Comprehensive Income (Loss)
For each of the quarters ended October 1, 2017 and October 2, 2016, there were no material differences between net income (loss) and comprehensive income (loss).
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, Leases: Topic 842 (“ASU 2016-02”), to supersede nearly all existing lease guidance under GAAP. ASU 2016-02 requires the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases. ASU 2016-02 also requires qualitative disclosures along with specific quantitative disclosures and is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. Entities are required to apply the amendments at the beginning of the earliest period presented using a modified retrospective approach.
The Company is evaluating the requirements of this guidance and has not yet determined the impact of the adoption on its consolidated financial position, results of operations and cash flows; however, the Company’s current operating lease commitments are disclosed in Note 13, Commitments and Contingencies, of the Company’s Form 10-K for the fiscal year ended June 30, 2017.
In May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers: Topic
606 (“ASU 2014-09”), to supersede nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU 2015-14 which defers the effective date for one year beyond the originally specified effective date. ASU 2014-09 is effective in the Company’s first quarter of fiscal 2019 and may transition to the standard using either the full retrospective approach or retrospectively with a cumulative effect of initially applying the amendments recognized at the date of initial application.
The Company has completed its initial assessment of the effect of adoption. Based on this initial assessment, the majority of the Company’s revenues will not be affected upon adoption. The Company is still analyzing the disclosure requirements of this new standard.
NOTE 3 – Divestitures
General Flange & Forge LLC (“GF&F”)
On September 15, 2017, the Company sold substantially all of the assets of GF&F to GFFC Holdings, LLC (“GFFC”) for $3.0 million in cash. GFFC is owned, in part, by Quadrant Management Inc., which is an affiliate of the Company. The sale of GF&F is therefore a related party transaction. The GF&F sale was made pursuant to an industry-wide auction undertaken on behalf of the Company by a registered investment banking organization that managed the sale process with prospective bidders. GFFC entered into the bidding for the GF&F assets only after the first rounds of the auction indicated uncertainty both in respect to the timing for closing any prospective sale and achieving the Company’s valuation objectives. Mr. Alan Quasha, CEO of Quadrant Management Inc. and Chairman of the Company’s Board of Directors, recused himself from any deliberations or voting by the Board of Directors in respect of the sale of the GF&F assets to GFFC. The Board of Directors appointed a special committee consisting solely of independent directors to oversee and negotiate the sale process. The special committee engaged its own independent legal counsel to advise the special committee in respect of the drafting of the asset sale agreement and ancillary transaction documents in accordance with customary terms and conditions for transactions of this type. In this manner, the special committee was able to conclude that the sale price and the terms and conditions for the transaction were superior to any other offers, as well as fair and reasonable to the Company and its shareholders.
certain eligible inventory and 85% of the net orderly liquidation value of certain eligible inventory, plus (iii) an amount not to exceed $4.2 million, which amount will be adjusted based on the face amount of certain letters of credit issued to Citizens Bank, N.A. in connection with certain operating leases and capitalized leases, minus (iv) reserves for any amounts which the lender deems necessary or appropriate.
Borrowings under the Senior ABL Credit Facility may be made as Base Rate Loans or Eurodollar Rate Loans. The Base Rate loans will bear interest at the fluctuating rate per annum equal to (i) the highest of (a) the Federal Funds Rate plus 1/2 of 1.00%, (b) Citizens own prime rate; and (c) the adjusted Eurodollar rate on such day for an interest period of one (1) month plus 1.00%; and (ii) plus the Applicable Rate, as described below. Eurodollar Rate Loans will bear interest at the rate per annum equal to (i) the ICE Benchmark Administration LIBOR Rate; plus (ii) the Applicable Rate. The “Applicable Rate” will be (a) 2.50% with respect to Base Rate Loans that are Term Loans and 3.50% with respect to Eurodollar Rate Loans that are Term Loans, and (b) 2.50% with respect to Base Rate Loans that are Revolving Loans and 3.50% with respect to Eurodollar Rate Loans that are Revolving Loans, in each case until December 31, 2016, and thereafter the Applicable Rate will be adjusted quarterly, responsive to the Company’s Quarterly Average Availability Percentage, ranging from 1.25% to 1.75% with respect to Base Rate Loans that are Revolving Loans and from 2.25% to 2.75% with respect to Eurodollar Rate Loans that are Revolving Loans. In addition to interest payments on the Senior ABL Credit Facility loans, the Company will pay commitment fees to the lender of 0.375% per quarter on undrawn Revolving Loans. The Company will also pay other customary fees and reimbursements of costs and disbursements to the lender.
The Maturity Date with respect to the Revolving Loan and the Term Loan is August 11, 2019, provided, however, upon repayment of Company subordinated indebtedness the maturity date will automatically extend to five years after the Closing Date for Revolving Loans and Revolving Commitments, and with respect to the Term Loans, the earlier of the date that is (i) ten years after the Closing Date and (ii) the maturity date of the Revolving Loans. The Senior ABL Credit Facility contains certain mandatory prepayment provisions, including mandatory prepayments due in respect of sales of assets, sales of equity securities, events of default and other customary events, with exceptions for non-core business dispositions.
The Senior ABL Credit Facility contains customary covenants and negative covenants regarding operation of the Company’s business, including maintenance of certain financial ratios, as well as restrictions on dispositions of Company assets.
