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Item 7. Management’s Discussion and Analysis

2020-08-26 compared with 2019-08-29 · 159 added, 105 removed, 126 unchanged (68% of the section changed)

Management's Discussion and Analysis of Financial Condition and Results of Operations

Special Note Regarding Smaller Reporting Company Status

Under SEC Release 33-10513;

34-83550, Amendments to Smaller Reporting Company Definition, the Company qualifies as a smaller reporting company based on its public float as of the last business day of the second quarter of fiscal 2020.

Accordingly, it has scaled some of its disclosures of financial and non-financial information in this annual report.

The Company will continue to determine whether to provide additional scaled disclosures of financial or non-financial information in future quarterly reports, annual reports and/or proxy statements if it remains a smaller reporting company under SEC rules.

Note on Forward-Looking Statements

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In addition to the assumptions and information referred to specifically in the forward-looking statements, other factors, including, but not limited to those factors discussed under Item 1A, Risk Factors, could cause actual results to be materially different from what is presented in any forward-looking statements.

Special Note Regarding Smaller Reporting Company Status

In June 2018, the SEC issued Release 33-10513;

34-83550, Amendments to Smaller Reporting Company Definition, which changed the definition of a smaller reporting company in Rule 12b-2 of the Securities Exchange Act of 1934, as amended.

Under this release, the new thresholds for qualifying are (1) public float of less than $250 million or (2) annual revenue of less than $100 million and public float of less than $700 million (including no public float).

The rule change was effective on September 10, 2018, the Company’s first fiscal quarter of fiscal year 2019.

The Company continues to qualify as a smaller reporting company based on its public float as of the last business day of its second fiscal quarter of fiscal year 2019.

A smaller reporting company may choose to comply with scaled or non-scaled financial and non-financial disclosure requirements on an item-by-item basis.

The Company has scaled some of its disclosures of financial and non-financial information in this annual report.

The Company may determine to provide scaled disclosures of financial or non-financial information in future quarterly reports, annual reports and/or proxy statements if it remains a smaller reporting company under SEC rules.

As discussed in Item 1A, Risk Factors, and Note A, Basis of Presentation and Significant Accounting Policies of the notes to the consolidated financial statements, as a result of the COVID-19 outbreak, the Company’s operations have decreased, starting on or around mid-March 2020, on a staggered basis, to curtail the spread of the virus and in compliance with regulatory authorities.

The Company’s plants and offices around the world have been subject to intermittent shutdowns, impacting the timeliness of supply chain arrangements and product shipments.

The COVID-19 outbreak exacerbates an already depressed global oil and gas market, which has recently been severely damaged by unprecedented drastic declines in the price of oil.

The consensus of experts is that the price of oil was driven down by an oversupply in the global market, and aggravated by the price war among members of OPEC and non-OPEC producer nations.

The COVID-19 outbreak, and its impact on consumption behaviors and expected general market contraction, impacts the future demand for oil, and exacerbates the already challenging market conditions.

The Company has already seen the impact of the depressed global energy market on its operations.

Its North American incoming orders for the fiscal 2020 fourth quarter were down approximately 50% from the fiscal year-to-date run rate through the third fiscal quarter.

As described further in Note E, Goodwill and Other Intangibles, the Company recorded significant non-cash impairment charges during the year.

While the Company continues to have a positive outlook of its operations in Europe, both in the European Propulsion and European Industrial reporting units, and remains committed to supporting those operations, the adverse economic effects of the COVID-19 outbreak are not fully known.

However, there is consensus that the impact will be adverse.

Hence, management has modeled those expectations from industry and subject matter experts and determined that prudence in the face of uncertainty warrants a robust scenario modeling approach.

This approach was deployed in the Company’s goodwill and long-lived asset impairment analyses.

In assessing the current environment, management expects that a contraction of the global economy, as is predicted by many experts, would reduce or shift the demand for its products in the near term.

For example, the Company expects that the demand for certain of the reporting units’ end-market products, such as passenger leisure cruise vessels, passenger ferries, and other commercial vessels that operate based on general economic activities, will likely be adversely impacted as social restrictions are put in place by governments to curb the outbreak.

As a consequence of these macroeconomic developments, market insights and expectations, the Company recorded asset impairment charges in the third fiscal quarter, primarily consisting of goodwill and other intangibles, in the amount of $27,603.

The full impact of the COVID-19 outbreak continues to evolve as of the date of this report.

The depth and duration of the economic effects caused by the outbreak are unknown.

Management is actively monitoring the global situation and its effect on its financial condition, liquidity, operations, suppliers, industry, and workforce.

Some of the initiatives undertaken so far include:

Protecting the welfare of our employees worldwide by implementing remote work arrangements, temporarily closing or suspending plants and offices, enhancing safety protocols to those employees who cannot work from home;

Availing of programs made available by the various countries through government-sponsored programs, such as emergency liquidity credit facilities, enhanced unemployment compensation benefits and furlough arrangements;

Working with customers to address the timing of customer orders and payment needs during the crisis;

Implementing wage reduction actions, curtailing non-critical capital expenditures, and other cost reduction and cash preservation actions;

Maintaining effective governance and internal controls in a remote environment.

