2019 fiscal year, which is a specified target for adjusted EBITDA generated from operations for the 2019 fiscal year. The RSUs are adjusted by comparing the actual adjusted EBITDA for the performance period to the target adjusted EBITDA. Actual adjusted EBITDA between 50% and 100% of the target adjusted EBITDA results in an adjustment of 50% to 100% of the RSU amount. Actual adjusted EBITDA between 100% and 115% of the target adjusted EBITDA results in an adjustment using a straight-line linear scale between 100% and 150% of the RSU amount. Actual adjusted EBITDA in excess of 115% results in an adjustment capped at 150% of the RSU amount. If actual adjusted EBITDA is below 50% of the target adjusted EBITDA for the 2019 fiscal year, these performance-based RSUs will be forfeited. In the first three months of 2019, the Company recognized compensation expense based on the probable number of performance-based RSUs expected to vest, which was 100% of the target RSU amount. Following the adjustment, the performance-based RSUs will be subject to additional time-based vesting, and will vest in three equal annual installments on March 10 of 2020, 2021, and 2022, provided that the officer is employed by the Company on the applicable vesting dates. On March 4, 2019, the Company also granted time-based RSUs representing 39,206 shares to its officers and employees with an aggregate grant date fair value of $3,385,000. These time-based RSUs generally vest in three equal annual installments on March 10 of 2020, 2021, and 2022, provided that a recipient remains employed by the Company on the applicable vesting dates.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
7. Retirement Benefit Plans
The Company includes the service cost of net periodic benefit cost in operating income and all other components are included in other expense, net in the accompanying condensed consolidated statement of income.
The components of net periodic benefit cost are as follows:
Three Months Ended March 30, 2019
Three Months Ended March 31, 2018
(In thousands, except percentages)
U.S. Pension
Non-U.S. Pension
Other Post-Retirement
U.S. Pension
Non-U.S. Pension
Other Post-Retirement
Service Cost
$
—
$
43
$
1
$
175
$
36
$
53
Interest Cost
283
29
38
298
30
43
Expected Return on Plan Assets
(249
)
(17
)
(1
)
(322
)
(11
)
(1
)
Recognized Net Actuarial Loss
8
5
3
135
16
34
Amortization of Prior Service Cost
—
—
—
—
2
22
$
42
$
60
$
41
$
286
$
73
$
151
The weighted average assumptions used to determine net periodic benefit cost are as follows:
Discount Rate
4.10
%
2.80
%
4.44
%
3.51
%
3.80
%
3.65
%
Expected Long-Term Return on Plan Assets
4.10
%
9.22
%
9.22
%
4.50
%
7.43
%
7.43
%
Rate of Compensation Increase
—
%
2.98
%
5.57
%
3.00
%
3.69
%
3.07
%
In 2018, the Company's board of directors and its compensation committee approved amendments to freeze and terminate the Company's U.S. pension plan (Retirement Plan) and its restoration plan (Restoration Plan) as of December 29, 2018. Procedures for plan settlement and distribution of the Retirement Plan assets will be initiated once the plan termination satisfies certain regulatory requirements, which is expected to occur in late 2019 or early 2020. At the settlement date, the Company will recognize a loss based on the difference between the unrecognized actuarial loss, unfunded benefit obligation, and any additional cash required to be paid. Participants in the Retirement Plan will have the option to receive either a lump sum payment or an annuity. Retirees will continue to receive payments pursuant to their current annuity elections. The Company will settle liabilities under the Restoration Plan by paying a lump sum to plan participants between twelve and twenty-four months following the termination date. The Company expects to settle the liabilities under the Restoration Plan in early 2020. The Company has included both the Retirement Plan liability of $1,020,000 and the Restoration Plan liability of $2,300,000 at March 30, 2019 in accrued payroll and employee benefits in the accompanying condensed consolidated balance sheet. The Company does not plan to make any material cash contributions to its other pension and post-retirement plans in 2019.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
8. Leases
Under ASC 842, Leases, the Company determines if an arrangement is a lease obligation at inception of the contract. The Company enters into operating and finance lease commitments primarily for its manufacturing and office space, fleet of vehicles, and equipment leases that expire on various dates over the next 15 years, some of which include one or more options to extend the lease for up to 5 years. In addition, the Company leases land associated with certain of its buildings in Canada and China, under long-term leases expiring on various dates ranging from 2032 to 2062, one of which includes an assumed option to extend the lease for up to 10 years.
