Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
|
Spartan Motors, Inc. was organized as a Michigan corporation on September 18, 1975, and is headquartered in Charlotte, Michigan. Spartan Motors began development of its first product that same year and shipped its first fire truck chassis in October 1975.
We are a niche market leader in specialty vehicle manufacturing and assembly for the commercial vehicle (including last-mile delivery, specialty service and vocation-specific up-fit segments), emergency response and recreational vehicle industries. Our products include: walk-in vans and truck bodies used in e-commerce/parcel delivery; up-fit equipment used in the mobile retail and utility trades; fire trucks and fire truck chassis; luxury Class A diesel motor home chassis; military vehicles; and contract manufacturing and assembly services. We also supply replacement parts and offer repair, maintenance, field service and refurbishment services for the vehicles that we manufacture. Our operating activities are conducted through our wholly-owned operating subsidiary, Spartan Motors USA, Inc. (“Spartan USA”), with locations in Charlotte, Michigan; Bristol, Indiana; Ephrata, Pennsylvania; Ladson, South Carolina; Pompano Beach, Florida; Brandon, South Dakota; Snyder and Neligh, Nebraska, along with contract manufacturing in Kansas City, Missouri and Saltillo, Mexico.
Our Bristol, Indiana location manufactures vehicles used in the parcel delivery, mobile retail and trades and construction industries, and supplies related aftermarket parts and services under the Utilimaster brand name. Our Kansas City, Missouri, Ladson, South Carolina and Saltillo, Mexico locations sell and install equipment used in fleet vehicles. Our Charlotte, Michigan location manufactures heavy-duty chassis and vehicles, and supplies aftermarket parts and accessories under the Spartan Chassis and Spartan ER brand names. Our Brandon, South Dakota; Snyder and Neligh, Nebraska; and Ephrata, Pennsylvania locations manufacture emergency response vehicles under the Spartan, Smeal, US Tanker and Ladder Tower Company brand names.
Our diversification across several sectors provides numerous opportunities while reducing overall risk as the various markets we serve tend to have different cyclicality. We have an innovative team focused on building lasting relationships with our customers by designing and delivering market leading specialty vehicles, vehicle components, and services. Additionally, our business structure provides the agility to quickly respond to market needs, take advantage of strategic opportunities when they arise and correctly size and scale operations to ensure stability and growth. Our expansion of equipment up-fit services in our Fleet Vehicles and Services segment and the growing opportunities that we have capitalized on in last mile delivery as a result of the rapidly changing e-commerce market are excellent examples of our ability to generate growth and profitability by quickly fulfilling customer needs.
We believe we can best carry out our long-term business plan and obtain optimal financial flexibility by using a combination of borrowings under our credit facilities, as well as internally or externally generated equity capital, as sources of expansion capital.
Executive Overview
|
●
|
Revenue of $234.0 million in the first quarter of 2019, an increase of 35.2% compared to $173.0 million in the first quarter of 2018.
|
|
●
|
Gross profit of $24.5 million in the first quarter of 2019, an increase of 10.7% compared to $22.2 million in the first quarter of 2018.
|
|
●
|
Gross Margin of 10.5% in the first quarter of 2019, compared to 12.8% in the first quarter of 2018.
|
|
●
|
Operating expense of $22.9 million, or 9.8% of sales in the first quarter of 2019, compared to $19.3 million or 11.1% of sales in the first quarter of 2018.
|
|
●
|
Operating income of $1.6 million in the first quarter of 2019, compared to $2.9 million in the first quarter of 2018.
|
|
●
|
Net income of $1.4 million in the first quarter of 2019, compared to $4.2 million in the first quarter of 2018.
|
|
●
|
Earnings per share of $0.04 in the first quarter of 2019, compared to $0.12 in the first quarter of 2018.
|
|
●
|
Order backlog of $432.3 million at March 31, 2019, a decrease of $122.3 million or 22.1% from our backlog of $554.6 million at March 31, 2018.
|
Table of Contents
We believe we are well positioned to take advantage of long-term opportunities, and continue our efforts to bring product innovations to each of the markets that we serve. Some of our recent innovations, strategic developments, and strengths include:
|
●
|
Our diversified business model. We believe the major strength of our business model is market diversity and customization. Our Fleet Vehicles and Specialty Chassis and Vehicles segments serve mainly business and consumer markets, effectively diversifying our company and complementing our Emergency Response Vehicles segment, which primarily serves governmental entities. Additionally, the fleet vehicle market is an early-cycle industry, complementary to the late-cycle emergency response vehicle industry. We intend to continue to pursue additional areas that build on our core competencies to diversify our business further.
|
|
|
|
|
●
|
Innovative product offerings such as the purpose-built up-fit featuring vehicle flooring with integrated mounting for the Ford Transit 130" wheelbase cargo van, which is built to withstand tough conditions, endure extra payload, and offer a quiet ride. The product boasts multiple storage and shelving options, as well as LED lights, a maximum-view partition, and a double-clamp ladder rack.
|
|
|
|
|
●
|
Our alliance with Motiv Power Systems, a leading producer of all-electric chassis for walk-in vans, box trucks, work trucks, buses and other specialty vehicles that provides Spartan with exclusive access to Motiv’s EPIC
TM
all-electric chassis in manufacturing Class 4 – Class 6 walk-in vans. This alliance demonstrates Spartan’s ability to innovate and advance the markets we serve, and places us ahead of the curve in the electric vehicle (EV) fleet market.
|
|
|
|
|
●
|
Our expansion into the equipment up-fit market for vehicles used in the parcel delivery, trades and construction industries. This rapidly expanding market offers an opportunity to add value to current and new customers for our fleet vehicles and vehicles produced by other original equipment manufacturers.
|
|
|
|
|
●
|
Spartan introduced its refrigeration technology to demonstrate our ability to apply the latest technical advancements with our unique understanding of last-mile delivery optimization. Utilimaster's Work-Driven Design™ process provides best-in-class conversion solutions in walk-in vans, truck bodies, and cargo van vehicles. The refrigerated van is up-fitted to optimally preserve cold cargo quality while offering customizations such as removable bulkheads and optional thermal curtains. The multi-temperature solution requires no additional fuel source, so it can serve a wide variety of categories from food and grocery to time and temperature sensitive healthcare deliveries.