In connection with the Senior ABL Credit Facility, the Company and the Borrowers together with certain subsidiaries (collectively, the “Guarantors”), have entered into an Amended and Restated Guarantee and Collateral Agreement with Citizens Bank, N.A. dated as of September 29, 2016, which secures all of the loans and credits drawn from the Senior ABL Credit Facility by the Borrowers. The security interests established under the Amended and Restated Guarantee and Collateral Agreement include senior secured liens on substantially all of the assets of the Guarantors. The Guarantors have agreed to guarantee the unconditional payment and performance to the lender of all obligations of the Borrowers under the Senior ABL Credit Facility.
On September 21, 2017, the Company entered into a third amendment to the Senior ABL Credit Facility to amend the definition of Consolidated EBITDA.
On November 12, 2017, the Company entered into the Fourth Amendment to the Senior ABL Credit Facility (the “Fourth Amendment”). The Fourth Amendment suspends the Company’s fixed charge coverage ratio covenant through December 31, 2018. The suspension of the fixed charge coverage ratio covenant is effective as of October 1, 2017. The Fourth Amendment also adds a minimum revolving credit availability financial covenant. The Company’s revolving credit availability under the Senior ABL Credit Facility exceeded the minimum requirements during the quarter. The Fourth Amendment also permits the Company to make infusions of junior capital, which may consist of subordinated debt and/or equity issuances. The junior capital infusions made under the Fourth Amendment will not be subject to mandatory prepayment of the Senior ABL Credit Facility, but subject to certain limitations in respect of outstanding subordinated indebtedness. Under the terms of the Fourth Amendment, the initial infusion of junior capital in amount of not less than $5.0 million must be completed by the Company no later than January 31, 2018. The minimum revolving credit availability covenant requires the Company to maintain the following availability: (a) at least $1,250,000 in revolving credit availability until the earlier of (i) the initial closing of the infusion of $5.0 million in junior capital and (ii) January 31, 2018; and (b) thereafter, at least $3,500,000 in such revolving credit availability. The Fourth Amendment also reduces the Line Cap (consisting of the lesser of the aggregate revolving credit commitment and the
borrowing base) in respect of certain prepayment obligations and conditions precedent to borrowing, by reducing the borrowing base by $1,250,000. The Fourth Amendment contains customary representations and warranties regarding the status of the Company and compliance with all terms and conditions of the Senior ABL Credit Facility.
Prior Amended & Restated Credit Agreement
On September 29, 2016, the Company refinanced all of the existing long-term debt obligations with Citizens Bank, N.A. into the Senior ABL Credit Facility described above. The Company accounted for the refinancing as an extinguishment of debt and wrote off $0.7 million of previously deferred financing fees.
Subordinated Term Loan Credit Agreement
On November 10, 2014, the
Company and certain of its subsidiaries entered into a $20.0 million, five-year Subordinated Term Loan Credit Agreement (“Subordinated Loan Agreement”) with McLarty Capital Partners SBIC, L.P. (“McLarty”), which bears interest at 11% annually
; subsequently the Company entered into amendments one through four. Upon an event of default under the Subordinated Loan Agreement, the interest rate increases automatically by 2.00% annually.
The proceeds were used to repay certain outstanding loans under the Company’s previous credit facility.
ARC’s Chairman is
indirectly related to McLarty; therefore, the Board of Directors appointed a special committee consisting solely of independent directors to assure that the Subordinated Loan Agreement is fair and reasonable to the Company and its shareholders.
The Subordinated Loan Agreement has been subordinated to the Senior ABL Credit Facility pursuant to a First Lien Subordination
Agreement.
The Subordinated Loan Agreement contains customary
representations
and warranties, events of default, affirmative covenants, negative covenants, and prepayment terms that are similar to those contained in the Senior ABL Credit Facility described above.
On September 22, 2017, the Company entered into a fourth amendment to the Subordinated Loan Agreement to amend the definition of Consolidated EBITDA
and the Maximum Total Leverage Ratio.
As of October 1, 2017, the Company was in compliance with its debt covenants under the Subordinated Credit Facility.
Loan Contract
On March 23, 2016, AFT-Hungary Kft. (“AFT Hungary”), a wholly owned subsidiary of the Company, entered into a Loan Contract with Erste Bank Hungary Zrt. in an amount equal to €4.0 million (“Loan Contract”). The initial funding of €4.0 million drawn on the Loan Contract occurred on March 31, 2016. Approximately $3.0 million of the net proceeds from the Loan Contract were used to partially repay obligations outstanding under the Amended & Restated Credit Agreement, with the remaining net proceeds to be used for capital expenditures and other investments to facilitate the export of goods and services provided by AFT Hungary.
The loan matures on March 7, 2021, and bears interest at a fixed rate of 0.98% per annum. The Company is required to make semi-annual principal payments in an amount equal to approximately €400,000 along with monthly interest payments. The Loan Contract is secured by certain of AFT Hungary’s assets, including the real estate and selected machinery and equipment located in Retsag, Hungary.