The Company continues to evaluate all possible avenues to reduce costs and improve liquidity in light of the unprecedented uncertainty in the global economy.

The following discussion of results of operations reflects actual Company performance through June 30, 2020.

They do not include management’s view of future performance as the COVID-19 impacts, as severe as they are expected to be, are difficult to predict with specificity.

Results of Operations

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Restructuring expenses

Goodwill and other asset impairment charge

Other operating income

Income from operations

(Loss) income from operations

Fiscal 2020 Compared to Fiscal 2019

Net sales for fiscal 2019 increased 25.7%, or $61.9 million, to $302.7 million from $240.7 million in fiscal 2018.

The Veth Propulsion acquisition, which closed on July 2, 2018, was the primary contributor to this increase, accounting for $54.9 million of the improvement.

Sales of the Company’s oil and gas related transmission products explain most of the remaining positive variance, as strong demand that began in late fiscal 2017 continued through much of fiscal 2019.

While demand for oil and gas related products weakened in the fiscal fourth quarter, the Company is experiencing positive trends in many of its markets.

In particular, global demand for commercial marine and industrial products has shown strong improvement, while pleasure craft demand remains steady.

Net sales for fiscal 2020 decreased 18.4%, or $55.8 million, to $246.8 million from $302.7 million in fiscal 2019.

The Company experienced weakness in North American demand for the Company’s oil and gas related products, with a decline of approximately $49.7 million compared to the prior year.

This weakness was a function of a cyclical downturn that began at the end of fiscal 2019, exacerbated by an oil price war between Russia and Saudi Arabi in the third quarter of fiscal 2020, and the significant decline in global demand for oil as a result of the COVID-19 pandemic.

Similarly, the remaining decline in the Company’s global industrial markets can be attributed primarily to global economic weakness during the second half of the fiscal year, brought on by the COVID-19 pandemic.

Currency translation had a $4.8 million unfavorable impact on fiscal 2020 sales.

Sales at our manufacturing segment increased 29.6%, or $64.0 million, versus the same period last year.

The largest contributor to this increase was the impact of the Veth Propulsion acquisition, as noted above, which contributed $54.9 million of additional revenue in fiscal 2019.

The Company’s North American manufacturing operation experienced a 9.5% increase in sales compared to fiscal 2018.

The primary driver for this increase was improved demand for the Company’s oil and gas related products, primarily new and replacement units, through the first half of the fiscal year.

This operation also saw improving demand for its airport rescue and fire fighting (“ARFF”) transmission throughout the fiscal year.

The Company’s Italian manufacturing operations were essentially flat, experiencing a currency driven decline of 3.7%.

The Company’s Belgian manufacturing operation saw a 12.6% decrease in sales in fiscal 2019 on a significant currency impact (4.7%) and weaker demand in the marine markets served by this operation.

The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 10.8% decrease in sales, primarily due to currency and timing of projects in the global pleasure craft and patrol boat markets.

Sales at our distribution segment were up 25.7%, or $21.8 million, compared to fiscal 2018.

The Company’s Asian distribution operation in Singapore, China and Japan experienced a 43.4% increase in sales due to a recovery in demand for the Company’s oil and gas, commercial marine and patrol craft products in the region.

The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of 42.3% primarily due to the sale of the Mill Log business in early March 2019.

The Company’s European distribution operation, a newly established entity in 2019 to distribute the Company’s products in the European market, accounts for $12.8 million.

The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems primarily for the pleasure craft market, saw sales improve by 1.7%, driven by improved activity in the Australian pleasure craft market over the prior fiscal year, offset by a significant unfavorable currency impact (8.6%).

Net sales for the Company’s marine and propulsion systems were up 55.2% compared to the prior fiscal year.

This increase primarily reflects the impact of the Veth Propulsion acquisition.

In the land-based transmission market, the year-over-year increase of 5.2% can be attributed primarily to increased shipments of the Company’s pressure pumping transmission systems and components to the North American and Asian oil and gas market, along with improved shipments of the Company’s ARFF transmission products.

The increase experienced in the Company’s industrial products of 10.2% was due to improving volume in agriculture, mining and general industrial markets, primarily in the North American and Italian regions.

The Company is beginning to see the benefits of the new industrial products released over the past few years.

Sales at our manufacturing segment decreased 18.9%, or $52.9 million, versus the same period last year.

The largest decline was seen at the Company’s North American manufacturing operation, the largest, which experienced a 27.4% decline in sales compared to fiscal 2019.

The primary driver for this decrease was reduced demand for the Company’s oil and gas related products, primarily new and replacement units, throughout the fiscal year.

This operation also experienced a general decline across its product lines as a result of the global economic impact of the COVID-19 pandemic.

The Company’s Veth Propulsion operation in the Netherlands generated a 6.2% increase in sales in fiscal 2020, offsetting the impact of the weakening global economy with improved market penetration and acceptance in their non-traditional markets (Asia and North America).

