KAMAN CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide readers of our condensed consolidated financial statements with the perspectives of management. It presents, in narrative and tabular form, information regarding our financial condition, results of operations, liquidity and certain other factors that may affect our future results, and is designed to enable the readers of this report to obtain an understanding of our businesses, strategies, current trends and future prospects. It should be read in conjunction with our Annual Report on Form 10-K for the year endedDecember 31, 2020 ("2020 Form 10-K") and the Condensed Consolidated Financial Statements included in Item 1 of this Form 10-Q.
OVERVIEW OF BUSINESS
Kaman Corporation (the "Company" or "Kaman") currently conducts business in the aerospace and defense, industrial and medical markets. Kaman produces and markets proprietary aircraft bearings and components; super precision, miniature ball bearings, proprietary spring energized seals, springs and contacts; complex metallic and composite aerostructures for commercial, military and general aviation fixed and rotary wing aircraft; and safe and arming solutions for missile and bomb systems for theU.S. and allied militaries. The Company also manufactures and supports our K-MAX® manned and unmanned medium-to-heavy lift helicopters and restores, modifies and supports our SH-2G Super Seasprite maritime helicopters.
Executive Summary
In the second quarter, consolidated net sales from continuing operations increased by 2.5% to$182.4 million , primarily due to an increase in sales on our medical and industrial and other commercial programs. Gross margin increased in the quarter to 34.0% compared to 31.9% in the prior year period. This performance was driven in part by the higher direct commercial sales ("DCS") of our joint programmable fuze ("JPF") to foreign militaries. Selling, general and administrative expenses ("S,G&A") remained relatively flat on a percentage of sales basis due to efficiencies achieved as part of our cost control efforts. Operating income in the period benefited from the absence of$5.7 million in costs associated with the acquired retention plans incurred in the prior year and$3.4 million in lower costs related to the transition services agreement ("TSA"). GAAP diluted earnings per share of$0.42 in the second quarter was the result of the activity discussed above and higher pension-related income, partially offset by lower income from theTSA .
Other financial highlights
•Earnings from continuing operations was$11.9 million and$19.8 million for the three-month and six-month fiscal periods endedJuly 2, 2021 , respectively, compared to losses from continuing operations of$0.1 million and$0.5 million in the comparable fiscal periods in the prior year. These changes were primarily driven by the absence of costs associated with the acquired retention plans incurred in the prior year and higher non-service pension and post retirement benefit income. Additionally, for the six-month fiscal period, earnings from continuing operations benefited from the absence ofBal Seal acquisition costs. •Cash used in operating activities of continuing operations during the six-month fiscal period endedJuly 2, 2021 , was$14.7 million , a$64.7 million improvement to the comparable fiscal period in the prior year. This change was primarily due to the collection of payments on outstanding receivables, more specifically significant receipts under a JPF DCS contract, partially offset by approximately$25.1 million in nonrecurring payments to eligible participants ofBal Seal's employee retention plans. •Total unfulfilled performance obligations ("backlog") decreased 19.2% to$510.2 million compared to total backlog atDecember 31, 2020 , driven by deliveries of direct commercial JPF orders and bearings products, partially offset by new orders of our bearings products and seals, springs and contacts.
Recent events
•InJuly 2021 ,James G. Coogan was appointed Senior Vice President and Chief Financial Officer, effectiveJuly 8, 2021 .Mr. Coogan succeededRobert D. Starr .Mr. Starr continued to be employed by the Company throughJuly 31, 2021 as Executive Vice President. •InApril 2021 ,Kineco Kaman Composites India Private Limited , our joint venture, was named a Gold Supplier ofBAE Systems and received theBAE Systems Partner 2 Win Supplier of the Year Award for Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance Systems ("C4ISR") for exceptional performance and contributions to supply chain success in the Electronic Systems sector in 2020. •InApril 2021 , the K-MAX TITANTM, our new unmanned helicopter, successfully completed its first test flight. 26 -------------------------------------------------------------------------------- •InApril 2021 ,Ian K. Walsh , President and CEO, was appointed Chairman of the Board of Directors andJennifer Pollino assumed the role of Lead Independent Director. COVID-19 Discussion The impact of the novel coronavirus ("COVID-19") and the precautionary measures instituted by governments and businesses to mitigate the spread, including limiting non-essential gatherings of people, ceasing all non-essential travel, ordering certain businesses and government agencies to cease non-essential operations at physical locations and issuing "shelter-in-place" orders, have contributed to a general slowdown in the global economy and significant volatility in financial markets, including a decrease in our stock price. We are closely monitoring the impact of the COVID-19 pandemic on all aspects of our business and across the geographies in which we operate and serve customers, and we are working to assess the extent to which it has impacted and will continue to impact our customers, suppliers and other business partners. Kaman is operating as an essential business inthe United States and in most of the markets in which it operates around the world. Despite efforts to mitigate the risks associated with COVID-19, our operations were adversely impacted during the first half of 2021. Additionally, earlier in the pandemic, certain