Future Debt Payments
The following schedule represents the Company’s future debt payments as of October 1, 2017 (in thousands):
|
|
|
|
|
|
|
2018 (1)
|
|
$
|
1,128
|
|
|
2019
|
|
|
1,819
|
|
|
2020
|
|
|
41,112
|
|
|
2021
|
|
|
944
|
|
|
2022
|
|
|
—
|
|
|
Total
|
|
$
|
45,003
|
|
|
|
(1)
|
|
Represents long-term debt principal payments for the nine months ending June 30, 2018.
|
NOTE 8 – Income Taxes
The income tax receivable was $0.6
million
and $0.5 million at October 1, 2017 and June 30, 2017, respectively, which are included in other current assets. The Company had unrecognized tax benefits for uncertain tax positions of $0.9 million and $1.0 million on October 1, 2017 and June 30, 2017, respectively, which are included in other long-term liabilities.
NOTE 9 – Earnings Per Share
Basic earnings per share is computed by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding during each period. Diluted earnings per share is computed by dividing net income available to common stockholders by the diluted weighted-average shares of common stock outstanding during each period. As a result of the Company’s net loss from continuing operations, f
or the three months ended October 1, 2017 and October 2, 2016, approximately 146,634 and 134,927 shares, respectively were considered anti-dilutive and were excluded from the computation of diluted
earnings per share.
NOTE 10 – Share-Based Compensation
The Company’s share-based compensation arrangements include grants of stock options under the ARC Group Worldwide, Inc. 2015 Equity Incentive Plan and the 2016 ARC Group Worldwide, Inc. Equity Incentive Plan and the Employee Stock Purchase Plan. The share-based compensation expense recognized during the three months ended October 1, 2017 and October 2, 2016 was $0.3 million and is included in selling, general and administrative expense. As of October 1, 2017, there was $0.6 million of total unrecognized compensation expense related to non-vested stock options, which is expected to be recognized over a weighted-average period of 1.6 years.
NOTE 11 – Commitments and Contingencies
During the third quarter of fiscal 2017, the Company’s stamping operations located in Michigan experienced a wind-generated power disruption that temporarily halted production for several days and severely damaged key equipment. The Company is insured for these business interruption and equipment repair costs and filed an insurance claim with its insurance provider. The estimated ongoing loss of approximately $1.0 million is expected to be fully covered by insurance and $0.9 million was collected through the first quarter of fiscal 2018. The remaining $0.1 million is recorded as in insurance claim receivable at October 1, 2017.
The Company leases land, facilities, and equipment under various non-cancellable operating lease agreements expiring through 2022, which contain various renewal options. The Company also leases equipment and a building under non-cancellable capital lease agreements expiring through 2024. The capital leases have interest rates ranging from 3.0% to 6.3%.
From time to time, the Company is a party to various litigation matters incidental to the conduct of its business. As of October 1, 2017, the Company is not presently a party to any legal proceedings, the resolution of which, management believes, would have a material adverse effect on its business, operating results, financial condition, or cash flows.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this report and the consolidated financial statements and notes in the ARC Group Worldwide, Inc. (“ARC,” “our,” “we,” or “us”) Annual Report on Form 10-K for the fiscal year ended June 30, 2017, as filed with the Securities and Exchange Commission (“SEC”).
Cautionary Statement Concerning Forward-Looking Statements
The information contained in this Quarterly Report (this “Report”) may contain certain statements about ARC that are or may be “forward-looking statements,” that is, statements related to future, not past, events, including forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. These statements are based on the current expectations of the management of ARC and are subject to uncertainty and changes in circumstances and involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied in such forward-looking statements. Factors that could cause our results to differ materially from current expectations include, but are not limited to, factors detailed in our reports filed with the SEC, including further but not limited to those discussed in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended June 30, 2016. In addition, these statements are based on a number of assumptions that are subject to change. The forward-looking statements contained in this Report may include all other statements in this document other than historical facts. Without limitation, any statements preceded or followed by, or that include the words “targets,” “plans,” “believes,” “expects,” “aims,” “intends,” “will,” “may,” “anticipates,” “estimates,” “approximates,” “projects,” “seeks,” “sees,” “should,” “would,” “expect,” “positioned,” “strategy,” or words or terms of similar substance or derivative variation or the negative thereof, are forward-looking statements. Forward-looking statements include statements relating to the following: (1) future capital expenditures, expenses, revenues, earnings, synergies, economic performance, indebtedness, financial condition, losses, and future prospects; (2) business and management strategies and the expansion and growth of ARC; (3) the effects of government regulation on ARC’s business; and (4) our plans, objectives, expectations and intentions generally.
There are a number of factors that could cause actual results and developments to differ materially from those expressed or implied by such forward-looking statements. Additional particular uncertainties that could cause our actual results to be materially different than those expressed in forward-looking statements include: risks associated with our international operations; significant movements in foreign currency exchange rates; changes in the general economy, as well as the cyclical nature of our markets; availability and cost of raw materials, parts and components used in our products; the competitive environment in the areas of our planned industrial activities; our ability to identify, finance, acquire and successfully integrate attractive acquisition targets; expected earnings of ARC; the amount of and our ability to estimate known and unknown liabilities; material disruption at any of our significant manufacturing facilities; the solvency of our insurers and the likelihood of their payment for losses; our ability to manage and grow our business and execution of our business and growth strategies; our ability and the ability our customers to access required capital at a reasonable costs; our ability to expand our business in our targeted markets; the level of capital investment and expenditures by our customers in our strategic markets; our financial performance; our ability to identify, address and remediate any material weakness in our internal control over financial reporting; our ability to achieve or maintain credit ratings and the impact on our funding costs and competitive position if we do not do so; and other risks. Other unknown or unpredictable factors could also cause actual results to differ materially from those in any forward-looking statement.