The Company’s Italian manufacturing operations were essentially flat for the year, as a weaker fourth quarter offset some improvement through the first three fiscal quarters.

The Company’s Belgian manufacturing operation saw a 27.8% decrease in sales in fiscal 2020 on weaker demand in the marine markets served by this operation resulting from the COVID-19 impact, along with a currency impact.

The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 25.9% decrease in sales, also due to generally weaker economic conditions.

Sales at our distribution segment were down 10.0%, or $10.7 million, compared to fiscal 2019.

The Company’s Asian distribution operation in Singapore, China and Japan experienced a 2.6% increase in sales due to a strong demand for the Company’s oil and gas transmissions, partially offset by a weakening Asian economy primarily in the fourth fiscal quarter.

The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of $13.2 million as this business was sold in early March 2019.

The Company’s European distribution operation saw an increase of $2.5 million as this is a new entity established in fiscal 2019 to distribute the Company’s products in the European market.

The Company’s North American distribution operation saw a decline of 4.3% on the reduced activity in the North American oil and gas market and a weaker North American economy in the fourth fiscal quarter.

The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems primarily for the pleasure craft market, saw sales decline slightly (1.2%), driven by a significant unfavorable currency impact (7.7%).

Net sales for the Company’s marine transmission, propulsion and boat management systems were up 1.5% compared to the prior fiscal year.

This increase primarily reflects a strong performance from the Veth Propulsion acquisition, which saw sales increase by $3.4 million (6.2%) compared to fiscal 2019.

In the off-highway transmission market, the year-over-year decrease of 44.4% can be attributed primarily to decreased shipments of the Company’s pressure pumping transmission systems and components to the North American market driven by the significant decline in global oil prices.

The decrease experienced in the Company’s industrial products of 22.3% was seen primarily in the second half of the fiscal year, brought on by a weakening global economy and the impacts of the COVID-19 pandemic.

Geographically, sales to the U.S.

and Canada declined 38% in fiscal 2020 compared to fiscal 2019, representing 36% of consolidated sales for fiscal 2020 compared to 47% in fiscal 2019.

The reduction is primarily due to the reduced shipments of oil and gas related products into North America during the second half of fiscal 2019.

Sales into China improved nearly 147% compared to fiscal 2018, driven by the combination of improving commercial marine activity and renewed oil and gas demand.

Sales into China reached their highest level since fiscal 2014, representing 10% of 2019 consolidated net sales.

Overall sales into the Asia Pacific market improved 58% compared to fiscal 2018 and represented approximately 18% of sales in fiscal 2019, compared to 15% in fiscal 2018.

The reduction is primarily due to the reduced shipments of oil and gas related products into North America during the fiscal 2020.

Sales into the Asia Pacific market declined 9% compared to fiscal 2019 and represented approximately 21% of sales in fiscal 2020, compared to 18% in fiscal 2019.

Sales into the European market improved approximately 8% from fiscal 2019 levels while accounting for 37% of consolidated net sales compared to 28% in fiscal 2019.

The large increase is primarily the result of the Veth Propulsion acquisition, which has a high percentage of sales into the European market.

See Note L, Business Segments and Foreign Operations, of the notes to the consolidated financial statements for more information on the Company’s business segments and foreign operations.

In fiscal 2019, gross profit increased $9.0 million, or 11.2%, to $89.6 million on a sales increase of $61.9 million.

The increase is primarily the result of the strong performance by the Veth Propulsion acquisition, which has a high percentage of sales into the European market.

See Note K, Business Segments and Foreign Operations, of the notes to the consolidated financial statements for more information on the Company’s business segments and foreign operations.

In fiscal 2020, gross profit decreased $33.9 million, or 37.9%, to $55.7 million on a sales decrease of $55.8 million.

Gross profit as a percentage of sales decreased 700 basis points in fiscal 2020 to 22.6%, compared to 29.6% in fiscal 2019.

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There were a number of factors that impacted the Company’s overall gross profit rate in fiscal 2020.

Gross profit for the year was primarily impacted by higher volumes, partially offset by a more challenging product mix.

As the chart above shows, the product mix during the second half of fiscal 2019 was less profitable than the first half.

This was driven by reduced sales of high-margin oil and gas transmissions and parts, along with increased sales of lower margin transmission units.

Margin was also negatively impacted by a move to higher cost suppliers in order to meet production demands.

In addition, there was purchase accounting inventory step-up to fair market value related to the Veth Propulsion acquisition that negatively impacted gross profit by $4.3 million in fiscal 2019.

The Company estimates the net favorable impact of increased volumes on gross margin in fiscal 2019 was approximately $16.6 million.

Gross profit for the year was primarily impacted by reduced volumes and an unfavorable product mix.

This was driven by reduced sales of high-margin oil and gas transmissions and parts.

Margin was also negatively impacted by a $6.2 million charge for a product performance issue related to one of the Company’s oil and gas transmission models.

The Company estimates the net unfavorable impact of reduced volumes on gross profit in fiscal 2020 was approximately $16.5 million.

The unfavorable shift in product mix, primarily related to the reduced shipments of the Company’s high margin oil and gas transmission units and aftermarket products, had an estimated unfavorable impact of $15.3 million.