of our customers and suppliers had temporarily shut down operations; however, disruptions to our supply chain have been limited to date and we continue to meet the demands of our customers. While we did not incur significant disruptions related to the COVID-19 pandemic during the first half of 2021, we continued to see declines in our commercial aerospace products through the second quarter of 2021 as compared to the corresponding periods in 2020 which were minimally impacted by COVID-19. We expect a meaningful ramp in sales for these products in the second half of the year due to the increase in air traffic and vaccination rates inthe United States ; however, we are monitoring the developments related to COVID-19 variants which make it difficult to predict the timing and magnitude of the recovery in the current year. We saw recoveries in our medical and industrial end markets through the second quarter and expect improved performance through the remainder of 2021. Our defense and safe and arm device end markets have not been impacted by COVID-19 and we do not expect future declines due to COVID-19 on the results of these end markets. The extent to which COVID-19 may adversely impact the Company depends on future developments, which are highly uncertain and unpredictable at this time. The health and safety of our employees, their families and communities, and our customers are our highest priorities. To maintain employee productivity and minimize the risk of exposure while working, we continue to follow guidance issued by theCenters for Disease Control and state and local governments to allow our employees to work with confidence knowing that their health and safety is a key priority. We have begun to allow visitors and business associates to our facilities, provided they adhere to the Company's guidelines. Resources are available to our employees via the Company's benefits website, which include the latest news on COVID-19, steps to prevent illness and resources for mental health. Refer to the Liquidity and Capital Resources section of Management's Discussion and Analysis for information on the impact of COVID-19 on the liquidity of the Company. RESULTS OF OPERATIONS
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
(in thousands)
Net sales $ 182,394 $ 177,890 $ 354,010 $ 385,212
$ change 4,504 3,178 (31,202) 44,066
% change 2.5 % 1.8 % (8.1) % 12.9 %
Sales of disposed businesses that
did not qualify for discontinued
operations - 4,812 1,704 13,298
Organic sales $ 182,394 $ 173,078 $ 352,306 $ 371,914
$ change 9,316 (19,608)
% change 5.4 % (5.3) %
27--------------------------------------------------------------------------------
For the Three Months Ended
Net sales increased for the three-month fiscal period endedJuly 2, 2021 , as compared to the corresponding period in 2020, due to a 5.4% increase in organic sales related to the recoveries in our medical and industrial end markets. Improvements in our miniature bearings contributed to the$8.1 million increase in sales in our medical products and$4.5 million increase in sales of our industrial products. Sales of our medical products also benefited from an increase in sales of products used in medical implantable and analytical devices. Additionally contributing to our higher organic sales were increases in sales of$1.2 million on our defense programs and$1.0 million under our safe and arm devices programs. These increases were primarily attributable to higher direct commercial sales of our JPF to foreign militaries and an increase in sales on our A-10 program, partially offset by unfavorable performance on certain fuzing and structures contracts. The increases discussed above were partially offset by lower sales on our commercial, business and general aviation programs which continue to be impacted by the effects of COVID-19, more specifically our commercial bearings products. Additionally contributing to the decrease was$4.8 million in lower sales due to the sale of ourUK Composites business in the current year. Foreign currency exchange rates relative to theU.S. dollar had a favorable impact of$2.4 million in the three-month fiscal period endedJuly 2, 2021 . The table below summarizes the changes in organic net sales by product line for the three-month fiscal period endedJuly 2, 2021 , compared to the corresponding period in 2020. Product Line Increase (Decrease) $ (in millions) % Defense ?$1.2 3.0% Safe and Arm Devices ?$1.0 1.8% Commercial, Business and ?$(5.5) (11.8)%General Aviation Medical ?$8.1 54.8% Industrial ?$4.5 28.2% For the Six Months Ended Net sales decreased for the six-month fiscal period endedJuly 2, 2021 as compared to the corresponding period in 2020, due to a 5.3% decrease in organic sales. The decrease was primarily attributable to$18.0 in lower organic sales on our commercial, business and general aviation programs which continue to be impacted by the effects of COVID-19 and lower sales on certain structures contracts, partially offset by a K-MAX® aircraft delivery in the current period. Sales of our safe and arm devices decreased$15.4 million primarily due to lower direct commercial sales of our JPF to foreign militaries, partially offset by higher sales under the JPF program with theU.S. Government ("USG"). Additionally contributing to the decrease in sales was$11.6 million in lower sales due to the sale of ourUK Composites business in the current year. The decreases discussed above were partially offset by recoveries in our medical and industrial end markets. Improvements in our miniature bearings contributed to the$7.7 million increase in sales in our medical products and$6.1 million increase in our industrial products. Sales of our medical products also benefited from an increase in sales of products used in medical implantable and analytical devices. Foreign currency exchange rates relative to theU.S. dollar had a favorable impact of$4.6 million in the six-month fiscal period ended.
Defense sales remained relatively flat due to higher sales on the A-10 program, mostly offset by unfavorable performance on certain structures programs.