|
|
|
|
|
●
|
The introduction of the K3 605 chassis. The K3 605 is equipped with Spartan Connected Coach, a technology bundle featuring the new digital dash display and keyless push-button start. It also features Spartan's Advanced Protection System, a collection of safety systems that includes collision mitigation with adaptive cruise control; electronic stability control; automatic traction control; Spartan Safe Haul; and factory chassis-integrated air supply for tow vehicle braking systems.
|
|
|
|
|
●
|
The introduction of Spartan Safe Haul. Spartan Safe Haul is the motor home industry’s only chassis-integrated air supply for tow vehicle braking systems, available on Spartan Class A motor home chassis for the 2019 model year.
|
|
|
|
|
●
|
Spartan Connected Coach, a technology bundle for our motor home chassis that includes a 15-inch digital dash displaying gauge functions, tire pressure monitoring, blind spot indicators, navigation, and other information. Connected Coach also offers passive keyless start and adjustable Adaptive Cruise Control, and brings proven automotive technology to the RV market.
|
|
|
|
|
●
|
Spartan will introduce the all new purpose-built 93' Mid-Mount Platform designed for operation in tight spaces, and an evolution to the Intelligent Pump Solution pumper, the IPS-NXT, which allows for traditional pumper volume in a more maneuverable platform.
|
|
|
|
|
●
|
The strength of our balance sheet, which includes robust working capital, low debt and access to credit through our revolving line of credit.
|
The following section provides a narrative discussion about our financial condition and results of operations. Certain amounts in the narrative may not sum due to rounding. The comments should be read in conjunction with our Condensed Consolidated Financial Statements and related Notes thereto included in Item 1 of this Form 10-Q and in conjunction with our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 5, 2019.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the components of the Company’s Condensed Consolidated Statements of Operations as a percentage of sales (percentages may not sum due to rounding):
|
|
Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Sales
|
|
|
100.0
|
|
|
|
100.0
|
|
Cost of products sold
|
|
|
89.5
|
|
|
|
87.2
|
|
Restructuring charge
|
|
|
0.0
|
|
|
|
0.0
|
|
Gross profit
|
|
|
10.5
|
|
|
|
12.8
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
1.0
|
|
|
|
0.8
|
|
Selling, general and administrative
|
|
|
8.8
|
|
|
|
10.3
|
|
Restructuring charge
|
|
|
0.0
|
|
|
|
0.0
|
|
Operating income
|
|
|
0.7
|
|
|
|
1.7
|
|
Other income (expense), net
|
|
|
0.0
|
|
|
|
0.7
|
|
Income before taxes
|
|
|
0.7
|
|
|
|
2.4
|
|
Taxes
|
|
|
0.0
|
|
|
|
(0.0
|
)
|
Net income attributable to non-controlling interest
|
|
|
(0.1
|
)
|
|
|
-
|
|
Net income
|
|
|
0.6
|
|
|
|
2.4
|
|
We adopted Accounting Standards Update 2016-02,
Leases
(“ASU 2016-02” or “ASC 842”) on January 1, 2019. Our adoption of ASC 842 resulted in changes to our lease policy whereby we now recognize a right of use asset and lease liability for operating and finance leases, among certain other changes. Please see Note 1,
General and Summary of Accounting Policies
, in the Notes to Condensed Consolidated Financial Statements appearing in Item 1 of this Form 10-Q for further information regarding our adoption of ASC 842.
Quarter Ended
March
3
1
, 201
9
Compared to the Quarter Ended
March
3
1
, 201
8
Sales
For the quarter ended March 31, 2019, we reported consolidated sales of $234.0 million, compared to $173.0 million for the first quarter of 2018 an increase of $61.0 million or 35.2%. This increase reflects sales volume increases of $63.0 million in our Fleet Vehicles and Services segment and $2.8 million in our Specialty Vehicles and Chassis segment. Pricing increases of $1.3 million and $0.7 million are reflected in the Specialty Vehicles and Chassis segment and the Emergency Response Vehicles segment, respectively. These increases were partially offset by a $5.7 million volume decrease in our Emergency Response Vehicles segment, a $0.6 million decrease due to sales mix and a decrease in intersegment eliminations of $0.5 million. Please refer to our segment discussion below for further information about segment sales.
Cost of Products Sold
Cost of products sold was $209.4 million in the first quarter of 2019, compared to $150.9 million in the first quarter of 2018, an increase of $58.5 million or 38.8%. Cost of products sold increased by $54.7 million due to the higher sales volumes in the first quarter of 2019. Product mix in 2019 added an additional $6.0 million to cost of products sold, while higher warranty expense added $1.1 million and $2.3 million was added in tariff-driven commodity and component cost increases in the first quarter of 2019. These were partially offset by a decrease of $4.8 million due to productivity improvements and cost reductions driven by the higher sales volume. As a percentage of sales, cost of products sold increased to 89.5% in the first quarter of 2019, compared to 87.2% in the first quarter of 2018. The higher volume, product mix and tariff-driven commodity and component costs experienced in 2019 resulted in decreases of 220, 20 and 10 basis points, respectively. These decreases were partially offset by a 20 basis point increase due to productivity improvements and cost reductions in 2019.
Gross Profi
t
Gross profit was $24.5 million for the first quarter of 2019, compared to $22.2 million for the first quarter of 2018, an increase of $2.3 million, or 10.7%. Higher sales volume contributed $4.8 million to the increase in gross profit and pricing increases added an additional $2.0 million in 2019. Productivity improvements and cost reductions added $4.4 million to gross profit in 2019. These increases were partially offset by a $6.6 million product mix impact and a $2.3 million tariff-driven commodity and component cost increase in 2019. Gross margin decreased to 10.5% from 12.8% over the same period, with decreases of 220 basis points due to higher volume and 20 basis points due to product mix experienced in the first quarter of 2019. These decreases were partially offset by increases of 10 basis points due to productivity improvements and cost reductions in the first quarter of 2019.
Operating Expenses
Operating expense was $22.9 million for the first quarter of 2019, compared to $19.3 million for the first quarter of 2018, an increase of $3.6 million or 18.8%. Research and development expense in the first quarter of 2019 was $2.4 million, compared to $1.4 million in the first quarter of 2018, an increase of $1.0 million, or 70.9%, due to higher spending on new product development projects in 2019. Selling, general and administrative expense was $20.5 million in the first quarter of 2019, compared to $17.9 million for the first quarter of 2018, an increase of $2.6 million or 14.7%. Higher selling costs of $0.4 million was driven by increased marketing costs to support the sales function. Increased spending related to the Strobes location in Florida and the Ephrata truck body location in Pennsylvania amounted to $1.0 million. Professional fees also increased by $1.0 million for outsourced services.
