Form 10-Q Wesco Aircraft Holdings, For: Dec 31
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2017
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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, CA 91355
(Address of Principal Executive Offices and Zip Code)
(661) 775-7200
(Registrant’s Telephone Number, Including Area Code)
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, and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 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 and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | x | Accelerated filer | o | |
Non-accelerated filer | o | (Do not check if a smaller reporting company) | ||
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. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares of common stock (par value $0.001 per share) of the registrant outstanding as of January 31, 2018 was 99,513,305.
INDEX
Page | ||
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PART I — FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)
December 31, 2017 | September 30, 2017 | ||||||
Assets | |||||||
Current assets | |||||||
Cash and cash equivalents | $ | 41,948 | $ | 61,625 | |||
Accounts receivable, net of allowance for doubtful accounts of $3,158 and $3,109 at December 31, 2017 and September 30, 2017, respectively | 253,602 | 256,301 | |||||
Inventories | 856,253 | 827,870 | |||||
Prepaid expenses and other current assets | 16,542 | 13,733 | |||||
Income taxes receivable | 3,057 | 3,617 | |||||
Total current assets | 1,171,402 | 1,163,146 | |||||
Property and equipment, net | 49,893 | 50,355 | |||||
Deferred debt issuance costs, net | 3,903 | 3,676 | |||||
Goodwill | 266,644 | 266,644 | |||||
Intangible assets, net | 174,578 | 178,292 | |||||
Deferred tax assets | 75,400 | 76,038 | |||||
Other assets | 16,466 | 15,956 | |||||
Total assets | $ | 1,758,286 | $ | 1,754,107 | |||
Liabilities and Stockholders’ Equity | |||||||
Current liabilities | |||||||
Accounts payable | $ | 161,684 | $ | 184,273 | |||
Accrued expenses and other current liabilities | 33,896 | 35,329 | |||||
Income taxes payable | 5,614 | 3,290 | |||||
Capital lease obligations, current portion | 3,153 | 2,952 | |||||
Short-term borrowings and current portion of long-term debt | 94,000 | 75,000 | |||||
Total current liabilities | 298,347 | 300,844 | |||||
Capital lease obligations, less current portion | 2,950 | 2,013 | |||||
Long-term debt, less current portion | 783,673 | 788,838 | |||||
Deferred income taxes | 3,797 | 3,197 | |||||
Other liabilities | 17,109 | 9,484 | |||||
Total liabilities | 1,105,876 | 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, $0.001 par value, 950,000,000 shares authorized, 99,517,543 and 99,450,902 shares issued and outstanding at December 31, 2017 and September 30, 2017, respectively | 99 | 99 | |||||
Additional paid-in capital | 438,310 | 436,522 | |||||
Accumulated other comprehensive loss | (83,361 | ) | (84,626 | ) | |||
Retained earnings | 297,362 | 297,736 | |||||
Total stockholders’ equity | 652,410 | 649,731 | |||||
Total liabilities and stockholders’ equity | $ | 1,758,286 | $ | 1,754,107 | |||
See the accompanying notes to the consolidated financial statements
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Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Statements of Earnings and Comprehensive Income
(In thousands, except share data)
(Unaudited)
Three Months Ended December 31, | ||||||||
2017 | 2016 | |||||||
Net sales | $ | 363,091 | $ | 339,371 | ||||
Cost of sales | 268,667 | 249,914 | ||||||
Gross profit | 94,424 | 89,457 | ||||||
Selling, general and administrative expenses | 69,852 | 63,201 | ||||||
Income from operations | 24,572 | 26,256 | ||||||
Interest expense, net | (11,838 | ) | (11,073 | ) | ||||
Other income, net | 260 | 288 | ||||||
Income before provision for income taxes | 12,994 | 15,471 | ||||||
Provision for income taxes | (13,368 | ) | (2,364 | ) | ||||
Net (loss) income | (374 | ) | 13,107 | |||||
Other comprehensive income (loss), net of income taxes | 1,265 | (11,257 | ) | |||||
Comprehensive income | $ | 891 | $ | 1,850 | ||||
Net (loss) income per share: | ||||||||
Basic | $ | (0.00 | ) | $ | 0.13 | |||
Diluted | $ | (0.00 | ) | $ | 0.13 | |||
Weighted average shares outstanding: | ||||||||
Basic | 99,096,914 | 98,319,926 | ||||||
Diluted | 99,096,914 | 98,821,794 | ||||||
See the accompanying notes to the consolidated financial statements
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Wesco Aircraft Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Three Months Ended December 31, | |||||||
2017 | 2016 | ||||||
Cash flows from operating activities | |||||||
Net (loss) income | $ | (374 | ) | $ | 13,107 | ||
Adjustments to reconcile net income to net cash used in operating activities: | |||||||
Depreciation and amortization | 7,256 | 6,729 | |||||
Amortization of deferred debt issuance costs | 1,508 | 3,202 | |||||
Bad debt and sales return reserve | 154 | 458 | |||||
Stock-based compensation expense | 1,815 | 2,690 | |||||
Inventory provision | 4,443 | 2,166 | |||||
Deferred income taxes | 593 | 491 | |||||
Other non-cash items | (95 | ) | (1,139 | ) | |||
Subtotal | 15,300 | 27,704 | |||||
Changes in assets and liabilities: | |||||||
Accounts receivable | 2,020 | (2,159 | ) | ||||
Income taxes receivable | 577 | (5,674 | ) | ||||
Inventories | (32,960 | ) | (44,335 | ) | |||
Prepaid expenses and other assets | (3,069 | ) | (1,993 | ) | |||
Accounts payable | (22,315 | ) | (8,334 | ) | |||
Accrued expenses and other liabilities | 8,226 | 6,008 | |||||
Income taxes payable | 2,341 | 697 | |||||
Net cash used in operating activities | (29,880 | ) | (28,086 | ) | |||
Cash flows from investing activities | |||||||
Purchase of property and equipment | (1,335 | ) | (1,316 | ) | |||
Net cash used in investing activities | (1,335 | ) | (1,316 | ) | |||
Cash flows from financing activities | |||||||
Proceeds from short-term borrowings | 46,000 | 25,000 | |||||
Repayment of short-term borrowings | (27,000 | ) | (5,000 | ) | |||
Repayment of long-term debt | (5,000 | ) | (6,344 | ) | |||
Debt issuance costs | (1,900 | ) | (10,462 | ) | |||
Repayment of capital lease obligations | (547 | ) | (330 | ) | |||
Net proceeds from exercise of stock options | — | 2,277 | |||||
Settlement on restricted stock tax withholding | (26 | ) | — | ||||
Net cash provided by financing activities | 11,527 | 5,141 | |||||
Effect of foreign currency exchange rate on cash and cash equivalents | 11 | (1,608 | ) | ||||
Net decrease in cash and cash equivalents | (19,677 | ) | (25,869 | ) | |||
Cash and cash equivalents, beginning of period | 61,625 | 77,061 | |||||
Cash and cash equivalents, end of period | $ | 41,948 | $ | 51,192 | |||
See the accompanying notes to the consolidated financial statements
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Wesco Aircraft Holdings, Inc. & Subsidiaries
Notes to the Consolidated Financial Statements
(Unaudited)
Note 1. Basis of Presentation and Significant Accounting Policies
The accompanying unaudited consolidated financial statements include the accounts of Wesco Aircraft Holdings, Inc. and its wholly owned subsidiaries (referred to herein as Wesco or the Company) prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The financial statements presented herein have not been audited by an independent registered public accounting firm, but include all material adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for fair statement of the financial position, results of operations and cash flows for the period. However, these results are not necessarily indicative of results for any other interim period or for the full fiscal year. The preparation of financial statements in conformity with GAAP requires us to make certain estimates and assumptions for the reporting periods covered by the financial statements. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent liabilities. Actual amounts could differ from these estimates. Our financial statements have been prepared under the assumption that our Company will continue as a going concern.
Certain information and footnote disclosures normally included in financial statements in accordance with GAAP have been omitted pursuant to the rules of the Securities and Exchange Commission (the SEC). The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K filed with the SEC on November 29, 2017 (the 2017 Form 10-K).
Certain reclassifications have been made to the amounts in prior periods to conform to the current period’s presentation.