28
--------------------------------------------------------------------------------
The table below summarizes the changes in organic net sales by product line for
the six-month fiscal period ended July 2, 2021 , compared to the corresponding
period in 2020.
Product Line Increase (Decrease) $ (in millions) %
Defense - $- -%
Safe and Arm Devices ? $(15.4) (13.4)%
Commercial, Business and ? $(18.0) (16.9)%
General Aviation
Medical ? $7.7 21.6%
Industrial ? $6.1 18.7%
Gross Profit from Continuing Operations
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
(in thousands)
Gross profit $ 61,946 $ 56,668 $
114,851
$ change 5,278 4,079 (9,519) 17,260
% change 9.3 % 7.8 % (7.7) % 16.1 %
% of net sales 34.0 % 31.9 % 32.4 % 32.3 %
Gross profit increased for the three-month fiscal period endedJuly 2, 2021 , as compared to the corresponding period in 2020. This increase was primarily attributable to higher direct commercial sales of our JPF to foreign militaries and higher sales and associated gross profit on the SH-2G program withNew Zealand and our springs, seals and contacts. These increases, totaling$9.0 million , were partially offset by lower sales and associated gross profit on our missile fuzing contracts and our bearings products. Gross profit decreased for the six-month fiscal period endedJuly 2, 2021 , as compared to the corresponding period in 2020. This decrease was primarily attributable to lower direct commercial sales of our JPF to foreign militaries and lower sales and associated gross profit on our commercial bearings products, the MK54 fuzing program and our Boeing Wing-to-Body Fairing program. These decreases, totaling$20.1 million , were partially offset by higher sales and associated gross profit under our JPF program with the USG and on our springs, seals and contacts. Selling, General & Administrative Expenses (S,G&A) from Continuing Operations For the Three Months Ended For the Six Months Ended July 2, July 3, July 2, July 3, 2021 2020 2021 2020 (in thousands) S,G&A$ 38,719 $ 38,396 $ 76,847 $ 91,724 $ change 323 843 (14,877) 16,202 % change 0.8 % 2.2 % (16.2) % 21.5 % % of net sales 21.2 % 21.6 % 21.7 % 23.8 % S,G&A remained relatively flat for the three-month fiscal period endedJuly 2, 2021 , when compared to the corresponding period in 2020. S,G&A as a percentage of sales decreased compared to the second quarter of 2020, driven in large part by efficiencies achieved as part of our cost reduction efforts and the benefit of lower employee related costs. 29 -------------------------------------------------------------------------------- S,G&A decreased for the six-month fiscal period endedJuly 2, 2021 , when compared to the corresponding period in 2020. This was primarily attributable to the absence of$8.5 million inBal Seal acquisition costs and$2.3 million in third party costs associated with our efforts to reduce general and administrative expenses in the prior year and lower employee-related costs due to our cost reductions efforts.
Costs from Transition Service Agreement
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
(in thousands)
Costs from transition services
agreement $ 999 $ 4,373 $ 1,704 $ 8,513
Upon closing the sale of our former Distribution business, the Company entered
into a TSA with the buyer, pursuant to which the Company agreed to support the
information technology, human resources and benefits, tax and treasury functions
of the Distribution business for six to twelve months. The buyer exercised the
option to extend the support period for up to a maximum of an additional year
for certain information technology services. The buyer has the right to
terminate individual services at any point over the renewal term and began to
terminate certain services in 2020. Substantially all services were completed as
of the end of the first quarter of 2021 and we expect the TSA to be fully
completed in the third quarter of 2021. We incurred $1.0 million and $1.7
million in costs associated with the TSA in the three-month and six-month fiscal
periods ended July 2, 2021 , respectively. These costs were partially offset by
$0.4 million and $0.9 million in income earned from the TSA in the three-month
and six-month fiscal periods ended July 2, 2021 , respectively, which was
included below operating income in income from transition services agreement on
the Company's Condensed Consolidated Statement of Operations. We incurred $4.4
million and $8.5 million in costs associated with the TSA in the three-month and
six-month fiscal periods ended July 3, 2020 , respectively. These costs were
partially offset by $3.1 million and $6.0 million in income earned from the TSA
in the three-month and six-month fiscal periods ended July 2, 2021 ,
respectively, which was included below operating income in income from
transition services agreement on the Company's Condensed Consolidated Statement
of Operations.
Cost of Acquired Retention Plans
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
(inthousands)
Costs of acquired retention plans $ -
$ -
Bal Seal's previous owner implemented employee retention plans prior to our acquisition in the first quarter of 2020. Upon closing, we funded$24.7 million of the purchase price into escrow accounts associated with these employee retention plans. As of the date of acquisition,Bal Seal had$1.9 million in costs accrued for these employee retention plans, and the remaining$22.8 million in compensation expense associated with these retention plans was incurred ratably throughout the year endedDecember 31, 2020 . This amount and related interest was included in restricted cash on the Company's Consolidated Balance Sheets as ofDecember 31, 2020 . Eligible participants received an allocation of the escrow balance one year following the acquisition date, which is reflected in the Company's cash flows from operating activities for the six-month fiscal period endedJuly 2, 2021 .