Other income/ (expense)
Interest expense was $0.4 million for the first quarter of 2019, comparable with the $0.3 million of expense for the first quarter of 2018. Interest and other income was $0.3 million in the first quarter of 2019, compared to the $1.6 million of income for the first quarter of 2018 which included the net working capital adjustment of $1.5 million related to the Smeal acquisition.
Taxes
Our effective income tax rate was 0.8% for the three months ended March 31, 2019
,
compared to (1.1)% for the three months ended March 31, 2018
.
Our effective tax rate in 2019 was primarily impacted by the recording of a discrete tax benefit related to additional state tax credits from prior years becoming available for utilization in future tax returns, with a net reduction in income tax expense of $296. Our effective tax rate for the first quarter ended March 31, 2018 was impacted by a discrete benefit related to the difference in stock compensation expense recognized for book purposes and tax purposes that reduced our tax expense by $1,355
,
partially offset by $249 of increases for other discrete items.
Net Income
We recorded net income of $1.4 million or $0.04 per share for the first quarter of 2019, compared to net income of $4.2 million, or $0.12 per share, for the first quarter of 2018. Driving the decrease in net income for the three months ended March 31, 2019 compared with the prior year were the factors discussed above.
Adjusted
EBITDA
Our consolidated adjusted EBITDA in the first quarter of 2019 was $4.6 million, compared to $5.6 million for the first quarter of 2018, a decrease of $1.0 million or 17.3%.
The table below describes the changes in Adjusted EBITDA for the three months ended March 31, 2019 compared to the same period of 2018 (in millions):
Adjusted EBITDA three months ended March 31, 2018
|
|
$
|
5.6
|
|
Tariff driven commodity and component cost increases
|
|
|
(2.3
|
)
|
Sales mix
|
|
|
(4.0
|
)
|
Higher sales volume in 2019
|
|
|
2.2
|
|
Price increase realized in 2019
|
|
|
2.0
|
|
Productivity improvements and cost reductions
|
|
|
4.6
|
|
Increase in new product development expense
|
|
|
(1.0
|
)
|
Increased marketing costs related to Strobes and Ephrata Truck Body
|
|
|
(0.4
|
)
|
Administrative infrastructure costs for Strobes and Ephrata Truck Body
|
|
|
(1.1
|
)
|
Increase in professional fees
|
|
|
(1.0
|
)
|
Adjusted EBITDA three months ended March 31, 2019
|
|
$
|
4.6
|
|
Adjusted net income
Our consolidated adjusted net income in the first quarter of 2019 was $1.5 million, compared to $3.3 million for the first quarter of 2018, a decrease of $1.8 million or 54.5%. This decrease was due to the factors impacting adjusted EBITDA described above, in addition to a $0.6 million increase in adjusted income tax expense in 2019.
Order Backlog
Our order backlog by reportable segment is summarized in the following table (in thousands).
|
|
March 31,
2019
|
|
|
March 31,
2018
|
|
Fleet Vehicles and Services
|
|
$
|
188,528
|
|
|
$
|
335,325
|
|
Emergency Response Vehicles
|
|
|
214,659
|
|
|
|
189,627
|
|
Specialty Chassis and Vehicles
|
|
|
29,137
|
|
|
|
29,663
|
|
Total consolidated
|
|
$
|
432,324
|
|
|
$
|
554,615
|
|
Our Fleet Vehicles and Services backlog decreased by $146.8 million, or 43.8%, driven by the partial build-out of the $214.3 million contract received in September 2017 to supply delivery vehicles, which will be fulfilled through 2019. Our Emergency Response Vehicles backlog increased by $25.0 million, or 13.2%, primarily due to increased orders received in 2019. Our Specialty Chassis and Vehicles segment backlog decreased by $0.5 million, or 1.8%, due to a reduced backlog related to parts. We anticipate filling our current backlog orders for our Fleet Vehicles and Services segment over the next 10 months, for our Emergency Response Vehicles segment over the next 12 months and our Specialty Chassis and Vehicles segment over the next 3 months.
While orders in the backlog are subject to modification, cancellation or rescheduling by customers, this has not been a major factor in the past. Although the backlog of unfilled orders is one of many indicators of market demand, several factors, such as changes in production rates, available capacity, new product introductions and competitive pricing actions, may affect actual sales. Accordingly, a comparison of backlog from period-to-period is not necessarily indicative of eventual actual shipments.
Reconciliation of Non-GAAP Financial Measures
This Form 10-Q contains adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) and adjusted net income, which are both non-GAAP financial measures. These non-GAAP financial measures are calculated by excluding items that we believe to be infrequent or not indicative of our continuing operating performance. For the periods covered by this Form 10-Q, such items include expenses associated with restructuring actions taken to improve the efficiency and profitability of certain of our manufacturing operations, various items related to business acquisition and litigation activities, and the impact of severe natural phenomena in areas surrounding our production facilities.
We present the non-GAAP financial measures adjusted EBITDA and adjusted net income because we consider them to be important supplemental measures of our performance. The presentation of adjusted EBITDA enables investors to better understand our operations by removing items that we believe are not representative of our continuing operations and may distort our longer term operating trends. The presentation of adjusted net income enables investors to better understand our operations by removing the impact of tax adjustments, including the impact that our deferred tax asset valuation allowance adjustment has had on our tax expense and net income in 2019, and other items that we believe are not indicative of our longer term operating trends. We believe these measures to be useful to improve the comparability of our results from period to period and with our competitors, as well as to show ongoing results from operations distinct from items that are infrequent or not indicative of our continuing operating performance. We believe that presenting these non-GAAP financial measures is useful to investors because it permits investors to view performance using the same tools that management uses to budget, make operating and strategic decisions, and evaluate our historical performance. We believe that the presentation of these non-GAAP financial measures, when considered together with the corresponding GAAP financial measures and the reconciliations to those measures, provides investors with additional understanding of the factors and trends affecting our business than could be obtained in the absence of these disclosures.