Due to such uncertainties and risks, readers are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date hereof. ARC undertakes no obligation to publicly update or revise forward-looking statements, whether as a result of new information, future events or otherwise, except to the extent legally required. Nothing contained herein shall be deemed to be a forecast, projection or estimate of the future financial performance of ARC unless otherwise expressly stated.
Overview
ARC Group Worldwide, Inc. is a global advanced manufacturer offering a full suite of products and services to our customers, with specific expertise in metal injection molding (“MIM”) and metal 3D printing (also referred to herein as additive manufacturing or “AM”). To further advance and support these core capabilities, the Company also offers complementary services associated with: (i) precision metal stamping; (ii) traditional and clean room plastic injection
molding; and (iii) advanced rapid and conformal tooling. Through our diverse product offering, we provide our customers with a holistic prototyping and full-run production solution for both precision metal and plastic fabrication. We further differentiate ourselves from our competitors by providing innovative, custom capabilities, which improve high-precision manufacturing efficiency and speed-to-market for our customers.
Our business model is to accelerate the widespread adoption of MIM and AM, along with other key technologies, including automation, robotics, and production software in traditional manufacturing, thereby benefiting from the elimination of inefficiencies currently present in the global supply chain. More specifically, the two key pillars of our business strategy are centered on the following areas:
|
|
·
|
|
Holistic Manufacturing Solution.
The metal and plastic fabrication industries are highly fragmented sectors with numerous single-solution providers. Given the inefficiencies associated with working with these disjointed groups, many manufacturers seek to improve their supplier base by working with more scaled, holistic providers. Our strategy is to facilitate the consolidation and streamlining of global supply chains by offering a holistic solution to our customers’ manufacturing needs. In particular, ARC provides a “one-stop shop” solution to our customers by offering a spectrum of highly advanced products, processes, and services, thereby delivering highly-engineered precision components at efficient production yields.
|
|
|
·
|
|
Accelerating Speed-to-Market.
The traditional prototype-to-production process is often subject to lengthy bottlenecks and is characterized by inefficient price quoting delays, time-consuming tooling procedures, and outdated production methodologies. To differentiate itself from competitors, ARC focuses on reducing inefficiencies in the development cycle by offering the seamless integration of a wide-variety of proprietary technologies in order to dramatically reduce the time and cost associated with new product development. Specifically, the Company has developed rapid and instant online quoting solutions, rapid prototype solutions, short-run production services, in-house rapid and advanced conformal tooling, and rapid full production capabilities.
|
Separately, U.S. manufacturing has been rejuvenated as global wage disparities mitigate and traditional labor-intensive processes are displaced by technology. These macroeconomic trends will aid in the adoption of our business strategy.
Our key fundamental strengths are built upon core capabilities, including:
|
|
·
|
|
Metal Injection Molding.
We are a large and well-respected MIM provider. As a pioneer of MIM technology, and driven by our material science understanding, powder metallurgy experience, and established global facilities, we are one of the most advanced MIM operators in the marketplace. ARC provides high-quality, complex, precise, net-shape metal components to market-leading companies in numerous sectors, including the medical and dental, firearm and defense, automotive, aerospace, consumer durable, and electronic device industries. Further, our process is highly automated, utilizing advanced robotics and automation to ensure high levels of quality and efficiency.
|
|
|
·
|
|
Metal 3D Printing.
We offer a variety of 3D printing solutions, with an emphasis on metal 3D printing. In general, given promising signs of growth and related barriers to entry, we believe the metal 3D printing sector is one of the more attractive segments of the overall additive manufacturing industry. Furthermore, metal 3D printing, while a complex technology still in its early stages, shares several fundamental similarities with our MIM business, thereby helping to accelerate our research and development. Separately, our metal 3D printing capabilities enable ARC to offer a variety of new services, including rapid prototyping, rapid tooling and short-run production, helping our customers improve their product speed-to-market. Given our established customer base, diverse metallurgy background, and scalable injection molding capabilities, we believe we are well-positioned in the industrial metal 3D printing market.
|
|
|
·
|
|
Additional Complementary Metal and Plastic Fabrication Capabilities.
We offer a number of additional specialty metal and plastic fabrication capabilities that enable us to provide our customers with a full suite of custom-component products. Our specialty capabilities include plastic injection molding (including medical clean room applications), precision stamping, magnesium injection molding and computer numerical control machining.
|
Our overall growth strategy is centered on:
|
|
·
|
|
Driving organic improvement through the expansion and cross-selling of our core services to existing clients;
|
|
|
·
|
|
Accelerating the adoption of our technology by new customers in traditional manufacturing markets;
|
|
|
·
|
|
Expanding our holistic service offerings through strategic vertical and horizontal acquisitions; and
|
|
|
·
|
|
Improving financial and operational results from the implementation of operational best practices.
|
Accordingly, all of our business divisions are managed consistently with this strategy in order to drive organic sales growth and cash flow generation, while improving quality, speed, and service to our customers.