Restructuring and Severance Costs
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
(in thousands)
Restructuring and severance costs $ 1,516 $
4,484
The Company continues to evaluate its costs with the objective of a lean organizational structure that provides a scalable infrastructure which facilitates future growth opportunities. In the three-month and six-month fiscal periods endedJuly 2, 2021 , the Company incurred$1.5 million and$2.9 million in severance costs associated with these cost reduction efforts. These actions are expected to contribute total annualized cost savings of approximately$4.8 million , which we expect to realize beginning in the first quarter of 2022. 30 -------------------------------------------------------------------------------- Following the sale of our former distribution business, we announced that we would undertake a comprehensive review of our general and administrative functions in order to improve operational efficiency and to align our costs with our revenues. We identified information technology functions to be outsourced, workforce reductions and other reductions in certain general and administrative expenses which were completed in 2020 to support the cost savings initiative. These actions resulted in$1.8 million and$3.1 million in severance costs in the three-month and six-month fiscal periods endedJuly 3, 2020 . Actions taken since the announcement of the cost savings initiative through 2020 are expected to contribute total annualized cost savings of approximately$18.2 million . During the second quarter of 2020, the Company implemented workforce reductions and elected to eliminate certain open positions as a response to the unprecedented hardships brought on by COVID-19. For the three-month fiscal period endedJuly 3, 2020 , the Company recorded severance costs of$2.7 million related to workforce reductions. In addition to the severance costs discussed above, we incurred$0.5 million in severance costs as we integrated the acquisition ofBal Seal in the six-month fiscal period endedJuly 3, 2020 .
Loss (Gain) on Sale of Business
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
(in thousands)
Loss (gain) on sale of business $ - $
-
In 2020, we received approval from our Board of Directors to sell ourUK Composites business. In the fourth quarter of 2020, we accrued a loss of$36.3 million on the anticipated sale. In the first quarter of 2021, we closed on a transaction to sell theUK Composites business. We recorded an additional loss of$0.2 million in the six-month fiscal period endedJuly 2, 2021 associated with the sale. During 2018, we sold ourUK Tooling business to better position the Company for increased profitability. In 2019, we incurred a loss of$3.7 million associated with the write-off of note receivables recorded for the remaining amounts to be collected on the sale of theUK Tooling business as this balance was deemed not likely to be collected. In the six-month fiscal period endedJuly 3, 2020 , we collected$0.5 million of the note receivables written off in 2019. Operating Income (Loss) For the Three Months Ended For the Six Months Ended July 2, July 3, July 2, July 3, 2021 2020 2021 2020 (in thousands) Operating income (loss)$ 14,832 $ (2,770) $ 20,445 $ (7,192) $ change 17,602 (13,345) 27,637 (30,136) % change 635.5 % (126.2) % 384.3 % (131.3) % % of net sales 8.1 % (1.6) % 5.8 % (1.9) % The Company had operating income of$14.8 million for the three-month fiscal period endedJuly 2, 2021 , compared to an operating loss of$2.8 million in the comparable period in 2020. The increase in operating income was primarily driven by higher sales and gross profit as discussed above, lower costs related to theTSA , the absence of costs associated with the acquired retention plans incurred in the prior year and lower severance costs. The Company had operating income of$20.4 million for the six-month fiscal period endedJuly 2, 2021 , compared to an operating loss of$7.2 million in the comparable period in 2020. The increase in operating income was primarily driven by lower costs related to theTSA , the absence ofBal Seal acquisition costs and the costs associated with the acquired retention plans incurred in the prior year, lower severance costs and lower employee-related costs. These changes were partially offset by lower sales and gross profit, as discussed above. 31 --------------------------------------------------------------------------------
Interest Expense, Net
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
(in thousands)
Interest expense, net $ 4,335 $ 5,808 $ 8,586 $ 9,055
Interest expense, net, generally consists of interest charged on our Credit
Agreement, which includes a revolving credit facility, our convertible notes and
the amortization of debt issuance costs, offset by interest income. The decrease
in interest expense, net for the three-month fiscal period ended July 2, 2021
was primarily attributable to lower average borrowings and a decrease in
interest expense associated with our deferred compensation plan. The decrease in
interest expense, net for the six-month fiscal period ended July 2, 2021 was
primarily attributable to lower average borrowings, partially offset by lower
interest income and an increase in interest expense associated with our deferred
compensation plan.
Effective Income Tax Rate from Continuing Operations
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
Effective income tax rate from
continuing operations 31.7 % 92.6 % 22.3 % 77.0 %
The effective income tax rate represents the combined federal, state and foreign
tax effects attributable to pretax earnings from continuing operations for the
period. The variation in the effective tax rate for the current periods compared
to the corresponding periods in the prior year was primarily attributable to
positive earnings in the current period versus certain discrete provision to
return benefits and the relatively small pretax loss in the prior periods.