Note 2. Recent Accounting Pronouncements
Changes to GAAP are established by the Financial Accounting Standards Board (FASB) in the form of Accounting Standards Updates (ASUs) to the FASB’s Accounting Standards Codification (ASC).
We consider the applicability and impact of all ASUs. ASUs not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial position and results of operations.
New Accounting Standards Issued
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which specifies the modification accounting applicable to any entity that changes the terms or conditions of a share-based payment award. ASU 2017-09 is effective for the Company in fiscal year 2019. Early adoption is permitted. We do not anticipate the adoption of ASU 2017-09 will have a significant impact on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other: Simplifying the Test for Goodwill Impairment, which simplifies the current requirements for testing goodwill for impairment by eliminating the second step of the two-step impairment test to measure the amount of an impairment loss. ASU 2017-04 is effective for the Company in fiscal year 2021, including interim reporting periods within that reporting period, and all annual and interim reporting periods thereafter. Early adoption is permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires lessees to recognize on the balance sheet a right-of-use asset, representing its right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from current GAAP. ASU 2016-02 retains a distinction between finance leases (i.e. capital leases under current GAAP) and operating leases. The classification criteria for distinguishing between finance leases and operating leases will be substantially similar to the classification criteria for distinguishing between capital leases and operating leases under current GAAP. ASU 2016-02 also requires qualitative and quantitative disclosures designed to assess the amount, timing, and uncertainty of cash flows arising from leases. A modified retrospective transition approach shall be used when adopting ASU 2016-02, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for the Company in fiscal year 2020 and interim periods therein, with early application permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements. As of September 30, 2017, total future minimum payments under our operating leases amounted to $51.4 million.
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In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. ASU 2016-01 is effective for the Company in fiscal year 2019, with early adoption permitted for certain provisions. We are currently evaluating the impact of ASU 2016-01 related to equity investments and the presentation and disclosure requirements of financial instruments on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 is amended by ASU 2015-14, ASU 2016-08, ASU 2016-10, ASU 2016-11, ASU 2016-12, ASU 2016-20, ASU 2017-10, ASU 2017-13 and ASU 2017-14, which FASB issued in August 2015, March 2016, April 2016, May 2016, May 2016, December 2016, May 2017, September 2017 and November 2017, respectively (collectively, the amended ASU 2014-09). The amended ASU 2014-09 provides a single comprehensive model for the recognition of revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. It requires an entity to recognize revenue when the entity transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amended ASU 2014-09 creates a five-step model that requires entities to exercise judgment when considering the terms of contract(s), which includes (1) identifying the contract(s) with the customer, (2) identifying the separate performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to the separate performance obligations, and (5) recognizing revenue as each performance obligation is satisfied. The amended ASU 2014-09 requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including qualitative and quantitative information about contracts with customers, significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The effective date for the amended ASU 2014-09 for the Company is fiscal year 2019, including interim reporting periods within that reporting period. Early adoption is permitted for fiscal year 2018, including interim reporting periods within that reporting period.
The amended ASU 2014-09 may have an impact on the timing and amount of revenues and cost of sales in our industry due primarily to changes in whether certain performance obligations are accounted for on a gross or net basis, separating service revenue from the related product revenue, reporting costs currently included in operating expense as costs of services, and capitalizing certain up-front costs related to contracts and amortizing them over the service period. We have completed reviewing our major contracts and are in the process of reviewing the remaining contracts on a sampling basis to determine the extent to which these and other issues may impact our results after adoption. We plan to adopt the amended ASU 2014-09 in fiscal 2019 using the modified retrospective method.
Adopted Accounting Standards
Effective October 1, 2017, we adopted ASU 2016-07, Investments - Equity Method and Joint Ventures (Topic 323), Simplifying the Transition to the Equity Method of Accounting. ASU 2016-07 eliminates the requirement that when an investment subsequently qualifies for use of the equity method as a result of an increase in level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. ASU 2016-07 requires that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and to adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. In addition, ASU 2016-07 requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The adoption of ASU 2016-07 did not have a material impact on our consolidated financial statements.
Effective October 1, 2017, we adopted ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which requires an entity to measure inventory at the lower of cost and net realizable value, and eliminates current GAAP options for measuring market value. ASU 2015-11 defines realizable value as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The adoption of ASU 2015-11 did not have a material impact on our consolidated financial statements.
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Note 3. Inventory
Our inventory is comprised solely of finished goods.
Charges to cost of sales related to provisions for excess and obsolete (E&O) inventory and related items were $4.4 million and $2.2 million during the three months ended December 31, 2017 and 2016, respectively. We believe that these amounts appropriately write-down E&O inventory to its net realizable value.
Note 4. Goodwill
As of December 31, 2017, goodwill consists of the following (in thousands):
Americas | EMEA | APAC | Total | |||||||||||||
Goodwill as of September 30, 2017, gross | $ | 773,384 | $ | 51,190 | $ | 16,955 | $ | 841,529 | ||||||||
Accumulated impairment | (569,201 | ) | — | (5,684 | ) | (574,885 | ) | |||||||||
Goodwill as of September 30, 2017, net | 204,183 | 51,190 | 11,271 | 266,644 | ||||||||||||
Changes during the period | — | — | — | — | ||||||||||||
Goodwill as of December 31, 2017, gross | 773,384 | 51,190 | 16,955 | 841,529 | ||||||||||||
Accumulated impairment | (569,201 | ) | — | (5,684 | ) | (574,885 | ) | |||||||||
Goodwill as of December 31, 2017, net | $ | 204,183 | $ | 51,190 | $ | 11,271 | $ | 266,644 | ||||||||
Note 5. Fair Value of Financial Instruments
Derivative Financial Instruments
We use derivative instruments primarily to manage exposures to foreign currency exchange rates and interest rates. Our primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with fluctuations in foreign exchange rates and changes in interest rates. Our derivatives expose us to credit risk to the extent that the counter-parties may be unable to meet the terms of the agreement. We, however, seek to mitigate such risks by limiting our counter-parties to major financial institutions. In addition, the potential risk of loss with any one counter-party resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counter-parties.
Cash Flow Hedges of Interest Rate Risk
Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish these objectives, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for our making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. We have one interest rate swap agreement outstanding, which we have designated as a cash flow hedge, in order to reduce our exposure to variability in cash flows related to interest payments on a portion of our outstanding debt. The interest rate swap agreement has an amortizing notional amount, which was $350.0 million on December 31, 2017, and matures on September 30, 2019, giving us the contractual right to pay a fixed interest rate of 2.2625% plus the applicable margin under the term loan B facility (as defined in Note 6 below; see Note 6 for the applicable margin).
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (loss) (AOCI) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three months ended December 31, 2017, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized immediately in earnings. During the three months ended December 31, 2017, we did not record any hedge ineffectiveness in earnings. No portion of our interest rate swap agreements is excluded from the assessment of hedge effectiveness.
Amounts reported in AOCI related to derivatives and the related deferred tax are reclassified to interest expense as interest payments are made on our variable-rate debt. As of December 31, 2017, we expect to reclassify approximately $1.3 million from accumulated other comprehensive loss and the related deferred tax to earnings as an increase to interest expense over the next 12 months when the underlying hedged item impacts earnings.
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Non-Designated Derivatives
On October 3 and October 5, 2016, we entered into two foreign currency forward contracts to partially reduce our exposure to foreign currency fluctuations for a subsidiary's net monetary assets, which are denominated in a foreign currency. Both foreign currency forward contracts expired on December 28, 2016. The derivatives were not designated as a hedging instrument. The change in their fair value is recognized as periodic gain or loss in the other income (loss), net line of our consolidated statement of earnings and comprehensive income. We did not have foreign currency forward contracts as of December 31, 2017 and September 30, 2017.
The following table summarizes the notional principal amounts at December 31, 2017, and September 30, 2017 of our outstanding interest rate swap agreement discussed above (in thousands).
Derivative Notional | |||||||||
December 31, 2017 | September 30, 2017 | ||||||||
Instruments designated as accounting hedges: | |||||||||
Interest rate swap contract | $ | 350,000 | $ | 375,000 | |||||
The following table provides the location and fair value amounts of our financial instrument, which is reported in our consolidated balance sheets as of December 31, 2017 and September 30, 2017 (in thousands).
