KLXI Klx Inc. (delisted)

PART I - FINANCIAL INFORMATIO N

See accompanying notes to condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

KLX INC.

Licensing , and in May 2016, ASU 2016-12, Revenues from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients both of which provide supplemental adoption guidance and clarification to ASU 2014-09. ASU 2016-10 and ASU 2016-12 must be adopted concurrently with the adoption of ASU 2014-09. The Company has not determined the impact this guidance will have on the financial statements.  However, the identification of implementation project team members and the inventorying of contracts with customers, particularly large customer contracts, has begun. Other than increased disclosures, the impact of the revised accounting guidance to the results of operations and cash flows of the Company cannot be determined until the assessment process is complete.

Note 3. Business Combinations

On May 17, 2016, the Company acquired Herndon Aerospace & Defense LLC (“Herndon”), an aftermarket aerospace supply chain management and consumables hardware distributor servicing principally aftermarket military depots as well as the commercial aerospace aftermarket for an aggregate purchase price of $220.8 (net of cash acquired). During the quarter ended October 31, 2016, Herndon’s acquired working capital was finalized resulting in a reduction in purchase price of $0.7 and customary working capital adjustments as of the closing date which were not material individually or in the aggregate. Additionally, the Company adjusted the allocation of the Herndon purchase price to increase intangible assets by $16.4 and decrease goodwill and inventories by $14.2 and $3.0, respectively, related to the Company’s preliminary purchase price allocation. The impact of the purchase price adjustment to the Company’s condensed consolidated statement of earnings from the date of acquisition was not material.

Based on the Company’s preliminary purchase price allocation, the excess of the purchase price of the fair value of the identifiable assets acquired approximated $113.6, of which $68.9 was allocated to identifiable intangible assets consisting of customer contracts and relationships and covenants not to compete, and $44.7 is included in goodwill. The useful life assigned to the customer contracts and relationships is 20 years, and the covenants not to compete are being amortized over their contractual periods of five years.

The Herndon acquisition was accounted for as a purchase under FASB ASC 805, Business Combinations. The assets acquired and liabilities assumed have been reflected in the accompanying condensed consolidated balance sheet as of October 31, 2016 and the results of operations are included in the accompanying condensed consolidated statements of earnings and comprehensive income from the date of acquisition. The valuation of certain assets, principally intangible assets and inventories, is not yet complete, and as such, the Company has not yet finalized its allocation of the purchase price for the acquisition.

The following table summarizes the current estimates of fair values of assets acquired and liabilities assumed in the Herndon acquisition in accordance with ASC 805, which are currently recorded based on management’s estimates as follows:

The majority of goodwill and intangible assets are expected to be deductible for tax purposes.

On a pro forma basis to give effect to the Herndon acquisition as if it occurred on February 1, 2015, revenues, net earnings (loss) and earnings (loss) per diluted share for the three months ended October 31, 2015 and the nine months ended October 31, 2016 and 2015 were:

The Company has begun integrating Herndon into its Aerospace Solutions Group (“ASG”) segment systems. As a result, it is not practicable to report stand-alone operating earnings of the acquired business since the acquisition date, and going forward it will not be practicable to report stand-alone revenues of the acquired business. Revenues from Herndon from the acquisition date of May 17, 2016 through October 31, 2016 were $56.7.

Note 4. Inventories

Inventories, made up of finished goods, consist primarily of aerospace fasteners and consumables. The Company values inventories at the lower of cost or market, using first‑in, first‑out or weighted average cost method. The Company reviews inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on historical demand, estimated product demand to support contractual supply agreements with its customers and the age of the inventory, among other factors. Demand for the Company’s products can fluctuate from period to period depending on customer activity.   In accordance with industry practice, inventories include amounts relating to long-term contracts with long production cycles, some of which are not expected to be realized within one year. In addition, the Company supports a substantial portion of the global fleet of aircraft in service, and in its capacity as a stocking distributor will acquire and hold inventories for aircraft maintenance at periodic intervals as mandated by the Federal Aviation Administration (“FAA”) or similar regulatory agencies. Based on historical experience, the support of the aftermarket activities with products such as those which the Company sells will necessitate holding inventory in excess of the amount required to support new build production activity contracts.  Obsolescence has historically been immaterial for the Company due to the long life of an aircraft and nature of the products sold by the Company. Inventory with a limited shelf life is continually monitored and reserved for in advance of expiration. The annual provision for inventory with limited shelf life has historically been immaterial. Reserves for excess and obsolete inventory were approximately $47.8   and $40.4 as of October 31, 2016 and January 31, 2016, respectively.

Amortization expense associated with identifiable intangible assets was approximately $4.8 and $5.8 for the three months ended October 31, 2016 and 2015, respectively, and $14.7 and $19.1 for the nine

months ended October 31, 2016 and 2015, respectively. The Company currently expects to recognize amortization expense of approximately $20.0 in each of the next five fiscal years (primarily related to our ASG business). The future amortization amounts are estimates. Actual future amortization expense may be different due to finalization of purchase price allocations of acquisitions, future acquisitions, impairments, changes in amortization periods or other factors such as changes in exchange rates for assets acquired outside the United States. The Company expenses costs to renew or extend the term of a recognized intangible asset.  Goodwill increased by $38.4 as compared to January 31, 2016 primarily as a result of the May 17, 2016 acquisition of Herndon by the ASG segment.