Additionally, in the three-month period ended July 2, 2021 , the effective tax
rate was impacted by discrete charges related to the sale of the Company's UK
Composites business. See Note 18, Income Taxes, for further information on the
Company's valuation allowance for deferred tax assets.
Backlog
July 2, December 31,
2021 2020
(in thousands)
Backlog $ 510,224 $ 631,236
Backlog decreased during the first six months of 2021. The decrease was
primarily attributable to revenue recognized on deliveries of direct commercial
JPF orders, bearings and springs, seals and contacts and work performed on our
structures and missile fuzing programs. These decreases were partially offset by
orders of our bearings products and springs, seals and contacts.
Major Programs/Product Lines
Below is a discussion of significant changes in our major programs during the first six months of 2021. See our 2020 Form 10-K, including Item 1A, "Risk Factors", for a complete discussion of our major programs.
FMU-152 A/B - JPF
We manufacture the JPF, an electro-mechanical bomb safe and arming device, which
allows the settings of a weapon to be programmed in flight. Sales of these fuzes
can be direct to the USG, Foreign Military Sales ("FMS") through the USG and
Direct Commercial Sales ("DCS") to foreign militaries that, although not funded
by or sold through the USG, require regulatory approvals from the USG.
A total of 8,200 fuzes were delivered to our customers during the second quarter
of 2021, bringing the year-to-date total to 16,290 fuzes for the six-month
fiscal period ended July 2, 2021 . We expect to deliver 30,000 to 35,000 fuzes in
2021.
32
--------------------------------------------------------------------------------
Total JPF backlog at July 2, 2021 , was $139.4 million , down from $214.7 million
at December 31, 2020 , reflecting the delivery of fuzes during the first six
months of the year. Of the $139.4 million in backlog at July 2, 2021 , $1.3
million requires the receipt of export approvals, licenses or authorizations
from the USG before we are permitted to ship the fuzes outside of the United
States . The timing and receipt of any such export approvals, licenses, or
authorizations are subject to political and geopolitical conditions that are
beyond our control. Therefore, there can be no assurance that this portion of
our backlog will be converted to a firm sale and, even if it is, the timing of
the conversion.
Our JPF program continues to move through its product lifecycle, reflecting the
previously announced decision of the United States Air Force ("USAF") to move to
the FMU-139 D/B (which we do not produce) as its primary fuze system. During the
first quarter of 2021, we completed our delivery requirements under Option 14 of
our USG contract and we began to satisfy the requirements under Option 15, which
relates solely to the procurement of fuzes by 25 foreign militaries and has an
expected value of approximately $57.3 million . We expect to receive an award
under Option 16 during the second half of 2021, and similar to Option 15, we
expect this order will relate solely to the procurement of fuzes by or in
support of foreign militaries and will not include any sales to the USAF. We
currently expect Option 16 to have a value of approximately $40 million to $45
million . Assuming that is the case, Option 16 would extend FMU-152 A/B
production into 2023.
We continue to market the FMU-152 A/B directly to foreign militaries, and we are
currently in discussions with two Middle Eastern customers for one or more
follow-on orders aggregating approximately $45.0 million . The final value of
these orders will be dependent on volume and pricing agreed upon in the
completed contracts. If received, these orders would continue to extend the life
of the program. As discussed above, these orders would be subject to export
approvals, licenses and other authorizations necessary to effectuate the sales,
which are subject to political and geopolitical conditions.
LIQUIDITY AND CAPITAL RESOURCES
Discussion and Analysis of Cash Flows
We assess liquidity in terms of our ability to generate cash to fund working capital requirements and investing and financing activities. Significant factors affecting liquidity include: cash flows generated from or used by operating activities, capital expenditures, investments in our business and programs, acquisitions, divestitures, dividends, availability of future credit, share repurchase programs, adequacy of available bank lines of credit, and factors that might otherwise affect the company's business and operations generally, as described under the heading "Risk Factors" and "Forward-Looking Statements" in Item 1A of Part I of our 2020 Form 10-K.