Fair Value | |||||||||||
Balance Sheet Locations | December 31, 2017 | September 30, 2017 | |||||||||
Instrument designated as accounting hedge: | |||||||||||
Interest rate swap contract | Accrued expenses and other current liabilities | $ | 1,269 | $ | 2,462 | ||||||
Interest rate swap contract | Other liabilities | 101 | 903 | ||||||||
The following table provides the losses of our cash flow hedging instruments (net of income tax benefit), which were transferred from AOCI to interest expense on our consolidated statement of comprehensive income during the three months ended December 31, 2017 and 2016 (in thousands).
Location in Consolidated Statement of Comprehensive Income | Three Months Ended December 31, | ||||||||||
Cash Flow Hedge | 2017 | 2016 | |||||||||
Interest rate swap contracts | Interest expense, net | $ | 557 | $ | 252 | ||||||
The following table provides the effective portion of the amount of gain recognized in other comprehensive income (net of income taxes) for the three months ended December 31, 2017 and 2016 (in thousands).
Three Months Ended December 31, | |||||||||
Cash Flow Hedge | 2017 | 2016 | |||||||
Interest rate swap contracts | $ | 1,370 | $ | 2,182 | |||||
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The following table provides a summary of changes to our AOCI related to our cash flow hedging instrument (net of income taxes) during the three months ended December 31, 2017 (in thousands).
AOCI - Unrealized Gain (Loss) on Hedging Instruments | Three Months Ended December 31, 2017 | |||||
Balance at beginning of period | $ | (2,133 | ) | |||
Change in fair value of hedging instruments | 813 | |||||
Amounts reclassified to earnings | 557 | |||||
Net current period other comprehensive income | 1,370 | |||||
Balance at end of period | $ | (763 | ) | |||
The following table provides the pretax effect of our derivative instruments not designated as hedging instruments on our consolidated statements of earnings and comprehensive income for the three months ended December 31, 2017 and 2016 (in thousands).
Location in Consolidated Statement of Comprehensive Income | Three Months Ended December 31, | |||||||||
Instruments Not Designated As Hedging Instruments | ||||||||||
2017 | 2016 | |||||||||
Foreign currency forward contracts | Other income (loss), net | $ | — | $ | (2,595 | ) | ||||
Other Financial Instruments
Our financial instruments consist of cash and cash equivalents, accounts receivable and payable, accrued expenses and other current liabilities, and a line of credit. The carrying amounts of these instruments approximate fair value because of their short-term duration. The fair value of the long-term debt instruments is determined using current applicable rates for similar instruments as of the balance sheet date, a Level 2 measurement (as defined below). The principal amounts and fair values of the debt instruments were as follows (in thousands):
December 31, 2017 | September 30, 2017 | ||||||||||||||
Principal Amount | Fair Value | Principal Amount | Fair Value | ||||||||||||
Term loan A facility | $ | 375,000 | $ | 372,000 | $ | 380,000 | $ | 376,960 | |||||||
Term loan B facility | 440,562 | 429,107 | 440,562 | 428,667 | |||||||||||
Total long-term debt | $ | 815,562 | $ | 801,107 | $ | 820,562 | $ | 805,627 | |||||||
Fair Value Measurement
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To determine fair value, we primarily utilize reported market transactions and discounted cash flow analysis. We use a three-tier fair value hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs. The fair value hierarchy prioritizes the inputs to valuation techniques into three broad levels whereby the highest priority is given to Level 1 inputs and the lowest to Level 3 inputs. The three broad categories are:
Level 1: | Quoted prices in active markets for identical assets or liabilities. |
Level 2: | Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. |
Level 3: | Unobservable inputs for the asset or liability. |
The definition of fair value includes the consideration of nonperformance risk. Nonperformance risk refers to the risk that an obligation (either by a counter party or us) will not be fulfilled. For financial assets traded in an active market (Level 1),
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the nonperformance risk is included in the market price. For certain other financial assets and liabilities (Level 2 and 3), our fair value calculations have been adjusted accordingly.
There were no transfers between the assets and liabilities under Level 1 and Level 2 during the three months ended December 31, 2017. The following tables provide the valuation hierarchy classification of assets and liabilities that are carried at fair value and measured on a recurring basis in our consolidated balance sheets as of December 31, 2017 and September 30, 2017 (in thousands).
December 31, 2017 | Balance Sheet Locations | Total | Level 1 | Level 2 | Level 3 | |||||||||
Instrument designated as accounting hedge: | ||||||||||||||
Interest rate contract | Accrued expenses and other current liabilities | 1,269 | — | 1,269 | — | |||||||||
Interest rate contract | Other liabilities | 101 | — | 101 | — | |||||||||
September 30, 2017 | Balance Sheet Locations | Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Instrument designated as accounting hedge: | ||||||||||||||||||
Interest rate contract | Accrued expenses and other current liabilities | $ | 2,462 | $ | — | $ | 2,462 | $ | — | |||||||||
Interest rate contract | Other liabilities | 903 | — | 903 | — | |||||||||||||
We use observable market-based inputs to calculate fair value of our interest rate swap agreements and outstanding debt instruments, in which case the measurements are classified within Level 2. If quoted or observable market prices are not available, fair value is based upon internally developed models that use, where possible, current market‑based parameters such as interest rates, yield curves and currency rates. These measurements are classified within Level 3.
Note 6. Long-Term Debt
Long-term debt consists of the following (in thousands):
December 31, 2017 | September 30, 2017 | |||||||||||||||||||||||
Principal Amount | Deferred Debt Issuance Costs | Carrying Amount | Principal Amount | Deferred Debt Issuance Costs | Carrying Amount | |||||||||||||||||||
Term loan A facility | $ | 375,000 | $ | (8,032 | ) | $ | 366,968 | $ | 380,000 | $ | (7,562 | ) | $ | 372,438 | ||||||||||
Term loan B facility | 440,562 | (3,857 | ) | 436,705 | 440,562 | (4,162 | ) | 436,400 | ||||||||||||||||
Revolving facility | 74,000 | — | 74,000 | 55,000 | — | 55,000 | ||||||||||||||||||
Less: current portion | (94,000 | ) | — | (94,000 | ) | (75,000 | ) | — | (75,000 | ) | ||||||||||||||
Non-current portion | $ | 795,562 | $ | (11,889 | ) | $ | 783,673 | $ | 800,562 | $ | (11,724 | ) | $ | 788,838 | ||||||||||
Sixth Amendment to Senior Secured Credit Facilities
As previously disclosed in the 2017 Form 10-K, on November 2, 2017, we entered into the Sixth Amendment to Credit Agreement (the Sixth Amendment) to our credit agreement, dated as of December 7, 2012, by and among the Company, Wesco Aircraft Hardware Corp. and the lenders and agents party thereto (as amended, the Credit Agreement).
The Sixth Amendment modified the Credit Agreement to increase the Excess Cash Flow Percentage (as such term is defined in the Credit Agreement) to 75%, provided that the Excess Cash Flow Percentage shall be reduced to (i) 50%, if the Consolidated Total Leverage Ratio (as such term is defined in the Credit Agreement) 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.
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The Sixth Amendment further modified the Credit Agreement to reduce the maximum amount permitted to be incurred under the Capped Incremental Facility (as such term is defined in the Credit Agreement) to zero, unless the Consolidated Total Leverage Ratio (as such term is defined in the Credit Agreement), after giving effect to the incurrence of any incremental loans or commitments and the use of proceeds thereof, on a pro forma basis, would be (i) less than 4.00 but greater than or equal to 3.50, in which case the Capped Incremental Facility would be increased to $75.0 million or (ii) less than 3.50, in which case the Capped Incremental Facility would be increased to $150.0 million.
The Sixth Amendment also modified the Credit Agreement to increase the Consolidated Total Leverage Ratio levels in the financial covenant set forth in the Credit Agreement to a maximum 6.25 for the quarters ending September 30, 2017, December 31, 2017 and March 31, 2018, with step-downs to 6.00 for the quarters ending June 30, 2018 and September 30, 2018; 5.75 for the quarter ending December 31, 2018; 5.50 for the quarter ending March 31, 2019; 5.25 for the quarter ending June 30, 2019; 4.75 for the quarters ending September 30, 2019, December 31, 2019 and March 31, 2020; 4.00 for the quarters ending June 30, 2020, September 30, 2020, December 31, 2020 and March 31, 2021; and 3.00 for the quarter ending June 30, 2021 and thereafter.