Our management uses adjusted EBITDA to evaluate the performance of and allocate resources to our segments. In addition, non-GAAP measures are used by management to review and analyze our operating performance and, along with other data, as internal measures for setting annual budgets and forecasts, assessing financial performance, and comparing our financial performance with our peers. Adjusted EBITDA is also used, along with other financial and non-financial measures, for purposes of determining certain incentive compensation for our management team.
Financial Summary (Non-GAAP)
Consolidated
(In thousands, Unaudited)
|
|
|
Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Net income attributable to Spartan Motors, Inc.
|
|
$
|
1,397
|
|
|
$
|
4,194
|
|
Add (subtract):
|
|
|
|
|
|
|
|
|
Restructuring charges
|
|
|
112
|
|
|
|
20
|
|
Acquisition related expenses
|
|
|
45
|
|
|
|
162
|
|
Litigation expense (settlement)
|
|
|
43
|
|
|
|
-
|
|
Nebraska flooding expense
|
|
|
123
|
|
|
|
-
|
|
Impact of acquisition adjustments for net working capital
|
|
|
-
|
|
|
|
(1,500
|
)
|
Deferred tax asset valuation allowance adjustment
|
|
|
(99
|
)
|
|
|
74
|
|
Tax effect of adjustments
|
|
|
(78
|
)
|
|
|
315
|
|
Adjusted net income attributable to Spartan Motors, Inc.
|
|
$
|
1,543
|
|
|
$
|
3,265
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to Spartan Motors, Inc.
|
|
$
|
1,397
|
|
|
$
|
4,194
|
|
Add (subtract):
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
374
|
|
|
|
323
|
|
Depreciation and amortization
|
|
|
2,525
|
|
|
|
2,452
|
|
Taxes on income
|
|
|
13
|
|
|
|
(48
|
)
|
Restructuring charges
|
|
|
112
|
|
|
|
20
|
|
Acquisition related expenses
|
|
|
45
|
|
|
|
162
|
|
Litigation expense (settlement)
|
|
|
43
|
|
|
|
-
|
|
Nebraska flooding expenses
|
|
|
123
|
|
|
|
-
|
|
Impact of acquisition adjustments for net working capital
|
|
|
-
|
|
|
|
(1,500
|
)
|
Adjusted EBITDA
|
|
$
|
4,632
|
|
|
$
|
5,603
|
|
Our Segments
We identify our reportable segments based on our management structure and the financial data utilized by our chief operating decision makers to assess segment performance and allocate resources among our operating units. We have three reportable segments: Fleet Vehicles and Services, Emergency Response Vehicles, and Specialty Chassis and Vehicles. Our Specialty Chassis and Vehicles segment now manufactures certain fleet vehicles due to a realignment of our operating segments completed during the second quarter of 2017. These vehicles are sold via intercompany transactions to our Fleet Vehicles and Services segment, which then sells the vehicles to the final customer.
We evaluate the performance of our reportable segments based on Adjusted EBITDA. Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, and other adjustments made in order to present comparable results from period to period. For the periods covered by this Form 10-Q, these adjustments include: restructuring charges; accruals and adjustments to prior accruals for product recalls; various items related to business acquisition and litigation activities; and the impact of temporary production disruptions due to severe weather-related flooding surrounding the Company’s facilities. We exclude these items from earnings because we believe they will be incurred infrequently and/or are otherwise not indicative of a segment's regular, ongoing operating performance. Adjusted EBITDA is also used as one performance metric for certain of our compensation programs, as discussed in our proxy statement for our 2019 annual meeting of shareholders, which proxy statement was filed with the SEC on April 19, 2019.
The table below presents the reconciliation of our total segment Adjusted EBITDA to consolidated income before taxes. Adjusted EBITDA is not a measurement of our financial performance under GAAP and should not be considered as an alternative to net income. Adjusted EBITDA may have limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. In addition, although we have excluded certain charges in calculating Adjusted EBITDA, we may in the future incur expenses similar to these adjustments, despite our assessment that such expenses are infrequent and/or not indicative of our regular, ongoing operating performance. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or infrequent items.
|
|
Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Total segment adjusted EBITDA
|
|
$
|
9,647
|
|
|
$
|
8,953
|
|
Add (subtract):
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(374
|
)
|
|
|
(323
|
)
|
Depreciation and amortization expense
|
|
|
(2,525
|
)
|
|
|
(2,452
|
)
|
Restructuring expense
|
|
|
(112
|
)
|
|
|
(20
|
)
|
Acquisition expense
|
|
|
(45
|
)
|
|
|
(162
|
)
|
Litigation (expenses) settlement
|
|
|
(43
|
)
|
|
|
-
|
|
Nebraska flooding expenses
|
|
|
(123
|
)
|
|
|
-
|
|
Net income attributable to non-controlling interest
|
|
|
140
|
|
|
|
-
|
|
Impact of acquisition adjustments for net working capital
|
|
|
-
|
|
|
|
1,500
|
|
Unallocated corporate expenses
|
|
|
(5,015
|
)
|
|
|
(3,350
|
)
|
Consolidated income before taxes
|
|
$
|
1,550
|
|
|
$
|
4,146
|
|
Our Fleet Vehicles and Services segment consists of our operations at our Bristol, Indiana location, along with our operations at our up-fit centers in Kansas City, Missouri, Ladson, South Carolina, Pompano Beach, Florida and Saltillo, Mexico. This segment focuses on designing and manufacturing walk-in vans for the parcel delivery, mobile retail, and trades and construction industries, and supplies related aftermarket parts and services under the Utilimaster brand name.
Our Emergency Response Vehicles segment consists of the emergency response chassis operations at our Charlotte, Michigan location and our operations at our Brandon, South Dakota; Snyder and Neligh, Nebraska; and Ephrata, Pennsylvania locations. This segment engineers and manufactures emergency response chassis and vehicles.
Our Specialty Chassis and Vehicles segment consists of our Charlotte, Michigan operations that engineer and manufacture motor home chassis, defense vehicles, the Reach delivery van and other specialty chassis and distribute related aftermarket parts and accessories.
For certain financial information related to each segment, see Note 10 -
Business Segments
, of the Notes to Condensed Consolidated Financial Statements appearing in Item 1 of this Form 10-Q.