Marketing, Engineering and Administrative (ME&A) Expenses

Marketing, engineering, and administrative (ME&A) expenses of $71.5 million were up $10.4 million, or 17.1%, compared to the prior fiscal year.

As a percentage of sales, ME&A expenses decreased to 23.6% of sales versus 25.4% of sales in fiscal 2018.

The increase in fiscal 2019 ME&A expenses compared to the prior year was driven by the addition of Veth Propulsion expenses ($11.4 million), growth-related salary and travel expense ($0.9 million), increased marketing expenses ($0.8 million), higher stock-based compensation expense ($0.8 million) and other inflation and growth-related increases ($2.2 million).

These increases were partially offset by reduced global bonus expense ($3.6 million), the elimination of Mill Log spending due to its divestiture in the third quarter ($1.1 million) and a foreign currency impact ($1.0 million).

Restructuring of Operations and Other Operating Income

During the course of fiscal 2019, the Company executed a series of targeted restructuring activities, resulting in a pre-tax restructuring charge of $1.2 million, or $0.09 per diluted share.

These actions are a continuation of the Company’s efforts to reduce operating costs and improve efficiencies, and relate primarily to headcount reductions and structural changes at the Company’s Belgian operation.

During the course of fiscal 2019, as part of its ongoing initiative to focus resources on core manufacturing and product development activities, the Company completed the divestiture of its distribution entities in in the northwestern U.S.

and western Canada territories (the “Mill Log business”).

The Company received a total consideration of $7.7 million, consisting of cash of $5.2 million and a note receivable of $2.5 million from the buyer, who is a major distributor customer of the Company, in exchange for substantially all the assets and intangible rights of the Mill Log business, including distribution rights over the territory.

The Company recognized a pre-tax gain on the sale of this business of $0.8 million.

During the course of fiscal 2019, the contingent consideration related to the Veth Propulsion acquisition (see Note B, Acquisition of Veth Propulsion Holding B.V.) was settled through the issuance of 139,347 shares of Company common stock.

The fair value of the shares of stock at settlement was lower than the fair value at which it was initially determined at opening balance sheet date.

Under ASC 805, Business Combinations, any change in fair value of the contingent consideration is recognized in the current period income statement and is not an adjustment to the opening balance sheet or the determination of goodwill.

Accordingly, the Company recognized a pre-tax gain of $0.8 million.

Marketing, engineering, and administrative (ME&A) expenses of $63.2 million were down $8.3 million, or 11.6%, compared to the prior fiscal year.

As a percentage of sales, ME&A expenses increased to 25.6% of sales versus 23.6% of sales in fiscal 2019.

The decrease in spending in fiscal 2020 compared to the prior year was driven by reduced spending on professional fees ($1.9 million), the elimination of the global bonus program for fiscal 2020 ($1.7 million), the impact of the sale of Mill Log in the fiscal 2019 third quarter ($1.8 million), reduced stock based compensation ($0.7 million), lower marketing spending ($0.8 million), reduced corporate travel expense ($0.7 million), a favorable foreign currency impact ($0.9 million) and general cost containment measures ($1.7 million).

These decreases were partially offset by an increase to intangible amortization expense ($1.9 million).

Restructuring of Operations

During the course of fiscal 2020, the Company incurred $5.1 million in restructuring charges.

Included in this amount is $3.2 million related to the termination of a marine propulsion program, for which the Company had provided development and production services.

The $3.2 million included a $2.2 million non-cash write-off of assets and liabilities associated with the program and $1.0 million of cash payments to satisfy supplier commitments related to the program.

The remaining $1.9 million of restructuring charges relates to productivity and cost reduction actions at the Company’s domestic and European operations.

The Company continues to focus on actively managing its cost structure and reducing fixed costs in light of the ongoing market challenges.

Impairment Charges

As described in Note E, Goodwill and Other Intangibles, due to the occurrence of a triggering event in the third fiscal quarter, the Company performed an assessment of its goodwill, intangibles and other long-lived assets as of March 27, 2020.

As a result, the Company recorded an impairment charge of $27.6 million during the third quarter of fiscal 2020.

This non-cash impairment charge does not result in any future cash expenditures, impact liquidity, affect ongoing business or financial performance of the Company, impact compliance with our lending arrangements or reduce borrowing capacity.

Interest Expense

Interest expense of $1.9 million for fiscal 2019 was significantly higher than the prior year total of $0.3 million due to the additional borrowings required for the Veth Propulsion acquisition, which closed on July 2, 2018.

The Company had an average term loan balance of $17.9 million in fiscal 2019, with an interest rate that ranged from 3.81% to 5.51%.

The average borrowing on the revolver, computed monthly, increased to $32.1 million in fiscal 2019, compared to $7.3 million in the prior fiscal year.

The interest rate on the revolver was a range of 2.98% to 4.25% in the prior fiscal year compared to a range of 1.25% to 4.75% in the current year.

Interest expense of $1.9 million for fiscal 2020 was essentially unchanged from the prior fiscal year.