As a result of the Sixth Amendment, we incurred $1.9 million in fees that were capitalized and will be amortized over the remaining life of the related debt, $1.3 million of which was related to the term loan A facility and $0.6 million of which was related to the revolving facility. Pursuant to GAAP, the Sixth Amendment is accounted for as a debt modification. As a result, the unamortized deferred debt issuance costs related to the term loan A and the revolving facility prior to the Sixth Amendment were added to the $1.9 million of deferred debt issuance costs related to the Sixth Amendment and will be amortized over the remaining life of the term loan A and the revolving facility. The following table summarizes the total deferred debt issuance costs for the term loan A facility, the term loan B facility and the revolving facility, which will be amortized over their remaining terms.
Term Loan A Facility | Term Loan B Facility | Revolving Facility | Total | |||||||||||||
Deferred debt issuance costs as of September 30, 2017 | $ | 7,562 | $ | 4,162 | $ | 3,676 | $ | 15,400 | ||||||||
Deferred debt issuance costs for the Sixth Amendment | 1,295 | — | 613 | 1,908 | ||||||||||||
Amortization of deferred debt issuance costs | (825 | ) | (305 | ) | (386 | ) | (1,516 | ) | ||||||||
Deferred debt issuance costs as of December 31, 2017 | $ | 8,032 | $ | 3,857 | $ | 3,903 | $ | 15,792 | ||||||||
Senior Secured Credit Facilities
The Credit Agreement 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 term loan A facility, the revolving facility and the term loan B facility, together, as the “Credit Facilities.”
As of December 31, 2017, our outstanding indebtedness under our Credit Facilities was $889.6 million, which consisted of (1) $375.0 million of indebtedness under the term loan A facility, (2) $74.0 million of indebtedness under the revolving facility, and (3) $440.6 million of indebtedness under the term loan B facility. As of December 31, 2017, $106.0 million was available for borrowing under the revolving facility to fund our operating and investing activities without breaching any covenants contained in the Credit Agreement.
During the three months ended December 31, 2017, we borrowed $46.0 million under the revolving facility, and made our required quarterly payment of $5.0 million on our term loan A facility and voluntary prepayments totaling $27.0 million on our borrowings under the revolving facility.
The interest rate for the term loan A facility is based on our Consolidated Total Leverage Ratio as determined in the most recently delivered financial statements, with the respective margins ranging from 2.00% to 3.00% for Eurocurrency loans and 1.00% to 2.00% for ABR loans. The term loan A facility amortizes in equal quarterly installments of 1.25% of the original principal amount of $400.0 million with the balance due on the earlier of (i) 90 days before the maturity of the term loan B facility, and (ii) October 4, 2021. As of December 31, 2017, the interest rate for borrowings under the term loan A facility was 4.35%, which approximated the effective interest rate.
The interest rate for the term loan B facility has a margin of 2.50% per annum for Eurocurrency loans (subject to a minimum Eurocurrency rate floor of 0.75% per annum) or 1.50% per annum for ABR loans (subject to a minimum ABR floor of 1.75% per annum). The term loan B facility amortizes in equal quarterly installments of 0.25% of the original principal
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amount of $525.0 million, with the balance due at maturity on February 28, 2021. As of December 31, 2017, the interest rate for borrowings under the term loan B facility was 3.84%, which approximated the effective interest rate. We have an interest rate swap agreement relating to this indebtedness, which is described in greater detail in Note 5 above.
The interest rate for the revolving facility is based on our Consolidated Total Leverage Ratio as determined in the most recently delivered financial statements, with the respective margins ranging from 2.00% to 3.00% for Eurocurrency loans and 1.00% to 2.00% for ABR loans. The revolving facility expires on the earlier of (i) 90 days before the maturity of the term loan B facility, and (ii) October 4, 2021. As of December 31, 2017, the weighted-average interest rate for borrowings under the revolving facility was 4.45%.
Our borrowings under the Credit Facilities are guaranteed by us and all of our direct and indirect, wholly-owned, domestic restricted subsidiaries (subject to certain exceptions) and secured by a first lien on substantially all of our assets and the assets of our guarantor subsidiaries, including capital stock of the subsidiaries (in each case, subject to certain exceptions).
The Credit Agreement 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 disclosed above in the description of the Sixth Amendment, 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 6.25 for the quarter ending December 31, 2017. After the Sixth Amendment and as of December 31, 2017, we were in compliance with all of the foregoing covenants, and our Consolidated Total Leverage Ratio was 4.91. After the Sixth Amendment, based on our current covenants and forecasts, we expect to be in compliance for the one year period after February 8, 2018.
UK Line of Credit
Our subsidiary, Wesco Aircraft EMEA, Ltd., has a £5.0 million ($6.8 million based on the December 31, 2017 exchange rate) line of credit that automatically renews annually on October 1 (the UK line of credit). The line of credit bears interest based on the base rate plus an applicable margin of 1.65%. As of December 31, 2017, the full £5.0 million was available for borrowing under the UK line of credit without breaching any covenants contained in the agreements governing our indebtedness.
Note 7. Comprehensive Income
Comprehensive income, which is net of income taxes, consists of the following (in thousands):
Three Months Ended December 31, | |||||||
2017 | 2016 | ||||||
Net (loss) income | $ | (374 | ) | $ | 13,107 | ||
Foreign currency translation loss | (105 | ) | (13,439 | ) | |||
Unrealized gain on cash flow hedging instruments | 1,370 | 2,182 | |||||
Total comprehensive income | $ | 891 | $ | 1,850 | |||
Note 8. Net (Loss) Income Per Share
Basic net (loss) income per share is computed by dividing net (loss) income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net (loss) income per share includes the dilutive effect of both outstanding stock options and restricted stock, if any, calculated using the treasury stock method. Assumed proceeds from in-the-money awards are calculated under the “as-if” method as prescribed by ASC 718, Compensation—Stock Compensation. The following table provides our basic and diluted net (loss) income per share for the three months ended December 31, 2017 and 2016 (dollars in thousands except share data):
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Three Months Ended December 31, | ||||||||
2017 | 2016 | |||||||
Net (loss) income | $ | (374 | ) | $ | 13,107 | |||
Basic weighted average shares outstanding | 99,096,914 | 98,319,926 | ||||||
Dilutive effect of stock options and restricted stock | — | 501,868 | ||||||
Dilutive weighted average shares outstanding | 99,096,914 | 98,821,794 | ||||||
Basic net (loss) income per share | $ | (0.00 | ) | $ | 0.13 | |||
Diluted net (loss) income per share | $ | (0.00 | ) | $ | 0.13 | |||
For the three months ended December 31, 2017 and 2016, respectively, 4,160,656 and 1,972,928 shares of common stock equivalents were not included in the diluted calculation due to their anti-dilutive effect.
Note 9. Segment Reporting
We are organized based on geographical location. We conduct our business through three reportable segments: the Americas, EMEA and APAC.
We evaluate segment performance based primarily on segment income 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.