COVID-19
We anticipate that the disruptions and delays resulting from the spread of COVID-19 and the measures instituted by governments and businesses to mitigate its spread could impact our liquidity in the next twelve months. AtJuly 2, 2021 , the Company had$98.4 million of cash on our Condensed Consolidated Balance Sheet. We are closely managing our daily cash flows to optimize our liquidity position. We also continue to closely monitor the collectability of our receivables from commercial aerospace customers as we recognize there may be delays in payments due to the impacts of COVID-19 on our customers. As of the date of this filing, we do not believe there has been any material impact on the collectability of these receivables. In addition to the daily reviews of collections and payables, management meets with our business units on a regular basis to review liquidity. As of the date of this filing, we believe the Company has adequate liquidity due to the cash we have on hand, the bank financing we have available to us and the other actions we have taken to enhance financial flexibility and reduce the potential impact of the pandemic on the Company. 33 -------------------------------------------------------------------------------- A summary of our consolidated cash flows from continuing operations is as follows: For the Six Months Ended July 2, July 3, 2021 2020 2021 vs. 2020 (in thousands) Total cash provided by (used in): Operating activities$ (14,723) $ (79,400) $ 64,677 Investing activities (12,201) (308,903) 296,702 Financing activities (10,620) 177,187 (187,807) Free Cash Flow (a) Net cash used in operating activities$ (14,723) $ (79,400) $ 64,677 Expenditures for property, plant and equipment (8,102) (9,592) 1,490 Free cash flow$ (22,825) $ (88,992) $ 66,167 (a) Free Cash Flow, a non-GAAP financial measure, is defined as net cash (used in) provided by operating activities less expenditures for property, plant and equipment, both of which are presented in our Condensed Consolidated Statements of Cash Flows. See Management's Discussion and Analysis of Financial Condition and Results of Operations-Non-GAAP Financial Measures for more information regarding Free Cash Flow. Net cash used in operating activities was$14.7 million for the six-month fiscal period endedJuly 2, 2021 , a$64.7 million improvement to cash used in the comparable period in 2020. This change was largely driven by the collection of payments on outstanding receivables, more specifically significant receipts on JPF DCS receivables and lower material receipts on the K-MAX® program and the JPF DCS program in the current period. These changes were partially offset by approximately$25.1 million in nonrecurring payments to eligible participants ofBal Seal's employee retention plans implemented prior to our acquisition in 2020. Net cash used in investing activities was$12.2 million for the six-month fiscal period endedJuly 2, 2021 ,$296.7 million less than cash used in the comparable period in 2020. This change was primarily attributable to cash used to acquireBal Seal in the prior year. Net cash used in financing activities was$10.6 million for the six-month fiscal period endedJuly 2, 2021 , compared to net cash provided by financing activities of$177.2 million in the comparable period in 2020. This change was primarily due to higher net borrowings under our revolving credit facility in the prior year in preparation for the potential impact of the COVID-19 pandemic, partially offset by lower purchases of treasury shares in the current period. We anticipate a variety of items will have an impact on our liquidity during the next twelve months, in addition to the impacts of the COVID-19 pandemic and our working capital requirements. These could include one or more of the following: •the matters described in Note 14, Commitments and Contingencies, in the Notes to Consolidated Financial Statements, including the cost of existing environmental remediation matters; •contributions to our qualified pension plan and Supplemental Employees' Retirement Plan ("SERP"); •deferred compensation payments to officers; •interest payments on outstanding debt; •income tax payments; •costs associated with acquisitions and corporate development activities; •finance and operating lease payments; •capital expenditures; •research and development expenditures; •repurchase of common stock under the 2015 Share Repurchase Program; •payment of dividends; •costs associated with the start-up of new programs; and •the timing of payments and the extension of payment terms by our customers.
Financing Arrangements
We continue to rely upon bank financing as an important source of liquidity for
our business activities, including acquisitions. We believe this, when combined
with cash generated from operating activities, will be sufficient to support our
anticipated
34
--------------------------------------------------------------------------------
future cash requirements; however, we may decide to borrow additional funds or
raise additional equity capital to support other business activities, including
potential future acquisitions. We regularly monitor credit market conditions to
identify potential issues that may adversely affect, or provide opportunities
for, the securing and/or advantageous pricing of additional financing, if any,
that may be necessary to continue with our growth strategy and finance working
capital requirements. Refer to Note 14, Debt, in the Notes to the Consolidated
Financial Statements, included in Item 8, Financial Statements and Supplementary
Data, of the 2020 Form 10-K for further information on our Financing
Arrangements.
Convertible Notes