Results of Operations – Three Months Ended October 1, 2017 and October 2, 2016
The following tables present information about our reportable segments for the respective periods:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
October 1, 2017
|
|
October 2, 2016
|
|
|
|
|
Amount
(in thousands)
|
|
Percent of Total
|
|
Amount
(in thousands)
|
|
Percent of Total
|
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
Precision Components Group
|
|
$
|
14,333
|
|
71.9%
|
|
$
|
20,004
|
|
77.8%
|
|
|
Stamping Group
|
|
|
4,752
|
|
23.8%
|
|
|
5,179
|
|
20.1%
|
|
|
3DMT Group
|
|
|
865
|
|
4.3%
|
|
|
289
|
|
1.2%
|
|
|
Wireless Group
|
|
|
—
|
|
—
|
|
|
240
|
|
0.9%
|
|
|
Total
|
|
$
|
19,950
|
|
100.0%
|
|
$
|
25,712
|
|
100.0%
|
|
|
$ Change
|
|
$
|
(5,762)
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
-22.41%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit:
|
|
Gross Profit
|
|
Gross Margin
|
|
Gross Profit
|
|
Gross Margin
|
|
|
Precision Components Group
|
|
$
|
983
|
|
6.9%
|
|
$
|
3,978
|
|
19.9%
|
|
|
Stamping Group
|
|
|
209
|
|
4.4%
|
|
|
697
|
|
13.5%
|
|
|
3DMT Group
|
|
|
230
|
|
26.6%
|
|
|
(69)
|
|
-23.9%
|
|
|
Wireless Group
|
|
|
—
|
|
—
|
|
|
72
|
|
30.0%
|
|
|
Total
|
|
$
|
1,422
|
|
7.1%
|
|
$
|
4,678
|
|
18.2%
|
|
|
$ Change
|
|
$
|
(3,256)
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
-69.60%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
The change in sales by reportable segment was as follows:
|
|
·
|
|
Precision Components Group sales during the three months ended October 1, 2017 decreased by $5.7 million, or 28.3%, due to lower MIM sales of $3.0 million and lower plastic and tooling sales of $2.7 million, declines primarily associated with customers in the firearms and defense industries.
|
|
|
·
|
|
Stamping Group sales during the three months ended October 1, 2017 decreased by $0.4 million, or 8.2%, primarily due to a wind-generated power disruption in late fiscal 2017, and certain program completions, partially offset by the ramp up of replacement programs. The Company expects insurance to cover generally all damages and business interruption associated with the power disruption.
|
|
|
·
|
|
3DMT sales during the three months ended October 1, 2017 increased by $0.6 million, or 199.3%, primarily due to higher sales to defense customers.
|
Gross Profit and Gross Margin
Gross profit is affected by a number of factors including product mix, cost of labor and raw materials, unit volumes, pricing, competition, new products and services as a result of acquisitions and new customer programs, and capacity
utilization. In the case of acquisitions and new customer programs, profitability normally lags revenue growth due to product start-up costs, lower manufacturing volumes in the start-up phase, operational inefficiencies, and under-absorbed overhead. Gross margin can improve over time if manufacturing volumes increase, as our utilization rates and overhead absorption improves. As a result of these various factors, our gross margin varies from period to period.
The change in gross profit and gross margin by reportable segment was as follows:
|
|
·
|
|
Precision Components Group gross profit decreased $3.0 million and gross margin decreased 13.0% during the three months ended October 1, 2017. The decreases in gross profit and gross margin were related to the decrease in revenue and customer volumes, primarily in the firearm and defense industries.
|
|
|
·
|
|
Stamping Group gross profit decreased $0.5 million and gross margin decreased 9.1% during the three months ended October 1, 2017. The primary reasons for the decreases in gross profit and gross margin were lower sales and lower margin tooling sales related to new product launches.
|
|
|
·
|
|
3DMT gross profit increased $0.3 million during the three months ended October 1, 2017. Gross margin increased to 26.6% in the three months ended October 1, 2017, compared with negative margin of 23.9% in the prior year period. 3DMT has transitioned from development to production and is growing rapidly.
|
The following paragraphs discuss other items affecting the results of our operations for the three months ended October 1, 2017 and October 2, 2016.
Selling, General and Administrative Expenses
Selling, general and administrative expense (“SG&A”) from continuing operations totaled $3.5 million, or 17.5% of sales, during the three months ended October 1, 2017, compared with $4.9 million, or 18.9% of sales, during the three months ended October 2, 2016. The decrease in SG&A expense during the three months ended October 1, 2017 was primarily due to workforce reductions and lower outside service fees.
Interest Expense, Net
Interest expense, net was $1.0 million and $1.1 million for the three months ended October 1, 2017 and October 2, 2016, respectively. The decrease in interest expense, net during the three months ended October 1, 2017 was primarily due to a reduction in the principal outstanding under our Senior ABL Credit Facility.
Loss on Extinguishment of Debt
During the first quarter of fiscal 2017, approximately $0.7 million of unamortized deferred financing costs were expensed as a result of the extinguishment of our
First Amended and Restated Credit Agreement.