Other Income (Expense), Net and Interest Income

In fiscal 2019, other expense, net, increased $0.6 million primarily due to the impact of currency movements related to the euro.

The effective tax rate for the twelve months of fiscal 2019 was 25.6%, which was lower than the prior year rate of 33.1%.

The lower fiscal 2019 rate was primarily the result of the full year impact of impact of the Tax Cuts and Jobs Act (the “Tax Act”), which was enacted in the middle of the Company’s prior fiscal year.

The prior year was also impacted by two significant discrete adjustments.

During the first quarter of fiscal 2018, the Company recorded a tax benefit of $3.8 million related to the reversal of a valuation allowance in a certain foreign jurisdiction that had been subject to a full valuation allowance.

Improvement in operating results, along with a business reorganization which provided favorable tax planning opportunities, allowed for the reversal of this valuation allowance.

During the second quarter of the prior fiscal year, in compliance with the Tax Act, the Company recorded a non-cash tax expense of $3.8 million, primarily due to a remeasurement of deferred tax assets and liabilities.

In addition, a rate change in Belgium resulted in a $0.4 million non-cash tax expense due to remeasurement of deferred tax assets and liabilities.

The mix of earnings by jurisdiction, smaller discrete adjustments and continued operational improvement explain the remaining movement in the Company’s effective tax rate.

In fiscal 2020, other expense, net, decreased $0.4 million primarily due to the impact of currency movements related to the euro and Asian currencies.

The effective tax rate for the twelve months of fiscal 2020 was 9.5%, which was significantly lower than the prior year rate of 25.6%.

Under the Tax Cuts and Jobs Act, a company is prohibited from recognizing certain foreign global intangible low taxed income (“GILTI”) deductions and credits when in a domestic loss position, but is required to include the foreign GILTI income inclusions.

In the current year, the benefit generated from domestic losses was reduced by the required GILTI foreign income inclusions and no GILTI deductions.

The $5.8 million GILTI inclusion and deemed taxes decreased the rate by 2.8%.

Management determined that the carrying value of certain goodwill and intangibles exceeded the fair value and a $27.6 million impairment loss was calculated which resulted in a decrease to the effective tax rate of 10.9%.

Income generated in foreign jurisdictions and other tax preference items also impacted the rate.

The Company maintains valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized.

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As of June 30, 2020, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $66.6 million or approximately 33% lower than the six-month backlog of $99.8 million as of June 30, 2019.

The reduced backlog is primarily attributable to a lower level of North American oil and gas transmission units on order, partially offset by the addition of the Veth Propulsion six month backlog.

The reduced backlog is primarily attributable to a lower level of North American oil and gas transmission units on order, along with the global economic weakness resulting from the COVID-19 pandemic and its impact across the Company’s products.

Liquidity and Capital Resources

Fiscal Years 2020 and 2019

The net cash used by operating activities in fiscal 2019 totaled $5.5 million, a decline of $12.0 million from the prior fiscal year.

While net income increased by $1.1 million from the prior year, this was more than offset by a $17.9 million increase in working capital, excluding the impact of the Veth Propulsion acquisition.

The largest increase came in inventory ($22.2 million), as the Company ramped up to meet increasing demand for oil and gas related products.

The movement of other components in working capital essentially offset, as reduced trade receivables (from lower fourth quarter sales) and reduced cash balance (from more aggressive global repatriation) were offset by lower trade payables (from reduced purchasing activity in the fourth quarter) and lower accruals (primarily bonus).

The acquisition of Veth Propulsion comprises $60.2 million of the total $66.9 million of cash used by investing activities.

Spending on capital projects increased 89% to $12.0 million in fiscal 2019, as the Company accelerated investments in critical machine tools with improved technology to drive greater productivity, along with additional spending on new product development.

This spending was partially offset by the proceeds from the sale of the Mill Log business during the third quarter of fiscal 2019 ($5.2 million).

In fiscal 2019, the net cash provided by financing activities is comprised of the proceeds from a follow-on public offering ($32.2 million) and net borrowings of long-term debt ($38.0 million).

The net cash provided by operating activities in fiscal 2020 totaled $9.1 million, an increase of $14.6 million from the prior fiscal year.

While net earnings decreased by $50.4 million from the prior year, a significant portion of this decline related to a $27.6 million non-cash impairment charge.

In addition, working capital improved by $20.0 million during the year, with the largest contributions coming from trade receivables ($13.1 million) and inventory ($6.8 million), as the Company focused on working capital management in light of difficult market conditions.

The net cash used by investing activities for fiscal 2020 primarily represents capital spending activity totaling $10.7 million.

This represents a $1.3 million (10.7%) decrease in spending on capital projects compared to fiscal 2019.

The Company continued to invest in critical machine tools with improved technology to increase productivity and quality performance.

The net cash used by financing activities relates to payments of withholding taxes on stock compensation ($0.9 million) and dividends paid to a noncontrolling interest ($0.3 million).

Total debt remained relatively unchanged compared to the prior year-end.

During fiscal 2020, the Company did not purchase any shares as part of its Board-authorized stock repurchase program.