The following tables present operating and financial information by business segment (in thousands):
Three Months Ended December 31, 2017 | |||||||||||||||||||
Americas | EMEA | APAC | Unallocated Corporate Costs | Consolidated | |||||||||||||||
Net sales | $ | 289,515 | $ | 64,238 | $ | 9,338 | $ | — | $ | 363,091 | |||||||||
Income (loss) from operations | 25,197 | 5,152 | 1,498 | (7,275 | ) | 24,572 | |||||||||||||
Interest expense, net | (10,648 | ) | (1,164 | ) | (26 | ) | — | (11,838 | ) | ||||||||||
Capital expenditures | 958 | 325 | 52 | — | 1,335 | ||||||||||||||
Depreciation and amortization | 6,376 | 806 | 74 | — | 7,256 | ||||||||||||||
Three Months Ended December 31, 2016 | |||||||||||||||||||
Americas | EMEA | APAC | Unallocated Corporate Costs | Consolidated | |||||||||||||||
Net sales | $ | 267,938 | $ | 63,905 | $ | 7,528 | $ | — | $ | 339,371 | |||||||||
Income (loss) from operations | 22,027 | 8,719 | 436 | (4,926 | ) | 26,256 | |||||||||||||
Interest expense, net | (10,117 | ) | (930 | ) | (26 | ) | — | (11,073 | ) | ||||||||||
Capital expenditures | 1,037 | 268 | 11 | — | 1,316 | ||||||||||||||
Depreciation and amortization | 5,934 | 778 | 17 | — | 6,729 | ||||||||||||||
As of December 31, 2017 | |||||||||||||||
Americas | EMEA | APAC | Consolidated | ||||||||||||
Total assets | $ | 1,441,365 | $ | 270,023 | $ | 46,898 | $ | 1,758,286 | |||||||
Goodwill | 204,183 | 51,190 | 11,271 | 266,644 | |||||||||||
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As of September 30, 2017 | |||||||||||||||
Americas | EMEA | APAC | Consolidated | ||||||||||||
Total assets | $ | 1,436,840 | $ | 275,445 | $ | 41,822 | $ | 1,754,107 | |||||||
Goodwill | 204,183 | 51,190 | 11,271 | 266,644 | |||||||||||
Note 10. Income Taxes
Three Months Ended December 31, | ||||||||
(dollars in thousands) | 2017 | 2016 | ||||||
Provision for income taxes | $ | (13,368 | ) | $ | (2,364 | ) | ||
Effective tax rate | 102.9 | % | 15.3 | % | ||||
For the three months ended December 31, 2017, our effective tax rate increased 87.6 percentage points compared to the same period in the prior year. The effective tax rates for both the three months ended December 31, 2017 and 2016 were impacted significantly by discrete adjustments recognized during the period. Without consideration of discrete adjustments, our effective tax rate for the three months ended December 31, 2017 and 2016 would have been 28.6% and 32.4%, respectively. The change in our effective tax rate without discrete adjustments was primarily caused by a decrease of the U.S. federal statutory tax rate from 35% to 21%, as further described below, which was offset partially by a negative impact associated with foreign taxes.
For the three months ended December 31, 2016, the 17.1 percentage point favorable impact of discrete adjustments was primarily related to the early adoption of ASU 2016-09 and the release of a valuation allowance on a net operating loss of a foreign subsidiary. For the three months ended December 31, 2017, the 74.3 percentage point negative impact of discrete adjustments was primarily related to the enactment of the Tax Cuts and Jobs Act (the Tax Act) on December 22, 2017.
As a fiscal-year taxpayer, certain provisions of the Tax Act will impact the Company for our fiscal year ending September 30, 2018, while other provisions will be effective as of our fiscal year beginning on October 1, 2018. In addition, our first fiscal quarter of the current year, which ended on December 31, 2017, will be taxed at a blended federal tax rate of 24.5%, which is equal to our federal tax rate for our fiscal year ending September 30, 2018. The principal impacts of the Tax Act for our fiscal year ending September 30, 2018 are the reduction of the corporate income tax rate and the imposition of a one-time repatriation tax on accumulated earnings of our foreign subsidiaries (the Transition Tax). Other key provisions of the Tax Act which could impact the Company for our fiscal year beginning on October 1, 2018 include a reduction or limitation on the deduction of business interest, certain executive compensation and entertainment expenses, while also allowing businesses to immediately write off the full cost of certain new equipment. The Tax Act also transitions 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.
Recognizing the complexity of the Tax Act, the staff of the US Securities and Exchange Commission has issued guidance in Staff Accounting Bulletin 118 (SAB 118) which clarifies the accounting for income taxes under ASC 740 if information is not yet available, prepared or analyzed in reasonable detail to complete the accounting for income tax effects of the Tax Act. SAB 118 provides for a measurement period of up to a one year during which the required analyses and accounting must be completed. During the measurement period, (1) income tax effects of the Tax Act must be reported if the accounting has been completed, (2) provisional amounts must be reported for income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined and (3) provisional amounts are not required to be reported for income tax effects of the Tax Act for which a reasonable estimate cannot be determined.
For the three months ended December 31, 2017, the Company recorded as a result of the Tax Act (1) a provisional $37.7 million of charge to tax expense related to the remeasurement of deferred tax assets and liabilities which resulted in a 290.4% increase in our effective tax rate, (2) a provisional $37.7 million tax benefit related to the partial reversal of its deferred tax liability for unremitted foreign earnings which resulted in a 290.3% decrease in our effective tax rate and (3) a provisional $9.1 million charge to the tax expense related to the Transition Tax which resulted in a 69.7% increase in our effective tax rate. The determination of the impact of the income tax effects of the items reflected as provisional amounts may change, possibly materially, following 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
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authorities. The Company will report revised provisional amounts in accordance with SAB 118 when additional information and guidance has become available.
Effective January 1, 2018, the U.S. corporate federal statutory income tax rate was reduced from 35% to 21%. The federal tax rate applicable to the Company for our fiscal year ending September 30, 2018 will be a blended rate of 24.5%, reflecting a rate of 35% for the three months ended December 31, 2017 and a rate of 21% for the remainder of the fiscal year. The 24.5% blended tax rate is applied to each quarter during our fiscal year ending September 30, 2018. The federal tax rate applicable to the Company for our fiscal year beginning October 1, 2018 will be 21%. ASC 740 requires deferred tax assets and liabilities to be measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled. For the three months ended December 31, 2017, the Company has remeasured deferred tax assets and liabilities based on the Company’s estimate as to when temporary differences are expected to be realized and the applicable federal tax rates at the time of realization. For the three months ended December 31, 2017, the Company recorded a provisional charge of $37.7 million to income tax expense as a result of the remeasurement of deferred tax assets and liabilities.
The Transition Tax imposes a one-time Federal repatriation tax on accumulated earnings and profits, determined at prescribed measurement dates, of the Company’s foreign subsidiaries. The tax rate is 15.5% on the foreign subsidiaries’ cash and cash equivalents, at prescribed measurement dates, and 8% on the foreign subsidiaries’ earnings and profits other than cash and cash equivalents. For the three months ended December 31, 2017, the Company recorded a provisional Transition Tax net of foreign tax credits of $9.1 million to income tax expense. The Transition Tax was recorded as a non-current liability since the Company intends to elect to pay the Transition Tax over an 8-year period, with the first payment required to be made during the three months ending March 31, 2019.
As previously disclosed, during the three months ended September 30, 2017, we reassessed the potential need to repatriate foreign earnings and determined it was likely that we would, in the future, repatriate approximately $126.5 million of previously earned and undistributed earnings. Accordingly, we provided for a $38.7 million deferred tax liability for U.S. Federal and state taxes that will become due upon such repatriation. Since the Transition Tax imposes a one-time Federal tax on the Company’s undistributed foreign earnings, no further taxes would be imposed upon the future repatriation of such earnings. Accordingly, for the three months ended December 31, 2017, the Company recorded a provisional $37.7 million partial reversal of its deferred tax liability as a tax provision benefit. The remaining $1.0 million deferred tax liability represents the Company’s estimated state tax liability which will be payable to states which, in the Company’s current estimate, are not expected to adopt the Transition Tax of the Tax Act and which will impose tax on foreign earnings at the time when such earnings are repatriated.
Note 11. Commitments and Contingencies
We are involved in various legal matters that arise in the ordinary course of business. Our management, after consulting with outside legal counsel, believes that the ultimate outcome of such matters will not have a material adverse effect on our business, financial position, results of operations or cash flows. There can be no assurance, however, that such actions will not be material or adversely affect our business, financial position, results of operations or cash flows.
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ITEM 2. 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 interim financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q.
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” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (the SEC) on November 29, 2017 (the 2017 Form 10-K) and “—Cautionary Note Regarding Forward-Looking Statements” and Part II, Item 1A. “Risk Factors” below. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Unless otherwise noted in this Quarterly Report on Form 10-Q, 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. 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.
Executive Overview
We are one of the world’s leading distributors and providers 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 565,000 active stock-keeping units (SKUs), including C-class hardware, chemicals, electronic components, bearings, tools and machined parts. 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.
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 providers. We also service customers in the automotive, energy, health care, industrial, pharmaceutical and space sectors.