Discontinued Operations
On September 15, 2017, the Company sold its subsidiary GF&F. Income from continuing operations for the three months ended October 1, 2017 and October 2, 2016 excludes the income from discontinued operations, before tax, of $3 thousand and $0.1 million, respectively, and the loss on disposition of this business, after tax, of $0.3 million.
In September 2016, the Company sold its subsidiary Tekna Seal LLC pursuant to the terms and conditions of a Membership Interests Purchase Agreement. Income from continuing operations for the three months ended October 2, 2016 excludes the income from discontinued operations, before tax, of $0.1 million and the gain on disposition of this business, after tax, of $4.2 million.
Income Tax
Income tax expense from continuing operations was $0.2 million for the three months ended October 1, 2017, as compared with an income tax benefit of $1.3 million for the three months ended October 2, 2016.
The primary reason for the income tax expense in the three months ended October 1, 2017 was due to the amortization of indefinite-lived intangible assets that were not available to offset existing deferred tax assets (termed a “naked credit”). The primary reason for the income tax benefit in the prior year period was due to our net loss from continuing operations.
Liquidity and Capital Resources
As of October 1, 2017, we had cash and cash equivalents of $0.4 million and $0.6 million as of October 1, 2017 and June 30, 2017, respectively, held in financial institutions outside the United States. Our Hungarian subsidiary, where these funds are held, is taxed in a similar manner to our domestic subsidiaries. Thus, we would not incur a material tax obligation should we decide to repatriate these funds.
Under our Senior ABL Credit Facility with Citizens Bank, N.A., we will not maintain any cash on hand in our domestic bank accounts by design. Instead, we maintain a $25.0 million asset-based revolver loan, which includes an automatic cash sweep feature that identifies any cash available in our bank accounts at the end of a banking business day and then applies that cash to reduce our outstanding revolver loan balance. The automatic cash sweep feature serves to decrease our daily interest expense. Disbursements are paid daily from cash being made available under our revolver loan based on a borrowing base calculation.
Our primary sources of liquidity are cash flows from operations, cash on hand, and revolving loans permitted under the Senior ABL Credit Facility. As of October 1, 2017, $10.1 million of borrowings were outstanding under the senior secured revolving loan, with additional borrowings subject to compliance with the terms of our Senior ABL Credit Facility as described in Note 7. While we believe these sources of liquidity to be sufficient to maintain ongoing operations for the next twelve months, we may seek additional sources of capital to provide incremental liquidity, to assist in the acceleration of organic growth, and to support the achievement of other strategic and financial objectives.
Operating Activities
Cash used in operating activities was $1.5 million, which consisted of the following:
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|
·
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|
Net loss of $3.6 million, adjusted for $3.0 million of non-cash expenses, including $2.5 million of depreciation and amortization, $0.3 million of share-based compensation and a loss on the sale of GF&F of $0.1 million; and
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·
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|
Cash used for working capital of $1.0 million primarily resulted from a cash outflow of $1.6 million in receivables, primarily driven by the timing of collections, and a cash inflow of $0.8 million in accounts payable due to the timing of payments to vendors.
|
Investing Activities
During the three months ended October 1, 2017, cash provided by investing activities was $2.0 million primarily due to the following:
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·
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|
Proceeds received from the sale of our subsidiary, GF&F, of $3.0 million; and
|
|
|
·
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|
$1.0 million was invested in property and equipment.
|
Financing Activities
During the three months ended October 1, 2017, cash used in financing activities was $0.9 million, primarily due to the following:
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|
·
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|
Higher net principal payments on our long-term debt primarily due to cash received of $3.0 million from the sale of our subsidiary, partially offset by borrowings; and
|
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|
·
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|
Receipt of $0.1 million from the issuance of stock through our employee stock purchase plan.
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Debt and Credit Arrangements
For a discussion of our long-term debt, see Note 7, Debt, to our condensed consolidated financial statements in Part I, Item 1 to this Report incorporated herein by reference thereto and Note 8, Debt, to the consolidated financial statements in our
Annual Report on
Form 10-K for the fiscal year ended June 30, 2017.
The descriptions of the Senior ABL Credit Facility and the Subordinated Term Loan Agreement (together, our “Credit Facilities”) do not purport to be complete and are subject to, and are qualified in their entirety by, the full text of the respective documents.
Financial Ratio Covenants
The terms and conditions of the Credit Facilities require us to comply with a number of financial and other covenants, such as maintaining debt service coverage and leverage ratios in certain situations and maintaining insurance coverage. These covenants may limit our flexibility in our operations, and breaches of these covenants could result in defaults under the instruments governing the applicable indebtedness even if we had satisfied our payment obligations. If we were to default on the credit agreements or other debt instruments, our financial condition would be adversely affected.
Non-compliance by us with any of the covenants would constitute events of default under both of the Credit Facilities pursuant to cross-default provisions and could result in acceleration of payment obligations for all outstanding principal and interest for loans made under both of the Credit Facilities, unless such defaults were waived or subject to forbearance by the respective creditors.
Senior ABL Credit Facility Financial Covenant.
Our Senior ABL Credit Facility contains a financial covenant, summarized as follows:
Minimum Availability
. We are required to maintain the following availability: (a) at least $1,250,000 in revolving credit availability until the earlier of (i) the initial closing of the infusion of $5.0 million in junior capital, which must be completed not later than January 31, 2018, and (ii) January 31, 2018; and (b) thereafter, at least $3,500,000 in such revolving credit availability.