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Future Liquidity and Capital Resources

On June 29, 2018, the Company entered into the Credit Agreement with BMO Harris Bank N.A.

On June 29, 2018, the Company entered into the Credit Agreement (the “Credit Agreement”) with BMO Harris Bank N.A.

(“BMO”) that provided for the assignment and assumption of the previously existing loans between the Company and Bank of Montreal (the “2016 Credit Agreement”) and subsequent amendments into a term loan (the “Term Loan”) and revolving credit loans (each a “Revolving Loan” and, collectively, the “Revolving Loans,” and, together with the Term Loan, the “Loans”).

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The Credit Agreement also allows the Company to obtain Letters of Credit from BMO, which if drawn upon by the beneficiary thereof and paid by BMO, would become Revolving Loans.

The Credit Agreement provides that the Company may elect that the Term Loan and each Revolving Loan to be either “LIBOR Loans” or “Eurodollar Loans”, as defined, and bear interest at the applicable rate per the Credit Agreement.

This rate as of June 30, 2019 was 3.68%.

In addition to the monthly interest payments and any mandatory principal payments required by the Credit Agreement (if applicable), the Company is responsible for paying a quarterly Revolving Credit Commitment Fee and quarterly Letter of Credit Fees.

The Company may prepay the Loans (or any one of the Loans), subject to certain limitations.

On March 4, 2019, the Company entered into a second amendment (the “Second Amendment”) to the June 29, 2018 Credit Agreement.

The Second Amendment reduces the principal amount of the term loan commitment under the Credit Agreement from $35.0 million to $20.0 million.

Under the Credit Agreement, the Company may not pay cash dividends on its common stock in excess of $3.0 million in any fiscal year.

On March 4, 2019, the Company entered into a second amendment (the “Second Amendment”) to the Credit Agreement.

The Second Amendment reduced the principal amount of the term loan commitment under the Credit Agreement from $35.0 million to $20.0 million.

In connection with the Second Amendment, the Company issued an amended and restated term note in the amount of $20.0 million to the Bank, which amended the original $35.0 million note provided under the Credit Agreement.

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The Second Amendment also extended the maturity date of the Term Loan from January 2, 2020 to March 4, 2026, and added a requirement that the Company make principal installments of $0.5 million per quarter starting with the quarter ending June 30, 2019.

The Second Amendment also reduces the applicable margin for purposes of determining the interest rate applicable to the Term Loan.

The Second Amendment also reduced the applicable margin for purposes of determining the interest rate applicable to the Term Loan.

Previously, the applicable margin was 3.00%, which was added to the Monthly Reset LIBOR Rate or the Adjusted LIBOR, as applicable.

Under the Second Amendment, the applicable margin is between 1.375% and 2.375%, depending on the Company’s total funded debt to EBITDA ratio.

The Second Amendment also adjusts certain financial covenants made by the Company under the Credit Agreement.

Specifically, the Company has covenanted (i) not to allow its total funded debt to EBITDA ratio to be greater than 3.00 to 1.00 (the cap had previously been 3.50 to 1.00 for quarters ending on or before September 30, 2019 and 3.25 to 1.00 for quarters ending on or about December 31, 2019 through September 30, 2020), and (ii) that its tangible net worth will not be less than $100.0 million plus 50% of net income for each fiscal year ending on and after June 30, 2019 for which net income is a positive number (the $100.0 million figure had previously been $70.0 million).

Under the Second Amendment, the applicable margin was between 1.375% and 2.375%, depending on the Company’s total funded debt to EBITDA ratio.

The Second Amendment also adjusted certain financial covenants made by the Company under the Credit Agreement.

Specifically, the Company covenanted (i) not to allow its total funded debt to EBITDA ratio to be greater than 3.00 to 1.00 (the cap had previously been 3.50 to 1.00 for quarters ending on or before September 30, 2019 and 3.25 to 1.00 for quarters ending on or about December 31, 2019 through September 30, 2020), and (ii) that its tangible net worth will not be less than $100.0 million plus 50% of net income for each fiscal year ending on and after June 30, 2019 for which net income is a positive number (the $100.0 million figure had previously been $70.0 million).

On January 28, 2020, the Company entered into a third amendment (the “Third Amendment”) to the Credit Agreement.

The Third Amendment restated the financial covenant provisions related to the maximum allowable ratio of total funded debt to EBITDA from 3.00 to 1.00 to 4.00 to 1.00 for the quarter ended December 27, 2019, 5.00 to 1.00 for the quarter ending March 27, 2020, 4.00 to 1.00 for the quarter ending June 30, 2020, 3.50 to 1.00 for the quarter ending September 25, 2020 and 3.00 to 1.00 for quarters ending on or after December 25, 2020.

For purposes of determining EBITDA, the Third Amendment added back extraordinary expenses (not to exceed $3.9 million) related to the previously reported isolated product performance issue on one of the Company’s oil and gas transmission models at certain installations.

Under the Third Amendment, the applicable margin for revolving loans, letters of credit, and term loans was between 1.25% and 3.375%, depending on the Company’s total funded debt to EBITDA ratio.