The fair value of the ASG reporting unit exceeded the carrying value by approximately 16% as of December 31, 2015, and approximately $993.3 of goodwill has been allocated to the ASG reporting unit as of October 31, 2016. ASG's cash flow projections were a significant input into the December 31, 2015 reporting unit fair value. Should ASG’s future cash from operations decline to levels inconsistent with ASG’s projected results, long-term projections may be adjusted downward, which could result in an impairment charge at the ASG reporting unit.

Note 6. Related Party Transactions

On December 17, 2014, B/E Aerospace, Inc. ( “B/E Aerospace”) created an independent public company through a spin-off of its ASG and Energy Services Group (“ESG”) businesses to B/E Aerospace’s stockholders (“Spin-Off”).  Following the Spin-Off, the Company created in-house substantially all of the functions that were previously provided to it by B/E Aerospace. In addition, the Company has entered into certain agreements with B/E Aerospace relating to transition services and IT services for a transitional period of approximately 24 months following the Spin-Off. In addition, the Company entered into an employee matters agreement and a tax sharing and indemnification agreement with B/E Aerospace in connection with the Spin-Off. This transitional support enables KLX to establish its stand-alone processes for various activities that were previously provided by B/E Aerospace and does not constitute significant continuing support of KLX’s operations. Expenses incurred under those agreements totaled $2.1 and $2.7 for the three months ended October 31, 2016 and 2015, respectively, and $7.1 and $8.8 for the nine months ended October 31, 2016 and 2015, respectively. As of October 31, 2016, the Company has recorded a tax indemnity payable to B/E Aerospace totaling $4.7, of which $0.1 is classified in other current liabilities and $4.6 is classified in other long term liabilities.

Sales to B/E Aerospace were $5.4 and $5.1 for the three months ended October 31, 2016 and 2015, respectively, and $18.6 and $14.4 for the nine months ended October 31, 2016 and 2015, respectively.

Note 8. Long-Term Debt

As of October 31, 2016, long-term debt consisted of $1,200.0 aggregate principal amount of the Company’s 5.875% senior unsecured notes due 2022 (the “5.875% Notes”). On a net basis, after taking into consideration the debt issue costs for the Term Loan Facility, total debt was $1,181.3.  As of October 31, 2016, the Company also had a $750.0 undrawn secured revolving credit facility pursuant to a credit agreement dated as of December 16, 2014 and amended and restated on May 19, 2015 (the “Revolving Credit Facility”).

Borrowings under the Revolving Credit Facility bear interest at an annual rate equal to the London interbank offered rate (“LIBOR”) (as defined in the Revolving Credit Facility) plus the applicable margin (as defined).  No amounts were outstanding under the Revolving Credit Facility as of October 31, 2016.

The Revolving Credit Facility is tied to a borrowing base formula and has no maintenance financial covenants.  This Revolving Credit Facility matures in May 2020. The credit agreement is collateralized by the Company’s assets and contains customary affirmative covenants, negative covenants, restrictions on the payment of dividends and the repurchase of our stock, and conditions precedent for borrowings, all of which were met as of October 31, 2016.

Letters of credit issued under the Revolving Credit Facility aggregated $4.8 and $3.2 at October 31, 2016 and 2015, respectively.

Note 9. Fair Value Measurements

All short-term financial instruments are generally carried at amounts that approximate estimated fair value. The fair value is the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties. Assets measured at fair value are categorized based upon the lowest level of significant input to the valuations.

Level 1 – quoted prices in active markets for identical assets and liabilities.

Level 2 – quoted prices for identical assets and liabilities in markets that are not active, or observable inputs other than quoted prices in active markets for identical assets and liabilities.

Level 3 – unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions.

The carrying amounts of cash and cash equivalents (which the Company classifies as Level 1 assets), accounts receivable – trade and accounts payable represent their respective fair values due to their short-term nature. There was no debt outstanding under the Revolving Credit Facility as of October 31, 2016. The fair value of the Company’s 5.875% Notes, based on market prices for publicly-traded debt (which the Company classifies as Level 2 inputs), was $1,218.2 and $1,136.4 as of October 31, 2016 and January 31, 2016, respectively.

Note 10. Commitments, Contingencies and Off-Balance Sheet Arrangements

Lease Commitments - The Company finances its use of certain facilities and equipment under committed lease arrangements provided by various institutions. Since the terms of these arrangements meet the accounting definition of operating lease arrangements, the aggregate sum of future minimum lease payments is not reflected on the condensed consolidated balance sheets. At October 31, 2016, future minimum lease payments under these arrangements approximated $90.9, the majority of which related to long-term real estate leases.

Litigation - The Company is a defendant in various legal actions arising in the normal course of business, the outcomes of which, in the opinion of management, neither individually nor in the aggregate are likely to result in a material adverse effect on the Company’s consolidated financial statements.