Fleet Vehicles and Services
|
|
Financial Data
|
|
|
|
(Dollars in Thousands)
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
Amount
|
|
|
%
|
|
|
Amount
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
122,649
|
|
|
|
100.0
|
%
|
|
$
|
59,691
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA
|
|
|
6,975
|
|
|
|
5.7
|
%
|
|
|
4,590
|
|
|
|
7.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets
|
|
|
117,934
|
|
|
|
|
|
|
|
79,584
|
|
|
|
|
|
Comparison of the Three-Month Periods Ended
March
3
1
, 201
9
and 201
8
Sales in our Fleet Vehicles and Services segment were $122.6 million for the first quarter of 2019, compared to $59.7 million for the first quarter of 2018, an increase of $62.9 million or 105.4%, driven by higher sales volumes in vehicle sales of $52.5 million and $10.4 million in parts sales due to higher volumes primarily from our up-fit business. Our Fleet Vehicles and Services segment had no changes in pricing of products sold that had a significant impact on our financial statements when comparing the first quarter of 2019 to the first quarter of 2018.
Adjusted EBITDA in our Fleet Vehicles and Services segment for the first quarter of 2019 was $7.0 million compared to $4.6 million in the first quarter of 2018, an increase of $2.4 million or 52.0%. Higher sales volume accounted for a $4.4 million increase while productivity improvements and cost reductions generated $4.5 million. These increases were partially offset by $1.0 million in tariff-driven commodity and component cost increases in the first quarter of 2019, while $3.8 million of the decrease was due to the product mix and $1.7 million was due to increased marketing, administrative and research and development costs.
Emergency Response Vehicles
|
|
Financial Data
|
|
|
|
(Dollars in Thousands)
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
Amount
|
|
|
%
|
|
|
Amount
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
61,757
|
|
|
|
100.0
|
%
|
|
$
|
66,712
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA
|
|
|
(2,292
|
)
|
|
|
(3.7
|
)%
|
|
|
1,242
|
|
|
|
1.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets
|
|
|
139,729
|
|
|
|
|
|
|
|
112,142
|
|
|
|
|
|
Comparison of the Three-Month Periods Ended March 31, 2019 and 2018
Sales in our Emergency Response Vehicles segment were $61.8 million in the first quarter of 2019, compared to $66.7 million in the same period of 2018, a decrease of $4.9 million or 7.4%. Lower sales volume resulted in a decrease of $5.7 million in 2019 revenue. This decrease was partially offset by a $0.8 million increase due to pricing changes realized in 2019.
Adjusted EBITDA for our Emergency Response Vehicles segment was $(2.3) million in the first quarter of 2019, compared to $1.2 million in the first quarter of 2018, a decrease of $3.5 million or 291.7%. This change was due to a decrease of $2.7 million from product mix, $0.4 million from the lower production volume, $0.4 million due to tariff-driven increases in commodity prices, and a $0.8 million increase in additional costs including higher warranty costs in 2019, which were partially offset by a $0.8 million increase due to pricing adjustments realized in 2019.
Specialty Chassis and Vehicles
|
|
Financial Data
|
|
|
|
(Dollars in Thousands)
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
Amount
|
|
|
%
|
|
|
Amount
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
51,685
|
|
|
|
100.0
|
%
|
|
$
|
48,236
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA
|
|
|
4,964
|
|
|
|
9.6
|
%
|
|
|
3,121
|
|
|
|
6.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets
|
|
|
41,845
|
|
|
|
|
|
|
|
29,323
|
|
|
|
|
|
Comparison of the Three-Month Periods Ended
March
3
1
, 201
9
and 201
8
Sales in our Specialty Chassis and Vehicles segment were $51.7 million in the first quarter of 2019, compared to $48.2 million in 2018, an increase of $3.5 million or 7.2%. This increase was driven by increases of $2.0 million in other specialty chassis and vehicles due to higher sales volumes and $0.7 million in sales of aftermarket parts and accessories. Pricing adjustments realized in the first quarter of 2019 added $1.1 million to sales of motor home chassis and $0.2 million to other specialty chassis and vehicles. These increases were partially offset by a decrease of $0.6 million due to product mix.
Adjusted EBITDA for our Specialty Chassis and Vehicles segment for the first quarter of 2019 was $5.0 million, compared to $3.1 million in the same period of 2018, an increase of $1.9 million, or 59.1%. Higher pricing in 2019 drove a $1.3 million increase, while higher sales volume in 2019 resulted in a $0.8 million increase and productivity improvements and cost reductions in 2019 resulted in a $0.9 million increase. These increases were partially offset by decreases of $1.0 million due to tariff-driven increases in commodity and component costs and $0.1 million due to the product mix experienced in 2019.
Financial Condition
Balance Sheet at March 31, 2019 compared to December 31, 2018
For line items impacted by our adoption of the new leasing standard on January 1, 2019, please see “
Note 1 – General and Summary of Accounting Policies
” in the Notes to Condensed Consolidated Financial Statements contained in Part 1 of this Form 10-Q for further information regarding the impact of this new accounting standard.
Cash decreased by $6.0 million, or 21.9%, to $21.4 million at March 31, 2019 from $27.4 million at December 31, 2018. Please see the discussion of cash flow activity below for more information on our sources and uses of cash in the first three months of 2019.
Accounts receivable decreased by $2.4 million, or 2.2%, to $104.4 million at March 31, 2019, compared to $106.8 million at December 31, 2018 due to a $2.8 million payment received on aged invoices.
Inventory increased by $14.5 million, or 20.7%, to $84.5 million at March 31, 2019 compared to $70.0 million at December 31, 2018 mainly due to an increase in raw materials and work in process inventory as a result of the ramp up in production following our traditional year-end shut down in December.
Contract assets increased to $8.1 million or 22.5%, to $44.1 million at March 31, 2019 compared to $36.0 million at December 31, 2018 due to the ramp up in production following our traditional year-end shut down in December.
Accounts payable increased by $11.4 million or 14.9% to $87.8 million at March 31, 2019 compared to $76.4 million at December 31, 2018 due to the timing of payments and the ramp-up in other production following our traditional year-end shut down in December.
Accrued compensation and related taxes decreased by $1.2 million or 11.4% to $9.3 million at March 31, 2019 compared to $10.5 million at December 31, 2018 due to the payout of accrued 2018 incentive compensation in the first quarter of 2019.