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
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stronger pace than seen historically. More recently, several airlines have slowed the pace of orders with large commercial OEMs in response to rapidly changing macroeconomic conditions. Nevertheless, large commercial OEMs have indicated that they continue to expect a high level of deliveries, primarily due to 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. Overall business aviation production levels remain well below their pre-recession peak, though newer models have seen a greater acceptance in the marketplace than older and previously owned aircraft.
Military Aerospace Market
Military build-rates have declined for the past few years (and they may continue to decline going forward), which has negatively affected this portion of our business. We believe the diversity of the military aircraft programs we support can help mitigate the impact of new program delays, changes or cancellations. In particular, we believe the services we provide the Joint Strike Fighter program will benefit our future business as production for that program increases. Increased sales for other established aircraft programs that directly benefit from such changes also help moderate build-rate declines.
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 is 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.
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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) strategic purchases (a) to take advantage of favorable pricing, (b) made in anticipation of the expected industry growth cycle, (c) to support new customer Contracts or (d) to acquire high-volume products that are typically difficult to obtain in sufficient quantities; (2) changes in supplier lead times and the timing of inventory deliveries; (3) purchases made in anticipation of future growth (particularly growth in our aftermarket business); and (4) purchases made in connection with 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.
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, and APAC. 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 from Operations
Income from operations is the result of subtracting the cost of sales and selling, general and administrative (SG&A) expenses from net sales, and is used primarily to evaluate our performance and profitability.
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The principal component of our cost of sales is product cost, which was 94.6% and 93.5% of our total cost of sales for the three months ended December 31, 2017 and 2016, respectively. The remaining components are freight and expediting fees, import duties, tooling repair charges, packaging supplies and physical inventory adjustment charges.
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 (E&O) inventory. 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 inventory policy, see Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates—Inventories” in the 2017 Form 10-K. Charges to cost of sales for the E&O provision and related items of $4.4 million and $2.2 million were recorded during the three months ended December 31, 2017 and 2016, respectively.
The principal components of our SG&A 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 SG&A 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, 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 (Expense), Net. Other income (expense), 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 evaluate our estimates and judgments on an on-going basis. 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. Actual results may vary from what we anticipate, and different assumptions or estimates about the future could change our reported results. For a description of our critical accounting policies and estimates, see Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in the 2017 Form 10-K.
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Results of Operations
Three Months Ended December 31, | ||||||||
Consolidated Result of Operations | 2017 | 2016 | ||||||
(dollars in thousands) | ||||||||
Net sales | $ | 363,091 | $ | 339,371 | ||||
Gross profit | $ | 94,424 | $ | 89,457 | ||||
Selling, general & administrative expenses | 69,852 | 63,201 | ||||||
Income from operations | 24,572 | 26,256 | ||||||
Interest expense, net | (11,838 | ) | (11,073 | ) | ||||
Other income, net | 260 | 288 | ||||||
Income before income taxes | 12,994 | 15,471 | ||||||
Income tax provision | (13,368 | ) | (2,364 | ) | ||||
Net (loss) income | $ | (374 | ) | $ | 13,107 | |||
(as a percentage of net sales, numbers rounded) | ||||||
Net sales | 100 | % | 100 | % | ||
Gross profit | 26.0 | % | 26.4 | % | ||
Selling, general & administrative expenses | 19.2 | % | 18.7 | % | ||
Income from operations | 6.8 | % | 7.7 | % | ||
Interest expense, net | (3.3 | )% | (3.3 | )% | ||
Other income, net | 0.1 | % | 0.2 | % | ||
Income before income taxes | 3.6 | % | 4.6 | % | ||
Income tax provision | (3.7 | )% | (0.7 | )% | ||
Net (loss) income | (0.1 | )% | 3.9 | % | ||
Three Months Ended December 31, 2017 compared with Three Months Ended December 31, 2016
Net Sales
Consolidated net sales increased $23.7 million, or 7.0%, to $363.1 million for the three months ended December 31, 2017, compared to $339.4 million for the same period in the prior year. The $23.7 million increase was primarily due to an increase in Contract sales for both chemicals and hardware products, which together added $21.7 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 $2.0 million when compared with the same period in the prior year, reflecting growth at several key customers. Ad hoc and Contract sales as a percentage of net sales represented 23% and 77%, respectively, for the three months ended December 31, 2017 as compared to 24% and 76%, respectively, for the same period in the prior year.
Income from Operations
Consolidated income from operations decreased $1.7 million, or 6.4%, to $24.6 million for the three months ended December 31, 2017, compared to $26.3 million for the same period in the prior year. The $1.7 million decrease in income from operations was comprised of an increase in SG&A expenses of $6.7 million, partially offset by an increase in gross profit of $5.0 million. Income from operations as a percentage of net sales was 6.8% for the three months ended December 31, 2017, compared with 7.7% for the same period in the prior year, a decrease of 0.9 percentage points.
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The increase in gross profit was primarily driven by higher sales levels that was partially offset by a change in sales mix. Average gross margins declined 0.4 percentage points, primarily due to sales mix changes, including a higher overall proportion of chemical product sales and some shifts within the chemical contract portfolio.
The $6.7 million increase in SG&A expenses largely reflected increases in payroll and other personnel related costs of $5.5 million, professional fees of $2.2 million, rent of $0.5 million and depreciation expense of $0.5 million. The increase in payroll and other personnel related costs was 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 assisting the business in various areas. These increases were partially offset by lower stock-based compensation expense of $0.9 million, with smaller declines in other costs. Higher SG&A costs are reflected in a 0.5 percentage point increase in SG&A measured as a percent of net sales.
Changes in unallocated corporate costs are included above, which were $2.3 million higher than the three months ended December 31, 2016, primarily driven by increases in payroll and other personnel related costs of $0.8 million, professional fees of $1.3 million and stock-based compensation expense of $0.2 million.
Interest Expense, Net
Interest expense, net was $11.8 million for the three months ended December 31, 2017, compared to $11.1 million for the same period in the prior year. The increase was primarily due to an increase in short-term borrowings and higher interest rates, partially offset by a lower amortization of deferred debt issuance costs when compared with the same period in the prior year which included a $2.3 million write off of deferred debt issuance costs.
Other Income, Net
Other income, net was $0.3 million for both the three months ended December 31, 2017 and 2016.
Provision for Income Taxes
The income taxes provision for the three months ended December 31, 2017 was $13.4 million, compared to $2.4 million for the same period in the prior year. Our effective tax rate was 102.9% and 15.3% for the three months ended December 31, 2017 and 2016, respectively. Without consideration of discrete adjustments, our effective tax rate for the three months ended December 31, 2017 and 2016 would have been 28.6% and 32.4%, respectively. The change in our effective tax rate without discrete adjustments was primarily caused by a decrease of the U.S. federal statutory tax rate from 35% to 21%, as described in Note 10 of the Notes to the Consolidated Financial Statements in Part I, Item 1. of this Quarterly Report on Form 10-Q, which was offset partially by a negative impact associated with foreign taxes.
For the three months ended December 31, 2016, the 17.1 percentage point difference between the 32.4% effective tax rate, without consideration of discrete adjustments, and the 15.3% effective tax rate was primarily related to the early adoption of ASU 2016-09 and the release of a valuation allowance on a net operating loss of a foreign subsidiary. For the three months ended December 31, 2017, the 74.3 percentage point difference between our 28.6% effective tax rate, without discrete adjustments, and our 102.9% effective tax rate was primarily related to the enactment of the Tax Cuts and Jobs Act (the Tax Act), as discussed in Note 10 of the Notes to the Consolidated Financial Statements in Part I, Item 1. of this Quarterly Report on Form 10-Q.
Net (Loss) Income
Net loss for the three months ended December 31, 2017 was $0.4 million, compared to a net income of $13.1 million for the same period in the prior year. This decrease in net income was primarily driven by a decrease in income from operations of $1.7 million, an increase in interest expense of $0.7 million and an increase in provision for income taxes of $11.0 million, as discussed above.