On July 22 2020, the Company entered into a fifth amendment to the Credit Agreement (the “Fifth Amendment”) that amends the Credit Agreement dated as of June 29, 2018, as amended between the Company and BMO.

The Fifth Amendment reduced BMO’s Revolving Credit Commitment from $50.0 million to $45.0 million.

The Fifth Amendment also gives the Company the option to make interest-only payments on the Term Loan for quarterly payments occurring on September 30, 2020 and December 31, 2020, and limits the Company’s Capital Expenditures for the fiscal year ending June 30, 2021 to $10.0 million.

The Fifth Amendment provides the Company with relief from its Total Funded Debt to EBITDA ratio financial covenant under the Credit Agreement through (and including) the earlier of June 30, 2021 or a date selected by the Company.

During the financial covenant relief period:

The “Applicable Margin” to be applied to Revolving Loans, the Term Loan, and the Commitment/Facility Fee will be increased to 3.25%, 3.875%, and 0.20%, respectively.

The Company may not make certain restricted payments (specifically, cash dividends, distributions, purchases, redemptions or other acquisitions of or with respect to shares of its common stock or other common equity interests).

The Company must maintain liquidity (as defined in the Fifth Amendment) of at least $15.0 million.

The Company must maintain minimum EBITDA of at least (1) $1.0 million for the fiscal quarter ending June 30, 2020 and the two fiscal quarters ending on or about September 30, 2020;

(2) $2.5 million for the three fiscal quarters ending on or about December 31, 2020;

(3) $6.0 million for the four fiscal quarters ending on or about March 31, 2021;

and (4) $10.0 million for the four fiscal quarters ending June 30, 2021.

For purposes of the minimum EBITDA covenant and the Total Funded Debt to EBITDA ratio, the Fifth Amendment clarified that EBITDA shall exclude any gain that is realized on the forgiveness of the Small Business Administration Paycheck Protection Program loan that the Company previously received.

The Fifth Amendment also changed the definition of “LIBOR” (used in calculating interest on Eurodollar Loans), “Monthly Reset LIBOR Rate” (used in calculating interest on LIBOR Loans), and “LIBOR Quoted Rate” (used in the definition of “Base Rate,” which is used in calculating interest on Letters of Credit that are drawn upon and not timely reimbursed).

The Company also entered into a Deposit Account Control Agreement with the Bank, reflecting the Bank’s security interest in deposit accounts the Company maintains with the Bank.

Under the Fifth Amendment, the Bank may not provide a notice of exclusive control of a deposit account (thereby obtaining exclusive control of the account) prior to the occurrence or existence of a Default or an Event of Default under the Credit Agreement or otherwise upon the occurrence or existence of an event or condition that would, but for the passage of time or the giving of notice, constitute a Default or an Event of Default under the Credit Agreement.

Borrowings under the Credit Agreement are secured by substantially all of the Company’s personal property, including accounts receivable, inventory, machinery and equipment, and intellectual property.

The Company has also pledged 100% of its equity interests in certain domestic subsidiaries and 65% of its equity interests in certain foreign subsidiaries.

The Company also entered into a Collateral Assignment of Rights under Purchase Agreement for its acquisition of Veth Propulsion described in Note B, Acquisition of Veth Propulsion Holding B.V., to the consolidated financial statements.

The Company also entered into a Collateral Assignment of Rights under Purchase Agreement for its acquisition of Veth Propulsion.

To effect these security interests, the Company entered into various amendment and assignment agreements that consent to the assignment of certain agreements previously entered into between the Company and the Bank of Montreal in connection with the 2016 Credit Agreement.

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If such Event of Default is due to the Company’s bankruptcy, BMO may take the three actions listed above without notice to the Company.

The Company’s balance sheet remains strong, there are no material off-balance-sheet arrangements, and the Company continues to have sufficient liquidity for near-term needs.

On April 17, 2020, the Company entered into a promissory note (the “PPP Note”) evidencing an unsecured loan in the amount of $8.2 million (the “PPP Loan”) made to the Company under the Paycheck Protection Program (“PPP”).

The PPP was established under the CARES Act and is a program under the U.S.

Small Business Administration (the “SBA”).

The PPP Loan to the Company is administered by BMO.

The PPP Loan has a two-year term and bears interest at a rate of 1.0% per annum.

Monthly principal and interest payments are deferred for six months.

Beginning November 17, 2020, seven months from the date of the PPP Note, the Company is required to make monthly payments of principal and interest to BMO.

Under the terms of the CARES Act, PPP loan recipients can be granted forgiveness for all or a portion of loans granted under the PPP.

Such forgiveness will be determined, subject to limitations, based on the use of loan proceeds for payment of payroll costs and any payments of mortgage interest, rent, and utilities.

The Company intends to use the Loan proceeds in accordance with PPP loan forgiveness requirements.

However, no assurance is provided that the Company will obtain forgiveness for any portion of the PPP Loan.

In connection with the PPP Loan, the Company entered into a fourth amendment to the Credit Agreement (the “Fourth Amendment”) on April 17, 2020.