Deposits from customers decreased by $3.4 million or 15.0% to $19.2 million at March 31, 2019 compared to $22.6 million at December 31, 2018 as a result of more deposits applied to invoices than received from customers.
Other current liabilities and accrued expenses increased by $5.9 million or 47.8%, to $18.3 million at March 31, 2019 from $12.4 million at December 31, 2018, due primarily to increases of $2.5 million for additional healthcare costs and $1.8 million for increased payroll deductions primarily due to withholdings on stock vesting along with fluctuations due to timing.
Other non-current liabilities and accrued expenses increased by $1.2 million or 29.8%, to $5.3 million at March 31, 2019 from $4.1 million at December 31, 2018, due to fluctuations from timing.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Cash and cash equivalents decreased by $6.0 million to $21.4 million at March 31, 2019, compared to $27.4 million at December 31, 2018. These funds, in addition to cash generated from future operations and available credit facilities, are expected to be sufficient to finance the Company’s foreseeable liquidity and capital needs.
Cash Flow from Operating Activities
We utilized $2.4 million of cash from operating activities during the three months ended March 31, 2019, a decrease of $2.8 million from $0.4 million of cash generated from operations for the three months ended March 31, 2018. Cash flow from operating activities decreased from 2018 due to an $11.3 million increase in cash utilized in the fulfillment of customer orders (including changes in accounts receivable, inventory, contract assets, and customer deposits) and a $2.0 million decrease in net income net of non-cash charges in 2019. This decrease was partially offset by a $10.5 million increase in cash generated through changes in other working capital items, including other current liabilities, accounts payable, accrued expenses and accrued compensation which were driven by the timing of payments.
See the Financial Condition section contained in Item 2 of this Form 10-Q for further information regarding balance sheet line items that drove cash flows for the three month period ended March 31, 2019. Also see the Condensed Consolidated Statements of Cash Flows contained in Item 1 of this Form 10-Q for the other various factors that represented the remaining fluctuation of cash from operations between the periods.
Cash Flow from Investing Activities
We utilized $1.9 million in investing activities in the first three months of 2019, for acquisition of capital assets related to our operations, a $0.1 million decrease compared to the $2.0 million utilized in the first three months of 2018.
During the remainder of 2019, we expect to make additional cash capital investments of $14.0 million to $15.0 million, including capital spending for expanding production facilities, the replacement and upgrades of machinery and equipment used in operations and the implementation of our ERP system.
Cash Flow from Financing Activities
We utilized $1.7 million of cash through financing activities in the first three months of 2019, compared to $2.5 million utilized in the first three months of 2018 due primarily to decreases in stock compensation.
Working Capital
Our working capital was as follows (in thousands):
|
|
March 31,
2019
|
|
|
December 31,
2018
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets
|
|
$
|
259,716
|
|
|
$
|
245,329
|
|
|
$
|
14,387
|
|
Current liabilities
|
|
|
153,580
|
|
|
|
138,097
|
|
|
|
15,483
|
|
Working capital
|
|
$
|
106,136
|
|
|
$
|
107,232
|
|
|
$
|
(1,096
|
)
|
The decrease in our working capital at March 31, 2019 from December 31, 2018, results from changes in cash, accounts receivable, and accounts payable and other liabilities, which were partially offset by increases in inventory and contract assets. Refer to the balance sheet discussion appearing above in Management’s Discussion and Analysis of Financial Condition and Results of Operations for an explanation of the causes of the material changes in working capital line items.
Contingent Obligations
Spartan-Gimaex joint venture
In February 2015, Spartan USA and Gimaex Holding, Inc. mutually agreed to begin discussions regarding the dissolution of the Spartan-Gimaex joint venture. In June 2015, Spartan USA and Gimaex Holding, Inc. entered into court proceedings to determine the terms of the dissolution. In February 2017, by agreement of the parties, the court proceeding was dismissed with prejudice and the judge entered an order to this effect as the parties agreed to seek a dissolution plan on their own. No dissolution terms have been determined as of the date of this Form 10-Q. In the fourth quarters of 2015 and 2014, we accrued charges totaling $1.0 million and $0.2 million to write down certain inventory items associated with this joint venture to their estimated fair values. Costs associated with the wind-down will be impacted by the final dissolution agreement. The costs we have accrued so far represent the low end of the range of the estimated total charges that we believe we may incur related to the wind-down. While we are unable to determine the final cost of the wind-down with certainty at this time, we may incur additional charges, depending on the final terms of the dissolution, and such charges are not expected to be material to our results.
Debt
On August 8, 2018, we entered into a Credit Agreement (the "Credit Agreement") by and among us, certain of our subsidiaries, as borrowers, Wells Fargo Bank, N.A., as administrative agent ("Wells Fargo"), and the lenders party thereto consisting of Wells Fargo, JPMorgan Chase Bank, N.A. and PNC Bank National Association (the "Lenders"). Under the Credit Agreement, we may borrow up to $150 million from the Lenders under a five-year secured revolving credit facility. The credit facility matures August 8, 2023. We may also request an increase in the facility of up to $75 million in the aggregate, subject to customary conditions. The credit facility is also available for the issuance of letters of credit of up to $20 million and swing line loans of up to $15 million, subject to certain limitations and restrictions. This line carries an interest rate of either (i) the highest of prime rate, the federal funds effective rate from time to time plus 0.5%, or the one month adjusted LIBOR plus 1.0%; or (ii) adjusted LIBOR plus margin based upon our ratio of debt to earnings from time to time. The applicable borrowing rate including margin was 3.75% (or one-month LIBOR plus 1.25%) at March 31, 2019. The credit facility is secured by security interests in, and liens on, all assets of the borrowers, other than real property and certain other excluded assets.
Under the terms of our Credit Agreement, we have the ability to issue letters of credit totaling $20.0 million. At March 31, 2019 and December 31, 2018, we had outstanding letters of credit totaling $0.9 million and $0.9 million, respectively, related to certain emergency response vehicle contracts and our workers compensation insurance.
Under the terms of our Credit Agreement we are required to maintain certain financial ratios and other financial covenants, which limited our available borrowings under our line of credit to a total of approximately $75.6 million and $86.4 million at March 31, 2019 and December 31, 2018. The agreement also prohibits us from incurring additional indebtedness; limits certain acquisitions, investments, advances or loans; limits our ability to pay dividends in certain circumstances; and restricts substantial asset sales. At March 31, 2019, we were in compliance with all covenants in our Credit Agreement, and based on our outlook for 2019, we expect to be able to meet these covenants over the next twelve months.