As of October 1, 2017, our availability under the Senior ABL Credit Facility exceeded the minimum availability covenant.
Subordinated Loan Agreement Financial Ratios
. Our Subordinated Loan Agreement contains the following financial ratio covenants, summarized as follows:
Minimum Fixed Charge Coverage Ratio
. We may not permit the Minimum Fixed Charge Coverage Ratio, as of the last day of any fiscal quarter ending during any period set forth in the table below, to be less than the ratio set forth opposite such period in the table below. The Fixed Charge Coverage Ratio is defined as the ratio of (a) Consolidated EBITDA minus the unfinanced portion of capital expenditures, excluding tooling, minus expense for taxes paid in cash (other than certain federal and state taxes excluded under the McLarty Second Amendment); to (b) fixed charges, all calculated on a consolidated basis in accordance with GAAP.
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|
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Period
|
|
Fixed Charge Coverage Ratio
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|
March 26, 2017 through September 23, 2017
|
|
1.05:1.00
|
|
September 24, 2017 through March 24, 2018
|
|
1.10:1.00
|
|
March 25, 2018 through September 29, 2018
|
|
1.15:1.00
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|
September 30, 2018 and thereafter
|
|
1.20:1.00
|
The summary calculation of our Subordinated Loan Agreement Fixed Charge Coverage Ratio as of October 1, 2017 is as follows:
|
|
|
|
|
|
|
(in thousands, except ratio)
|
|
Amount
|
|
|
Consolidated EBITDA
|
|
$
|
14,874
|
|
|
Less unfinanced portion of capital expenditures
|
|
|
(3,382)
|
|
|
Less expense for taxes paid in cash
|
|
|
(19)
|
|
|
Coverage Amount (a)
|
|
$
|
11,473
|
|
|
Fixed Charges (b)
|
|
$
|
6,471
|
|
|
Fixed Charge Coverage Ratio (a:b)
|
|
|
1.77:1.00
|
|
Maximum Total Leverage Ratio
. We may not have a Total Leverage Ratio, as of the last day of any fiscal quarter ending during any period set forth in the table below, to exceed the ratio set forth opposite such period in the table below. The Total Leverage Ratio means the ratio of (a) our funded indebtedness as of such date, to (b) Consolidated EBITDA for the Test Period ended as of such date.
|
|
|
|
|
|
|
Period
|
|
|
Total Leverage Ratio
|
|
|
June 30, 2017 through June 30, 2018
|
|
|
4.00:1.00
|
|
|
July 1, 2018 and thereafter
|
|
|
3.50:1.00
|
|
The summary calculation of our Subordinated Loan Agreement Total Leverage Ratio as of October 1, 2017 is as follows:
|
|
|
|
|
|
|
(in thousands, except ratio)
|
|
Amount
|
|
|
Funded Indebtedness (a)
|
|
$
|
48,095
|
|
|
Consolidated EBITDA (b)
|
|
$
|
14,874
|
|
|
Maximum Total Leverage Ratio (a:b)
|
|
|
3.23:1.00
|
|
Compliance with Financial Ratio Covenants
As of October 1, 2017, we were in compliance with our debt covenants under our Senior ABL Credit Facility and our Subordinated Loan Agreement.
GAAP to Non-GAAP Reconciliation
Fixed Charges and Consolidated EBITDA used in our debt covenant calculations are non-GAAP financial measures. We have provided this non-GAAP financial information to aid in better understanding our financial ratios as used in our debt covenant calculations. The methodology used is defined in our debt agreements. Non-GAAP financial measures are not in accordance with, or an alternative for, GAAP. The non-GAAP financial measures are not meant to be considered in isolation or as a substitute for comparable GAAP financial measures, and should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP.
Fixed Charges consist of interest payments, principal payments on our debt, and capital lease payments for the prior four quarters. Consolidated EBITDA used in our debt covenant calculations is based on the sum of the prior four quarter actual amounts.
The reconciliation of GAAP net income to Consolidated EBITDA under our Subordinated Loan Agreement is as follows (in thousands):
|
|
|
|
|
|
For the twelve months ended:
|
|
October 1, 2017
|
|
Net loss
|
|
$
|
(8,983)
|
|
Share-based compensation
|
|
|
818
|
|
Interest expense, net
|
|
|
3,936
|
|
Income taxes
|
|
|
(928)
|
|
Depreciation and amortization
|
|
|
10,018
|
|
Transaction related expenses (1)
|
|
|
705
|
|
Restructuring and severance expenses
|
|
|
732
|
|
Other non-recurring expenses (2)
|
|
|
8,324
|
|
Other non-recurring income or gains (3)
|
|
|
(132)
|
|
Pro-forma EBITDA adjustment to exclude discontinued subsidiaries
|
|
|
384
|
|
Consolidated EBITDA (4)
|
|
$
|
14,874
|
|
|
(1)
|
|
Transaction related expenses relate to legal fees incurred to amend certain debt agreements and the sale of our non-core subsidiaries.
|
|
|
(2)
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|
Other non-recurring expenses relate to certain capitalized tooling costs, an insurance claim for lost production at our Kecy facility, costs incurred to relocate our plastic injection molding operations, and certain projected cost reductions allowed as an adjustment to EBITDA.