DuringMay 2017 , we issued$200.0 million aggregate principal amount of convertible senior unsecured notes dueMay 2024 (the "2024 Notes") pursuant to an indenture, datedMay 12, 2017 , between the Company andU.S. Bank National Association , as trustee (as amended by the First Supplemental Indenture thereto, datedJuly 15, 2019 , the "Indenture"). In connection therewith, we entered into certain capped call transactions that cover, collectively, the number of shares of the Company's common stock underlying the 2024 Notes. The 2024 Notes bear 3.25% interest per annum on the principal amount, payable semiannually in arrears onMay 1 andNovember 1 of each year, beginning onNovember 1, 2017 . The 2024 Notes will mature onMay 1, 2024 , unless earlier repurchased by the Company or converted. We will settle any conversions of the 2024 Notes in cash, shares of the Company's common stock or a combination of cash and shares of common stock, at our election. The sale of our former Distribution business in the third quarter of 2019 was deemed to be a "Fundamental Change" and a "Make-Whole Fundamental Change" pursuant to the terms and conditions of the indenture governing the 2024 Notes. As a result, the sale triggered the right of the holders of our 2024 Notes to require us to repurchase all of the 2024 Notes, or any portion thereof that is a multiple of$1,000 principal amount onSeptember 27, 2019 . The aggregate principal amount of the 2024 Notes validly tendered and not validly withdrawn was$0.5 million , representing approximately 0.25% of all outstanding notes. Holders of such notes received the repurchase price equal to 100% of the principal amount of the 2024 Notes being purchase, plus accrued and unpaid interest. We incurred$7.4 million of debt issuance costs in connection with the sale of the 2024 Notes, which was allocated between the debt and equity components of the instrument. Of the total amount,$0.7 million was recorded as an offset to additional paid-in capital. The balance,$6.7 million , was recorded as a contra-debt balance and is being amortized over the term of the 2024 Notes. Total amortization expense for the three-month fiscal periods endedJuly 2, 2021 andJuly 3, 2020 was$0.3 million in both periods. Total amortization expense for the six-month fiscal periods endedJuly 2, 2021 andJuly 3, 2020 was$0.5 million in both periods. Credit Agreement OnDecember 13, 2019 , the Company closed an amended and restated$800.0 million Credit Agreement (the "Credit Agreement") withJPMorgan Chase Bank, N.A ., as Administrative Agent and as Collateral Agent. The Credit Agreement matures onDecember 13, 2024 and consists of revolving commitments of$800.0 million . Capitalized terms used but not defined within this discussion of the Credit Agreement have the meanings ascribed thereto in the Credit Agreement, which with amendments is included as Exhibit 10.39 to our 2020 Form 10-K. We incurred$3.6 million of debt issuance costs in connection with the amendment and restatement of the Credit Agreement. Total amortization expense for the three-month fiscal periods endedJuly 2, 2021 andJuly 3, 2020 was$0.2 million in both periods. Total amortization expense for the six-month fiscal periods endedJuly 2, 2021 andJuly 3, 2020 was$0.4 million in both periods. Interest rates on amounts outstanding under the Credit Agreement are variable based on LIBOR. The LIBOR benchmark has been the subject of national, international, and other regulatory guidance and proposals for reform. InJuly 2017 , theU.K. Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit rates for calculation of LIBOR after 2021. InNovember 2020 , theICE Benchmark Association announced its intention to delay the timeline for the retirement of LIBOR until mid-2023. These reforms may cause LIBOR to perform differently than in the past, and LIBOR may ultimately cease to exist after 2021. Alternative benchmark rate(s) may replace LIBOR and could affect the Company's debt securities, derivative instruments, receivables, debt payments and receipts. At this time, it is not possible to predict the effect of any changes to LIBOR, any phase out of LIBOR or any establishment of alternative benchmark rates. Any new benchmark rate will likely not replicate LIBOR exactly, which could impact our contracts that terminate after 2023. There is uncertainty about how applicable law, the courts or the Company will address the replacement of LIBOR with alternative rates on variable rate retail loan contracts and other contracts that do not include alternative rate fallback provisions. In addition, any changes to benchmark rates may have an uncertain impact on our cost of funds and our access to the capital markets, which could impact our liquidity, financial position or results of operations. 35 -------------------------------------------------------------------------------- No amounts were outstanding under the revolving credit facility in the second quarter of 2021; therefore, the interest rate for the period was 0%. We are required to pay a quarterly commitment fee on the unused revolving loan commitment amount at a rate ranging from 0.150% to 0.250% per annum, based on the Senior Secured Net Leverage Ratio. Fees for outstanding letters of credit range from 1.125% to 1.625%, based on the Senior Secured Net Leverage Ratio. There were no bank borrowings during the six-month period endedJuly 2, 2021 , compared to total average bank borrowings of$111.9 million for the year endedDecember 31, 2020 .
The following table shows the amounts available for borrowing under the Company's revolving credit facility:
July 2, December 31,
2021 2020
In thousands
Total facility $ 800,000 $ 800,000
Amounts outstanding, excluding letters of credit - -
Amounts available for borrowing, excluding letters of credit 800,000
800,000
Letters of credit under the credit facility(1)(2) 92,646 165,373
Amounts available for borrowing $
707,354
Amounts available for borrowing subject to EBITDA, as defined by the Credit Agreement(3)
$
350,809
(1) The Company has entered into standby letters of credit issued on the Company's behalf by financial institutions, and directly issued guarantees to third parties primarily related to advances received from customers and the guarantee of future performance on certain contracts. Letters of credit generally are available for draw down in the event the Company does not perform its obligations. (2) Of these amounts,$86.3 million and$146.2 million letters of credit relate to a JPF DCS contract in the periods endedJuly 2, 2021 andDecember 31, 2020 , respectively. (3) Amounts available for borrowing subject to EBITDA reflect the minimum borrowing capacity under EBITDA, subject to adjustments.