Equity Securities
On April 28, 2016, our Board of Directors authorized the repurchase of up to 1.0 million shares of our common stock in open market transactions. At March 31, 2019 there were 0.8 million shares remaining under this repurchase authorization. During the first quarter of 2019, we repurchased a total of 101,006 shares of our common stock under this authorization. If we were to repurchase the remaining 0.8 million shares of stock under the repurchase program, it would cost us approximately $7.4 million based on the closing price of our stock on April 25, 2019. We believe that we have sufficient resources to fund any potential stock buyback in which we may engage.
Dividends
The amounts or timing of any dividend distribution are subject to earnings, financial condition, liquidity, capital requirements and such other factors as our Board of Directors deems relevant. We declared dividends on our outstanding common shares in 2019 and 2018 as shown in the table below.
Date dividend
declared
|
|
Record date
|
|
Payment date
|
|
Dividend per
share ($)
|
|
|
Total
dividend paid
($000)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 24, 2018
|
|
November 14, 2018
|
|
December 14, 2018
|
|
$
|
0.05
|
|
|
$
|
1,757
|
|
May 2, 2018
|
|
May 15, 2018
|
|
June 15, 2018
|
|
|
0.05
|
|
|
|
1,759
|
|
October 24, 2017
|
|
November 15, 2017
|
|
December 15, 2017
|
|
|
0.05
|
|
|
|
1,753
|
|
May 2, 2017
|
|
May 15, 2017
|
|
June 15, 2017
|
|
|
0.05
|
|
|
|
1,755
|
|
CRITICAL ACCOUNTING POLICIES
The following discussion of critical accounting policies is intended to supplement Note 1,
General and Summary of Accounting Policies
, of the Notes to Consolidated Financial Statements contained in Item 8 in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 5, 2019. These policies were selected because they are broadly applicable within our operating units and they involve additional management judgment due to the sensitivity of the methods, assumptions and estimates necessary in determining the related statement of income, asset and/or liability amounts.
Revenue Recognition
Essentially all of our revenue is generated through contracts with our customers. We may recognize revenue over time or at a point in time when or as obligations under the terms of a contract with our customer are satisfied, depending on the terms and features of the contract and the products supplied. Our contracts generally do not have any significant variable consideration. The collectability of consideration on the contract is reasonably assured before revenue is recognized. On certain vehicles, payment may be received in advance of us satisfying our performance obligations. Such payments are recorded in Customer deposits on the Condensed Consolidated Balance Sheets. The corresponding performance obligations are generally satisfied within one year of the contract inception. In such cases, we have elected to apply the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component. The financing impact on contracts that contain performance obligations that are not expected to be satisfied within one year are expected to be immaterial to our financial statements. We have elected to utilize the practical expedient to recognize the incremental costs of obtaining a contract as an expense when incurred because the amortization period for the prepaid costs that would have otherwise been deferred and amortized is one year or less.
Revenue recognized in a current period from performance obligations satisfied in a prior period, if any, is immaterial to our financial statements. We use an observable price to allocate the stand-alone selling price to separate performance obligations within a contract or a cost-plus margin approach when an observable price is not available. The estimated costs to fulfill our base warranties are recognized as expense when the products are sold. Our contracts with customers do not contain a provision for product returns, except for contracts related to certain parts sales.
Revenue for parts sales for all segments is recognized at the time that control and risk of ownership has passed to the customer, which is generally, when the ordered part is shipped to the customer. Historical return rates on parts sales have been immaterial. Accordingly, no return reserve has been recorded. Instead, returns are recognized as a reduction of revenue at the time that they are received.
For certain of our vehicles and chassis, we sell separately priced service contracts that provide roadside assistance or extend certain warranty coverage beyond our base warranty agreements. These separately priced contracts range from 1 to 6 years from the date of the shipment of the related vehicle or chassis. We receive payment with the shipment of the related vehicle or at the inception of the extended service contract, if later, and recognize revenue over the coverage term of the agreement, generally on a straight-line basis, which approximates the pattern of costs expected to be incurred in satisfying the obligations under the contract.
See Note 1,
General and Summary of Accounting Policies
, of the Notes to Condensed Consolidated Financial Statements contained in Item 1 of this Form 10-Q for more information regarding our revenue recognition policies.
Accounts Receivable
We maintain an allowance for customer accounts that reduces receivables to amounts that are expected to be collected. In estimating the allowance for doubtful accounts, we make certain assumptions regarding the risk of uncollectable open receivable accounts. This risk factor is applied to the balance on accounts that are aged over 90 days: generally, this reserve has an estimated range from 10-25%. The risk percentage applied to the aged accounts may change based on conditions such as: general economic conditions, industry-specific economic conditions, historical and anticipated customer performance, historical experience with write-offs and the level of past due amounts from year to year. However, generally our assumptions are consistent year-over-year and there has been little adjustment made to the percentages used. In addition, in the event there are certain known risk factors with an open account, we may increase the allowance to include estimated losses on such “specific” account balances. The “specific” reserves are identified by a periodic review of the aged accounts receivable. If there is an account in question, credit checks are made and there is communication with the customer, along with other means to try to assess if a specific reserve is required. The inclusion of the “specific” reserve has historically caused the greatest fluctuation in our allowance for doubtful accounts balance. Please see Note 1,
General and Summary of Accounting Policies
, in the Notes to Consolidated Financial Statements contained in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2018 for further details.
Goodwill and Other Indefinite-Lived Intangible Assets
In accordance with authoritative guidance on goodwill and other indefinite-lived intangible assets, such assets are tested for impairment at least annually and written down when and to the extent impaired. We perform our annual impairment test for goodwill and indefinite-lived intangible assets as of October 1 of each year, or more frequently if an event occurs or conditions change that would more likely than not reduce the fair value of the asset below its carrying value.
At March 31, 2019 and December 31, 2018, we had recorded goodwill at our Fleet Vehicles and Services, Emergency Response Vehicles and Specialty Chassis and Vehicles reportable segments. The Fleet Vehicles and Services and Emergency Response Vehicles reportable segments were determined to be reporting units for goodwill impairment testing, while the reporting unit for the goodwill recorded in the Specialty Chassis and Vehicles segment was determined to be limited to the Reach Manufacturing component of that reportable segment. The goodwill recorded in these reporting units was evaluated for impairment as of October 1, 2018 using a discounted cash flow valuation except for SRUS which is included in the Fleet Vehicles and Services segment and was recently acquired in December 2018.