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Americas Segment
Three Months Ended December 31, | ||||||||
Americas Result of Operations | 2017 | 2016 | ||||||
(dollars in thousands) | ||||||||
Net sales | $ | 289,515 | $ | 267,938 | ||||
Gross profit | 74,980 | $ | 69,098 | |||||
Selling, general & administrative expenses | 49,783 | 47,071 | ||||||
Income from operations | $ | 25,197 | $ | 22,027 | ||||
(as a percentage of net sales, numbers rounded) | ||||||
Net sales | 100 | % | 100 | % | ||
Gross profit | 25.9 | % | 25.8 | % | ||
Selling, general & administrative expenses | 17.2 | % | 17.6 | % | ||
Income from operations | 8.7 | % | 8.2 | % | ||
Three Months Ended December 31, 2017 compared with Three Months Ended December 31, 2016
Net Sales
Net sales for our Americas segment increased $21.6 million, or 8.1%, to $289.5 million for the three months ended December 31, 2017, compared to $267.9 million for the same period in the prior year. The $21.6 million increase in net sales for the three months ended December 31, 2017 was due primarily to an increase in Contract sales in both chemical and hardware products.
Income from Operations
Income from operations increased $3.2 million, or 14.4%, to $25.2 million for the three months ended December 31, 2017, compared to $22.0 million for the same period in the prior year. The $3.2 million increase in income from operations was comprised of an increase in gross profit of $5.9 million partially offset by an increase in SG&A expenses of $2.7 million. Income from operations as a percentage of net sales was 8.7% for the three months ended December 31, 2017, compared to 8.2% for the same period in the prior year, an increase of 0.5 percentage points.
The $5.9 million increase in gross profit was primarily driven by higher sales levels and due to higher margins from Contract sales for hardware products as well as for ad hoc sales when compared with the same period in the prior year. Average gross margins increased 0.1 percentage point.
The $2.7 million increase in SG&A expenses largely reflected increases in payroll and other personnel related costs of $3.5 million, professional fees of $0.8 million, rent of $0.4 million and depreciation expense of $0.4 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. These increases were partially offset by declines primarily in stock-based compensation expense of $1.1 million and IT related costs of $0.7 million. SG&A as a percent of net sales decreased 0.4 percentage points.
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EMEA Segment
Three Months Ended December 31, | ||||||||
EMEA Result of Operations | 2017 | 2016 | ||||||
(dollars in thousands) | ||||||||
Net sales | $ | 64,238 | $ | 63,905 | ||||
Gross profit | 16,643 | 18,738 | ||||||
Selling, general & administrative expenses | 11,491 | 10,019 | ||||||
Income from operations | $ | 5,152 | $ | 8,719 | ||||
(as a percentage of net sales, numbers rounded) | ||||||
Net sales | 100 | % | 100 | % | ||
Gross profit | 25.9 | % | 29.3 | % | ||
Selling, general & administrative expenses | 17.9 | % | 15.7 | % | ||
Income from operations | 8.0 | % | 13.6 | % | ||
Three Months Ended December 31, 2017 compared with Three Months Ended December 31, 2016
Net Sales
Net sales for our EMEA segment increased $0.3 million, or 0.5%, to $64.2 million for the three months ended December 31, 2017, compared to $63.9 million for the same period in the prior year. The increase in net sales for the three months ended December 31, 2017 reflects an increase in Contracts sales for chemical products, which was largely offset by a decline in Contract hardware sales. Ad hoc sales improved $0.2 million.
Income from Operations
Income from operations declined $3.6 million, or 40.9%, to $5.2 million for the three months ended December 31, 2017, compared to $8.7 million for the same period in the prior year. The $3.6 million decline in income from operations was comprised of a decline in gross profit of $2.1 million and an increase in SG&A expenses of $1.5 million. Income from operations as a percentage of net sales was 8.0% for the three months ended December 31, 2017, compared to 13.6% for the same period in the prior year, a decrease of 5.6 percentage points.
The $2.1 million decrease in gross profit was primarily driven by a decline in gross margins which were 3.4 percentage points lower. The 3.4 percentage point decline in gross margins was due primarily to higher inventory adjustments, the decline in higher margin hardware Contract sales and lower chemical margins when compared with the same period of the prior year.
The $1.5 million increase in SG&A expenses primarily reflected increases in payroll and other personnel related costs of $1.1 million, with rent, professional fees and depreciation expense comprising most of the remaining increase. The increase in exchange rate of the British Pounds to U.S. dollars contributed to approximately $0.6 million increase in SG&A expenses when compared with the same period of the prior year. SG&A as a percent of net sales increased 2.2 percentage points.
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APAC Segment
Three Months Ended December 31, | ||||||||
APAC Result of Operations | 2017 | 2016 | ||||||
(dollars in thousands) | ||||||||
Net sales | $ | 9,338 | $ | 7,528 | ||||
Gross profit | 2,801 | 1,621 | ||||||
Selling, general & administrative expenses | 1,303 | 1,185 | ||||||
Income from operations | $ | 1,498 | $ | 436 | ||||
(as a percentage of net sales, numbers rounded) | ||||||
Net sales | 100 | % | 100 | % | ||
Gross profit | 30.0 | % | 21.5 | % | ||
Selling, general & administrative expenses | 14.0 | % | 15.7 | % | ||
Income from operations | 16.0 | % | 5.8 | % | ||
Three Months Ended December 31, 2017 compared with Three Months Ended December 31, 2016
Net Sales
Net sales for our APAC segment increased $1.8 million, or 24.0%, to $9.3 million for the three months ended December 31, 2017, compared to $7.5 million for the same period in the prior year. The $1.8 million increase in net sales for the three months ended December 31, 2017 primarily reflects an increase in ad hoc sales.
Income from Operations
Income from operations increased $1.1 million, or 243.6%, to $1.5 million for the three months ended December 31, 2017, compared to $0.4 million for the same period in the prior year. The $1.1 million increase in income from operations was due to an increase in gross profit of $1.2 million slightly offset by a small increase in SG&A expenses of $0.1 million. Income from operations as a percentage of net sales was 16.0% for the three months ended December 31, 2017, compared to 5.8% for the same period in the prior year, an increase of 10.2 percentage points.
The $1.2 million increase in gross profit was primarily driven by higher ad hoc sales and gross margin. Average gross margins increased 8.5 percentage points due primarily to higher margins for ad hoc sales and lower write downs of E&O inventory, offset by lower chemical margins when compared with the same period of the prior year.
The $0.1 million increase in SG&A expenses was due primarily to increases in payroll and other personnel related costs. SG&A as a percent of net sales decreased 1.7 percentage points.
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 $41.9 million and $61.6 million as of December 31, 2017 and September 30, 2017, respectively, of which $35.2 million, or 84.0%, and $48.7 million, or 79.0%, was held by our foreign subsidiaries as of December 31, 2017 and September 30, 2017, respectively. None of our cash and cash equivalents consisted of
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restricted cash and cash equivalents as of December 31, 2017 or September 30, 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 Sixth Amendment to 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 provided for 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 $1.0 million during the three months ended December 31, 2017 (see Note 10 of the Notes to the Consolidated Financial Statements in Part I, Item 1. of this Quarterly Report on Form 10-Q).
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 and our warehouse operations; and |
• | debt service requirements for borrowings under the Credit Facilities (as defined below under “—Credit Facilities”). |
Generally, cash provided by operating activities has been adequate to fund our operations. Due to fluctuations in our cash flows and the 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 $106.0 million was available as of December 31, 2017. 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. For additional information about our revolving facility, see “—Credit Facilities” below. As of December 31, 2017, we did not have any material capital expenditure commitments.
Cash Flows
Our cash and cash equivalents decreased by $19.7 million during the three months ended December 31, 2017. The decrease was primarily due to cash used in operating activities, offset by cash provided by financing activities.
A summary of our operating, investing and financing activities are shown in the following table (in thousands):
Three Months Ended December 31, | ||||||||
Consolidated statements of cash flows data: | 2017 | 2016 | ||||||
Net (loss) income | $ | (374 | ) | $ | 13,107 | |||
Adjustments to reconcile net income to net cash used in operating activities | 15,674 | 14,597 | ||||||
Subtotal | 15,300 | 27,704 | ||||||
Changes in assets and liabilities | (45,180 | ) | (55,790 | ) | ||||
Net cash used in operating activities | $ | (29,880 | ) | $ | (28,086 | ) | ||
Net cash used in investing activities | (1,335 | ) | (1,316 | ) | ||||
Net cash provided by financing activities | 11,527 | 5,141 | ||||||
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 other changes in working capital accounts such as changes in our prepaid expenses and accrued liabilities or the timing of our tax payments.