The Company's operating lease ROU assets and operating lease liabilities with contract terms greater than 12 months are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. In determining the present value of future lease payments, the Company utilizes either the rate implicit in the lease if that rate is readily determinable or the Company’s incremental secured borrowing rate commensurate with the term of the underlying lease. In addition, the calculation may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. The Company recognizes its operating lease expense for lease payments on a straight-line basis over the lease term. Variable lease costs are not included in fixed lease payments and as a result, are excluded from the measurement of the ROU assets and lease liabilities. The Company expenses all variable lease costs as incurred, which were not material for the quarter ended March 30, 2019.
The Company's lease agreements often contain lease and non-lease components. For real estate and equipment leases, the Company accounts for the lease and non-lease components as a single lease component. For vehicle leases, the Company does not combine lease and non-lease components.
The components of lease expense are as follows:
Three Months Ended
(In thousands)
March 30, 2019
Operating Lease Cost
$
1,370
Short-Term Lease Cost
185
Finance Lease Cost:
ROU asset amortization
293
Interest on lease liabilities
19
Total Finance Lease Cost
312
Total Lease Costs
$
1,867
Supplemental cash flow information related to leases is as follows:
Three Months Ended
(In thousands)
March 30, 2019
Cash Paid for Amounts Included in the Measurement of Lease Liabilities:
Operating cash flows from operating leases
$
1,391
Operating cash flows from finance leases
$
19
Financing cash flows from finance leases
$
274
ROU Assets Obtained in Exchange for Lease Obligations (a):
Operating leases
$
27,044
Finance leases
$
2,161
(a)
Includes additions related to the transition adjustment for the adoption ASC 842. The post-adoption additions of operating leases were $11,726,000, of which $10,994,000 related to ROU assets obtained as part of our acquisition of SMH. The post-adoption additions of finance leases were not material.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
8. Leases (continued)
Supplemental balance sheet information related to leases is as follows:
(In thousands, except lease term and discount rate)
Balance Sheet Line Item
March 30, 2019
Operating Leases:
ROU assets
Other assets
$
29,348
Short-term liabilities
Other current liabilities
$
4,188
Long-term liabilities
Other long-term liabilities
26,607
Total operating lease liabilities
$
30,795
Finance Leases:
ROU assets, at cost
Property, plant, and equipment, at cost
$
3,288
ROU assets accumulated amortization
Less: accumulated depreciation and amortization
(1,219
)
ROU assets, net
Property, plant, and equipment, net
$
2,069
Short-term obligations
Current maturities of long-term obligations
$
978
Long-term obligations
Long-term obligations
943
Total finance lease liabilities
$
1,921
Weighted Average Remaining Lease Term:
Operating leases
10.6 years
Finance leases
2.2 years
Weighted Average Discount Rate:
Operating leases
3.94
%
Finance leases
4.13
%
As of March 30, 2019, future lease payments for lease liabilities are as follows:
Operating
Finance
(In thousands)
Leases
Leases
2019
$
4,038
$
803
2020
4,876
806
2021
4,079
347
2022
3,416
37
2023
3,065
14
Thereafter
18,657
—
Total Future Lease Payments
38,131
2,007
Less: Imputed Interest
(7,336
)
(86
)
Present Value of Lease Payments
$
30,795
$
1,921
As of March 30, 2019, the Company has no significant operating and finance leases that had not yet commenced.
As previously disclosed in the Company's 2018 Annual Report on Form 10-K and under the previous lease accounting standard, future minimum lease payments for noncancelable operating leases were as follows:
Notes to Condensed Consolidated Financial Statements
(Unaudited)
9. Accumulated Other Comprehensive Items
Comprehensive income combines net income and other comprehensive items, which represent certain amounts that are reported as components of stockholders' equity in the accompanying condensed consolidated balance sheet.
Changes in each component of accumulated other comprehensive items (AOCI), net of tax, are as follows:
(In thousands)
Foreign
Currency
Translation
Adjustment
Pension and Other Post-Retirement Benefit Liability Adjustments
Deferred Loss on Cash Flow Hedges
Total
Balance at December 29, 2018
$
(34,804
)
$
(4,375
)
$
(197
)
$
(39,376
)
Other comprehensive (loss) income before reclassifications
(432
)
9
(222
)
(645
)
Reclassifications from AOCI
—
12
(15
)
(3
)
Net current period other comprehensive (loss) income