We first assess qualitative factors including, but not limited to, macroeconomic conditions, industry conditions, the competitive environment, changes in the market for our products and current and forecasted financial performance to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we determine that it is more likely than not that the fair value of the reporting unit is greater than its carrying amount, we are not required to calculate the fair value of a reporting unit. We have the option to bypass this qualitative assessment and proceed to a quantitative goodwill impairment assessment. If we elect to bypass the qualitative assessment, or if after completing the assessment it is determined to be more likely than not that the fair value of a reporting unit is less than its carrying value, we perform an impairment test by comparing the fair value of a reporting unit with its carrying amount, including goodwill. The fair value of the reporting unit is determined by estimating the future cash flows of the reporting unit to which the goodwill relates, and then discounting the future cash flows at a market-participant-derived weighted-average cost of capital (“WACC”). In determining the estimated future cash flows, we consider current and projected future levels of income based on our plans for that business; business trends, prospects and market and economic conditions; and market-participant considerations. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered to not be impaired. If the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to the excess, up to the value of the goodwill.
We evaluate the recoverability of our indefinite lived intangible assets, which, as of March 31, 2019, consisted of our Utilimaster and Smeal trade names, by comparing the estimated fair value of the trade names with their carrying values. We estimate the fair value of our trade names based on estimates of future royalty payments that are avoided through our ownership of the trade name, discounted to their present value. In determining the estimated fair value of the trade names, we consider current and projected future levels of revenue based on our plans for Utilimaster and Smeal branded products, business trends, prospects and market and economic conditions.
Significant judgments inherent in these analyses include assumptions about appropriate sales growth rates, WACC and the amount of expected future net cash flows. The judgments and assumptions used in the estimate of fair value are generally consistent with the projections and assumptions that are used in current operating plans. Such assumptions are subject to change as a result of changing economic and competitive conditions. The determination of fair value is highly sensitive to differences between estimated and actual cash flows and changes in the related discount rate used to evaluate the fair value of the reporting units and trade name.
In 2018, we elected to bypass the qualitative assessment and proceed to the quantitative goodwill impairment assessment for all of our reporting units. The estimated fair values of these reporting units exceeded their carrying values by 184%, 36% and 378%, respectively, as of October 1, 2018, the most recent annual assessment date. Based on the discounted cash flow valuations at October 1, 2018, an increase in the WACC for the reporting units of 400 basis points would not result in impairment.
The acquired Utilimaster and Smeal trade names have indefinite lives as it is anticipated that they will contribute to our cash flows indefinitely. The estimated fair values of our Utilimaster and Smeal trade names exceeded their associated carrying values of $2.9 million and $2.4 million, respectively, by 1,758% and 269%, respectively, as of October 1, 2018. Accordingly, there was no impairment recorded on these trade names. Based on the discounted cash flow valuations at October 1, 2018, an increase in the WACC used for these impairment analyses of 400 basis points would not result in impairment in the trade names.
Since October 1, 2018, there have been no events or changes in circumstances that would more likely than not reduce the fair value of our Fleet Vehicles and Services, Emergency Response Vehicles, or Specialty Chassis and Vehicles reporting units or our indefinite-lived intangible assets below their respective carrying costs.
We cannot predict the occurrence of certain events or changes in circumstances that might adversely affect the carrying value of goodwill and indefinite-lived intangible assets. Such events may include, but are not limited to, the impact of the general economic environment; a material negative change in relationships with significant customers; strategic decisions made in response to economic and competitive conditions; and other risk factors as detailed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018.
See Note 1,
General and Summary of Accounting Policies
and Note 5,
Goodwill and Intangible Assets,
in the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2018 for further details on our goodwill and indefinite-lived intangible assets.
Warranties
Our policy is to record a provision for the estimated cost of warranty-related claims at the time of the sale, and periodically adjust the warranty liability to reflect actual experience. The amount of warranty liability accrued reflects actual historical warranty cost, which is accumulated on specific identifiable units. From that point, there is a projection of the expected future cost of honoring our obligations under the warranty agreements. Historically, the cost of fulfilling our warranty obligations has principally involved replacement parts and labor for field retrofit campaigns and recalls, which increase the reserve. Our estimates are based on historical experience, the number of units involved and the extent of features and components included in product models. See Note 7,
Commitments and Contingent Liabilities,
in the Notes to Condensed Consolidated Financial Statements contained in Item 1 of this Form 10-Q, for further information regarding warranties.
Provision for Income Taxes
We account for income taxes under a method that requires deferred income tax assets and liabilities to be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. Authoritative guidance also requires deferred income tax assets, which include state tax credit carryforwards, operating loss carryforwards and deductible temporary differences, be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred income tax assets will not be realized.
We evaluate the likelihood of realizing our deferred income tax assets by assessing our valuation allowance and by adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization include our forecast of future taxable income, the projected reversal of temporary differences and available tax planning strategies that could be implemented to realize the net deferred income tax assets.
We recognize 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. The determination is based on the technical merits of the position and presumes that each uncertain tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information. Although management believes the estimates are reasonable, no assurance can be given that the final outcome of these matters will not be different from what is reflected in the historical income tax provisions and accruals.
Interest and penalties attributable to income taxes are recorded as a component of income taxes.
EFFECT OF INFLATION
Inflation affects us in two principal ways. First, our revolving credit agreement is, generally, tied to the prime and LIBOR interest rates so that increases in those interest rates would be translated into additional interest expense. Second, general inflation impacts prices paid for labor, parts and supplies. Whenever possible, we attempt to cover increased costs of production and capital by adjusting the prices of our products. However, we generally do not attempt to negotiate inflation-based price adjustment provisions into our contracts. Since order lead times can be as much as nine months, we have limited ability to pass on cost increases to our customers on a short-term basis. In addition, the markets we serve are competitive in nature, and competition limits our ability to pass through cost increases in many cases. We strive to minimize the effect of inflation through cost reductions and improved productivity. Refer to the
Commodities Risk
section in Item 3 of this Form 10-Q, for further information regarding commodity cost fluctuations.