Our operating activities used $29.9 million of cash in the three months ended December 31, 2017, an increase of $1.8 million as compared to the same period in the prior year. The $1.8 million increase in net cash used in operating activities
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reflects a $12.4 million decline in cash provided from net (loss) income excluding non-cash items, offset partially by a series of year-over-year differences in balance sheet changes totaling $10.6 million, which includes a smaller inventory increase of $11.4 million, a $4.2 million favorable difference in the change of accounts receivable balance and a $9.0 million favorable difference in the balance change for remaining working assets and liabilities, which primarily mirrors the recording of a $9.1 million non-cash provisional transition tax for our foreign earnings as part of our income tax provision for the three months ended December 31, 2017. These favorable changes in our working assets and liabilities were offset by a $14.0 million greater reduction in accounts payable during the three months ended December 31, 2017 as compared with the same period in the prior year. See Note 10 of the Notes to the Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion about the transition tax provision for our foreign earnings under the Tax Act.
Investing Activities
Our investing activities used $1.3 million of cash during both the three months ended December 31, 2017 and 2016. Investing activities consist primarily of software development and implementation projects and the purchase of property and equipment.
Financing Activities
Our financing activities generated $11.5 million of cash during the three months ended December 31, 2017, which consisted primarily of $46.0 million of short-term borrowings, partially offset by $27.0 million and $5.0 million for repayments of our borrowings under our revolving facility and long-term debt, respectively, $0.5 million for repayments of our capital lease obligations and a $1.9 million payment for debt issuance costs (see Note 6 of the Notes to the Consolidated Financial Statements in Part I, Item 1. of this Quarterly Report on Form 10-Q).
Our financing activities generated $5.1 million of cash during the three months ended December 31, 2016, which consisted primarily of $25.0 million of short-term borrowings and $2.3 million of proceeds received in connection with the exercise of stock options, partially offset by $11.4 million for repayments of our long-term debt, $0.3 million for repayments of our capital lease obligations and a $10.5 million payment for debt issuance costs.
Credit Facilities
As previously disclosed in the 2017 Form 10-K, on November 2, 2017, we entered into the Sixth Amendment to Credit Agreement (the Sixth Amendment) to our credit agreement, dated as of December 7, 2012, by and among the Company, Wesco Aircraft Hardware Corp. and the lenders and agents party thereto (as amended, the Credit Agreement). See Note 6 of the Notes to the Consolidated Financial Statements in Part I, Item 1. of this Quarterly Report on Form 10-Q for a summary of the Sixth Amendment.
The Credit Agreement 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 6 of the Notes to the Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a summary of the Credit Facilities and the Credit Agreement.
As of December 31, 2017, our outstanding indebtedness under our Credit Facilities was $889.6 million, which consisted of (1) $375.0 million of indebtedness under the term loan A facility, (2) $74.0 million of indebtedness under the revolving facility and (3) $440.6 million of indebtedness under the term loan B facility. As of December 31, 2017, $106.0 million was available for borrowing under the revolving facility to fund our operating and investing activities without breaching any covenants contained in the Credit Agreement.
As disclosed in Note 6 of the Notes to the Consolidated Financial Statements in Part 1, Item 1. of this Quarterly Report on Form 10-Q, 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 6.25 for the quarter ended December 31, 2017 pursuant to the Credit Agreement (as amended by the Sixth Amendment). In addition, the Sixth Amendment modified the Credit Agreement to increase the Excess Cash Flow Percentage (as such term is defined in the Credit Agreement) to 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.
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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 December 31, 2017, we were in compliance with all of the foregoing covenants, and our Consolidated Total Leverage Ratio was 4.91.
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 in full our debt.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements.
Recent Accounting Pronouncements
See Note 2 of the Notes to the Consolidated Financial Statements in Part I, Item 1. of this Quarterly Report on Form 10-Q for a summary of recent accounting pronouncements.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q 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 our long-term, fixed-price agreements that have no guarantee of future sales volumes; 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; 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; our ability to maintain effective information technology systems; our ability to retain key personnel; risks associated with our international operations, including exposure to foreign currency movements; 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. tax law; our dependence on third-party package delivery companies; fuel price risks; fluctuations in our financial results from period-to-period; environmental risks; 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” in the 2017 Form 10-K and the other documents we file from time to time with the SEC, including this Quarterly Report on Form 10-Q. All forward-looking statements included in this Quarterly Report on Form 10-Q (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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a description of our exposure to market risks, see Part II, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in the 2017 Form 10-K. There have been no material changes to our market risks since September 30, 2017, except as already disclosed in the 2017 Form 10-K under the sub-heading “Interest Rate Risk” regarding the Sixth Amendment.
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ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act), as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the three months ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1. 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.
ITEM 1A. RISK FACTORS
The risk factor presented below amends and restates the corresponding risk factor previously disclosed in Part I, Item 1A. “Risk Factors” of the 2017 Form 10-K:
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 will impact the Company for our fiscal year ending September 30, 2018, while other provisions of the Tax Act will impact the Company for our fiscal year beginning October 1, 2018 and beyond. Although 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, based on our current estimates, we believe these changes will be material (see Note 10 of the Notes to the Consolidated Financial Statements in Part I, Item 1. of this Quarterly Report on Form 10-Q). 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) a remeasurement of our deferred tax assets and liabilities resulting from the reduced U.S. corporate tax rate, (ii) the imposition of a one-time repatriation tax on accumulated earnings of our foreign subsidiaries, (iii) 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 (iv) the limitations on the deductibility of interest expense, entertainment expense and certain 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.
There have been no other material changes to the risk factors disclosed in Part I, Item 1A. “Risk Factors” of the 2017 Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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During the quarter ended December 31, 2017, we repurchased 2,689 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 Wesco Aircraft Holdings, Inc. 2014 Incentive Award Plan. We expended approximately $26,000 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) | ||||||||||||||||||
October 1, 2017 - October 31, 2017 | 2,689 | $ | 9.70 | — | $ | — | ||||||||||||||||
November 1, 2017 - November 30, 2017 | — | — | — | — | ||||||||||||||||||
December 1, 2017 - December 31, 2017 | — | — | — | — | ||||||||||||||||||
Total | 2,689 | $ | 9.70 | — | $ | — | ||||||||||||||||
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS
(a) Exhibits
Exhibit Number | Description | ||
10.1 | |||
31.1 | |||
31.2 | |||
32.1 | |||
101.INS | XBRL Instance Document | ||
101.SCH | XBRL Taxonomy Extension Schema Document | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | ||
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: February 8, 2018 | WESCO AIRCRAFT HOLDINGS, INC. | |
By: | /s/ Todd S. Renehan | |
Name: Todd S. Renehan | ||
Title: Chief Executive Officer | ||
Date: February 8, 2018 | By: | /s/ Kerry A. Shiba |
Name: Kerry A. Shiba | ||
Title: Executive Vice President and Chief Financial Officer | ||
32
Exhibit 31.1
MANAGEMENT CERTIFICATION
I, Todd S. Renehan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Wesco Aircraft Holdings, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated: | February 8, 2018 |
/s/ Todd S. Renehan | |
Name: Todd S. Renehan | |
Title: Chief Executive Officer | |
Exhibit 31.2
MANAGEMENT CERTIFICATION
I, Kerry A. Shiba, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Wesco Aircraft Holdings, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated: | February 8, 2018 |
/s/ Kerry A. Shiba | |
Name: Kerry A. Shiba | |
Title: Executive Vice President and Chief Financial Officer | |
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Wesco Aircraft Holdings, Inc. (the “Company”) on Form 10-Q for the quarter ended December 31, 2017 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Todd S. Renehan, Chief Executive Officer of the Company, and Kerry A. Shiba, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350 as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: | February 8, 2018 |
/s/ Todd S. Renehan | |
Name: Todd S. Renehan | |
Title: Chief Executive Officer | |
Dated: | February 8, 2018 |
/s/ Kerry A. Shiba | |
Name: Kerry A. Shiba | |
Title: Executive Vice President and Chief Financial Officer | |