Other Sources/Uses of Capital
Letters of Credit
Of the standby letters of credit under our credit facility,$86.3 million in letters of a credit relate to a JPF DCS contract, including the offset agreement. In the event that we default on the contract and we are unable to fulfill our contractual obligations, our customer has the ability to draw on the letters of credit. Pension Plans Management regularly monitors pension plan asset performance and the assumptions used in the determination of our benefit obligation, comparing them to actual performance. We continue to believe the assumptions selected are valid due to the long-term nature of our benefit obligation. We contributed$10.0 million to the qualified pension plan and$0.3 million to the SERP through the end of the second quarter of 2021. No further contributions are expected to be made to the qualified pension plan during 2021. We plan to contribute an additional$2.5 million to the SERP in 2021. For the 2020 plan year, we contributed$10.0 million to the qualified pension plan and$0.5 million to the SERP. EffectiveDecember 31, 2015 , our qualified pension plan was frozen with respect to future benefit accruals. Under USG Cost Accounting Standard ("CAS") 413, we must calculate the USG's share of any pension curtailment adjustment calculated resulting from the freeze. Such adjustments can result in an amount due to the USG for pension plans that are in a surplus position or an amount due to the contractor for plans that are in a deficit position. During the fourth quarter of 2016, we accrued a$0.3 million liability representing our estimate of the amount due to the USG based on our pension curtailment calculation, which was submitted to the USG for review inDecember 2016 . We have maintained our accrual at$0.3 million as ofJuly 2, 2021 . There can be no assurance that the ultimate resolution of this matter will not have a material adverse effect on our results of operations, financial position and cash flows.
Share-based Arrangements
In 2021, the Company modified its long-term incentive program to increase the
emphasis on equity. Beginning in the first quarter of 2021, the long-term
incentive awards granted to the Company's Named Executive Officers ("NEOs") will
consist of a
36
--------------------------------------------------------------------------------
combination of service-based RSAs and PSUs which are intended to be settled in
shares, as opposed to cash-based awards that had been utilized in the past.
These awards are expected to increase the alignment of interests between the
Company's NEOs and shareholders and help build stock ownership for new
executives, supporting both executive retention and the Company's long-term
financial performance. RSAs will vest over a three-year period on each of the
first three anniversaries of the date of grant. The number of PSUs that will
vest will be determined based on total shareholder return ("TSR") and return on
total invested capital ("ROIC") over a three-year performance period, each of
which will remain equally weighted in determining payouts. The achievement level
for both factors may range from zero to 200%. As of July 2, 2021 , future
compensation costs related to non-vested stock options, restricted stock grants
and performance stock grants is $11.1 million . The Company anticipates that this
cost will be recognized over a weighted-average period of 2.49 years.
NON-GAAP FINANCIAL MEASURES
Management believes the non-GAAP (Generally Accepted Accounting Principles) measures used in this report provide investors with important perspectives into our ongoing business performance. We do not intend for the information to be considered in isolation or as a substitute for the related GAAP measures. Other companies may define the measures differently. We define the non-GAAP measures used in this report and other disclosures as follows:
Organic Sales
Organic Sales is defined as "Net Sales" less sales derived from acquisitions
completed or businesses disposed of that did not qualify for accounting as a
discontinued operation during the previous twelve months. We believe that this
measure provides management and investors with a more complete understanding of
underlying operating results and trends of established, ongoing operations by
excluding the effect of acquisitions, which can obscure underlying trends. We
also believe that presenting Organic Sales separately provides management and
investors with useful information about the trends impacting our operations and
enables a more direct comparison to other businesses and companies in similar
industries. Management recognizes that the term "Organic Sales" may be
interpreted differently by other companies and under different circumstances.
Organic Sales from continuing operations (in thousands)
For the Three Months Ended For the Six Months Ended
July 2, July 3, July 2, July 3,
2021 2020 2021 2020
Net sales $ 182,394 $ 177,890 $ 354,010 $ 385,212
Acquisition sales - - - -
Sales of disposed businesses that
did not qualify for discontinued
operations - 4,812 1,704 13,298
Organic Sales $ 182,394 $ 173,078 $ 352,306 $ 371,914
Free Cash Flow
Free Cash Flow is defined as GAAP "Net cash provided by (used in) operating
activities" in a period less "Expenditures for property, plant & equipment" in
the same period. Management believes Free Cash Flow provides an important
perspective on our ability to generate cash from our business operations and, as
such, that it is an important financial measure for use in evaluating the
Company's financial performance. Free Cash Flow should not be viewed as
representing the residual cash flow available for discretionary expenditures
such as dividends to shareholders or acquisitions, as it may exclude certain
mandatory expenditures such as repayment of maturing debt and other contractual
obligations. Management uses Free Cash Flow internally to assess overall
liquidity.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
There have been no material changes outside the ordinary course of business in
our contractual obligations or off-balance sheet arrangements during the first
six months of 2021. See our 2020 Form 10-K for a discussion of our contractual
obligations and off-balance sheet arrangements.
37
--------------------------------------------------------------------------------CRITICAL ACCOUNTING ESTIMATES
Preparation of the Company's financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Management believes the most complex and sensitive judgments, because of their significance to the Consolidated Financial Statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Management's Discussion and Analysis and the Notes to Consolidated Financial Statements in the Company's 2020 Form 10-K describe the critical accounting estimates and significant accounting policies used in preparing the Consolidated Financial Statements. Actual results in these areas could differ from management's estimates.
RECENT ACCOUNTING STANDARDS
Information regarding recent changes in accounting standards is included in Note 2, Recent Accounting Standards, of the Notes to Condensed Consolidated Financial Statements in this report.
© Edgar Online, source