Indemnities, Commitments and Guarantees - During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to other parties to certain acquisition agreements. The duration of these indemnities, commitments and guarantees varies, and in

certain cases, is indefinite. Many of these indemnities, commitments and guarantees provide for limitations on the maximum potential future payments the Company could be obligated to make. However, the Company is unable to estimate the maximum amount of liability related to its indemnities, commitments and guarantees because such liabilities are contingent upon the occurrence of events that are not reasonably determinable. Management believes that any liability for these indemnities, commitments and guarantees would not be material to the accompanying consolidated financial statements. Accordingly, no significant amounts have been accrued for indemnities, commitments and guarantees.

The Company has employment agreements with three year initial terms, which renew for one additional year on each anniversary date, with certain key members of management. The Company’s employment agreements generally provide for certain protections in the event of a change of control. These protections generally include the payment of severance and related benefits under certain circumstances in the event of a change of control.

Note 11. Accounting for Stock-Based Compensation

The Company has a Long-Term Incentive Plan (“LTIP”) under which the Company’s Compensation Committee has the authority to grant stock options, stock appreciation rights, restricted stock, restricted stock units or other forms of equity-based or equity-related awards.

The Company accounts for share-based compensation arrangements in accordance with the provisions of FASB ASC 718, Compensation—Stock Compensation , whereby share-based compensation cost is measured on the date of grant, based on the fair value of the award, and is recognized over the requisite service period.

Compensation cost recognized during the three and nine months ended October 31, 2016 and 2015 related to KLX restricted stock and stock options was $4.8 and $3.5, and $14.3 and $10.6, respectively. Unrecognized compensation expense related to these grants was $32.5 at October 31, 2016.

KLX has established a qualified Employee Stock Purchase Plan, the terms of which allow for qualified employees (as defined in the Plan) to participate in the purchase of designated shares of KLX’s common stock at a price equal to 85% of the closing price on the last business day of each semi ‑ annual stock purchase period. The fair value of employee purchase rights represents the difference between the closing price of KLX’s shares on the date of purchase and the purchase price of the shares. Compensation cost for this plan was not material to any of the periods presented.

Note 12. Segment Reporting

The Company is organized based on the products and services it offers. The Company’s reportable segments which are also its operating segments, are comprised of ASG and ESG. The segments regularly report their results of operations and make requests for capital expenditures and acquisition funding to the Company’s chief operational decision-making group (“CODM”). This group is comprised of the Chairman and Chief Executive Officer and the President and Chief Operating Officer. As a result, the CODM has determined the Company has two reportable segments.

The following table presents revenues and operating earnings (losses) by reportable segment:

The following table presents capital expenditures by reportable segment:

Corporate capital expenditures have been allocated to the above segments based on each segment’s percentage of total capital expenditures.

The following table presents goodwill by reportable segment:

The following table presents total assets by reportable segment:

Corporate assets (primarily cash and cash equivalents) of $411.9 and $559.5 at October 31, 2016 and January 31, 2016, respectively, have been allocated to the above segments based on each segment’s percentage of total assets.

Note 13. Net Earnings Per Common Share

Basic net earnings per common share is computed using the weighted average common shares outstanding during the period. Diluted net earnings per common share is computed by using the weighted average common shares outstanding including the dilutive effect of stock options, shares issued under the KLX LTIP and restricted shares based on an average share price during the period. For the three months ended October 31, 2016 and 2015, approximately 0.4 and no shares and for the nine months ended October 31, 2016 and 2015, approximately 0.3 and no shares of the Company’s common stock, respectively, were excluded from the determination of diluted earnings per common share because their effect would have been anti-dilutive. The computations of basic and diluted earnings per share for the three and nine months ended October 31, 2016 and 2015 are as follows:

Note 14. Income Taxes

In accordance with FASB ASC 740, Income Taxes , the Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. As of October 31, 2016 and 2015, the Company had $12.3 and $10.3, respectively, of uncertain tax positions, including accrued interest of $1.7 and $1.1 at October 31, 2016 and 2015, respectively, all of which would affect the Company’s effective tax rate if recognized. During the quarter, the Company determined that certain loss carryforwards, previously reserved in the Company’s valuation allowance, would no longer require a reserve as we realized a one-time benefit from our ongoing tax planning initiatives. The release of valuation allowance with respect to these loss carryforwards resulted in a tax benefit for the quarter. The tax benefit netted against the Company’s tax expense on book income for the quarter, which resulted in no tax expense for the quarter.

As a result, the Company now expects an effective tax rate of approximately 27.5% for the year ending January 31, 2017. 

Pursuant to the terms of the Tax Sharing Agreement with our former parent, B/E Aerospace, the Company may be liable for income tax in certain foreign jurisdictions arising from the examination of tax years during which the Company was part of the B/E Group.  The statute of limitations in these foreign jurisdictions is open for tax years 2007-2015. The Company is currently undergoing a U.S. federal income tax examination for the period from December 17, 2014 through December 31, 2015.