|
|
|
(3)
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|
Other non-recurring income or gains relates to the gain on termination of an operating lease.
|
|
|
(4)
|
|
Consolidated EBITDA excludes interest expense, net and income taxes because these items are associated with our capitalization and tax structures. Consolidated EBITDA excludes depreciation and amortization expense because these non-cash expenses reflect the impact of prior capital expenditure decisions which may not be indicative of future capital expenditure requirements. Share-based compensation, transaction related costs, restructuring and severance expenses, non-recurring gains, and pro-forma EBITDA adjustment to exclude discontinued subsidiaries are adjustments made in accordance with our bank debt covenants.
|
Off Balance Sheet Arrangements
We had no off-balance sheet arrangements that would have a material effect on our financial position, results of operations or cash flows as of October 1, 2017.
Critical Accounting Policies and Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein, including estimates about the effects of matters or future events that are inherently uncertain. Policies determined to be critical are those that have the most significant impact on our financial statements and require management to use a greater degree of judgment and/or estimates. For a discussion of our critical accounting policies, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation, in our Form 10-K for the fiscal year ended June 30, 2017.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Pursuant to permissive authority under Regulation S-K, Rule 305, we have omitted Quantitative and Qualitative Disclosures About Market Risk.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our filings with the SEC is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our interim Chief Executive and Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely
decisions regarding required disclosure based on the definition of “disclosure controls and procedures” as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
As of the end of the period covered by this Report, and under the supervision and with the participation of our management, including our interim Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, we have concluded that our disclosure controls and procedures were not effective as of October 1, 2017, at the reasonable assurance level due to weaknesses in our internal control over financial reporting.
We previously reported material weaknesses that were identified as of June 30, 2016. Our information technology and accounting infrastructure was inadequate that could lead to the untimely identification and resolution of accounting and disclosure matters.
Changes in Internal Control over Financial Reporting
To address the material weaknesses associated with the Company’s information technology infrastructure, planned actions in fiscal year 2018 include:
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|
·
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|
Reorganization of global finance team to consolidate operations, thereby creating greater efficiency and separation of duties;
|
|
|
·
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|
Complete the implementation of our consolidation software package; and
|
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|
·
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|
Strengthen the documentation of processes, procedures, and the review and approval of financial activities at our facilities.
|
During the first quarter of fiscal year 2018, we implemented the following changes in our internal control over financial reporting to address the previously reported material weakness and to enhance our overall financial control environment:
|
|
·
|
|
We sold GF&F, which was a smaller, non-core subsidiary.
|
Due to financial considerations, management has delayed enhancement to the Company’s staffing and IT infrastructure.
Except as described above, there have been no changes in our internal control over financial reporting during the quarterly period ended October 1, 2017, that would have materially affected, or are reasonably likely to materially affect, our control over financial reporting.
PART II. OTHER INFORMATION
Item 1A. Risk Factors
There have been no material changes to the risk factors described in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.
Item 6. Exhibits
EXHIBIT INDEX
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|
|
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Exhibit Number
|
|
Description
|
|
2.1*
|
|
Asset Purchase Agreement, dated September 15, 2017, between General Flange & Forge LLC and GFFC Holdings, LLC. Schedules to the Asset Purchase Agreement have been omitted pursuant to Item 601 (b)(2) of Regulation S-K. The Company will furnish supplementally a copy of any omitted schedule to the Securities and Exchange Commission upon request
.
|
|
10.1*
|
|
Third Amendment to Second Amended and Restated Credit Agreement by and among ARC Group Worldwide, Inc. and certain of its subsidiaries as borrowers, and Citizens Bank, N.A., dated as of September 21, 2017
.
|
|
10.2*
|
|
Fourth Amendment to the Subordinated Loan Agreement by and among ARC Group Worldwide, Inc. and certain of its subsidiaries as borrowers, and McLarty Capital Partners SBIC, L.P., dated as of September 22, 2017
.
|
|
31.1*
|
|
Officers’ Certifications of Periodic Report pursuant to Section 302 of Sarbanes-Oxley Act of 2002
|
|
31.2*
|
|
Officers’ Certifications of Periodic Report pursuant to Section 302 of Sarbanes-Oxley Act of 2002
|
|
32.1&
|
|
Officers’ Certifications of Periodic Report pursuant to Section 906 of Sarbanes-Oxley Act of 2002
|
|
101.INS*
|
|
XBRL Instance Document
|
|
101.SCH*
|
|
XBRL Taxonomy Schema
|
|
101.CAL*
|
|
XBRL Taxonomy Calculation Linkbase
|
|
101.DEF*
|
|
XBRL Taxonomy Definition Linkbase
|
|
101.LAB*
|
|
XBRL Taxonomy Label Linkbase
|
|
101.PRE*
|
|
XBRL Taxonomy Presentation Linkbase
|
|
|
|
|
|
|
|
|
*
Filed with this Form 10-Q.
&
This certification is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended or the Exchange Act.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
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ARC GROUP WORLDWIDE, INC.
|
|
|
|
|
Date: November 14
, 201
7
|
/s/ Drew M. Kelley
|
|
|
Name:
|
Drew M. Kelley
|
|
|
|
Interim Chief Executive Officer (Principal Executive Officer), Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer), Director
|
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|
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