The Fourth Amendment:

(1) permits the Company to incur indebtedness in the form of the PPP Loan notwithstanding the Credit Agreement’s restrictions limiting the Company’s ability to incur indebtedness, and (2) provides that the PPP Loan (to the extent that the PPP Loan is forgiven) shall be disregarded for purposes of calculating financial covenants in the Credit Agreement.

Any unforgiven portion of the PPP Loan and the interest thereon will not be disregarded for purposes of calculating the covenants.

The Company is closely tracking qualified expenses to ensure its compliance to the PPP program and to support its application for forgiveness.

As of June 30, 2020, the Company estimates that the amount of forgivable expenses it has incurred to date is approximately $6.0 million.

These expenses are included in cost of goods sold and marketing, engineering and administrative expenses in the accompanying statement of operations and comprehensive (loss) income.

While the forgiveness of the loan is not taxable, the expenses that were used by the funds are not deductible for tax purposes.

Although the rules are still fluid and subject to revisions, currently the Company expects that at the end of the measurement period, it would be able to provide support and qualify for loan forgiveness in the amount of approximately $7.0 million to $7.6 million.

If, and when, forgiveness of this amount is assured, the Company would record this as a gain on debt extinguishment in fiscal 2021.

This is described further in Note H, Debt, of the notes to the consolidated financial statements.

The Company has no material off-balance-sheet arrangements, and it continues to have sufficient liquidity for near-term needs.

The Company had approximately $27.0 million of available borrowings under the Credit Agreement as of June 30, 2020.

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In fiscal 2021, the Company expects to contribute $2.3 million to its defined benefit pension plans, the minimum contribution required.

Net working capital increased $32.4 million, or 33.4%, during fiscal 2019 and the current ratio (calculated as total current assets divided by total current liabilities) increased from 2.6 at June 30, 2018 to 2.8 at June 30, 2019.

The increase in net working capital was primarily driven by the acquisition of Veth Propulsion in July 2018 and demand-related increases to inventory.

Net working capital decreased $20.0 million, or 15.7%, during fiscal 2020 and the current ratio (calculated as total current assets divided by total current liabilities) decreased from 2.7 at June 30, 2019 to 2.6 at June 30, 2020.

The decrease in net working capital was primarily driven by volume driven reductions in trade accounts receivable and inventory, along with aggressive management of working capital in light of difficult economic conditions.

The Company expects capital expenditures to be approximately $7 million - $9 million in fiscal 2021.

These anticipated expenditures reflect the Company’s plans to ramp up investment in modern equipment to meet volume demands and drive productivity improvements, its global sourcing program and new products.

These anticipated expenditures reflect the Company’s plans to moderate investment in maintenance capital and modern equipment to address the liquidity demands of an anticipated challenging global economy.

Management believes that available cash, the BMO credit facility, cash generated from future operations, and potential access to debt markets will be adequate to fund the Company’s capital requirements for the foreseeable future.

Off Balance Sheet Arrangements

The Company had no off-balance sheet arrangements as of June 30, 2019 and 2018.

Off Balance Sheet Arrangements and Contractual Obligations

The Company had no material off-balance sheet arrangements as of June 30, 2020 and 2019.

On July 31, 2020, the Company finalized an agreement to lease a manufacturing, assembly and office facility in Lufkin, Texas, with an initial term of 15 years and minimum annual lease payments of $0.4 million.

Other Matters

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In addition, senior management reviews the accounts receivable aging on a monthly basis to determine if any receivable balances may be uncollectible.

Although the Company’s accounts receivable are dispersed among a large customer base, a significant change in the liquidity or financial position of any one of its largest customers could have a material adverse impact on the collectibility of its accounts receivable and future operating results.

Although the Company’s accounts receivable are dispersed among a large customer base, a significant change in the liquidity or financial position of any one of its largest customers could have a material adverse impact on the collectability of its accounts receivable and future operating results.

Inventories are valued at the lower of cost or net realizable value.

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The Company is subject to financial statement risk to the extent the carrying amount of a reporting unit exceeds its fair value.

Based upon the goodwill impairment test completed as of the end of June 30, 2019, goodwill was not impaired and no impairment charge was necessary for fiscal 2019.

See discussion in Note F, Goodwill and Other Intangibles, of the notes to the consolidated financial statements.

The Company believes that the economic disruptions and unprecedented market volatilities and uncertainties resulting from the COVID-19 outbreak was a triggering event in the third quarter of fiscal 2020.

Consequently, it performed an interim goodwill impairment test as of the quarter ended March 27, 2020, and recorded a goodwill impairment charge of $25.4 million, that completely wrote-off goodwill from its financial statements.

See discussion in Note E, Goodwill and Other Intangibles, of the notes to the consolidated financial statements.

Long-lived Assets

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Compensation Increase – reflect the long-term actual experience, the near-term outlook and assumed inflation.

Retirement and Mortality Rates – based upon the Society of Actuaries RP-2014 base tables for annuitants and non-annuitants, adjusted for generational mortality improvement based on the Society of Actuaries MP-2018 projection scale.

Retirement and Mortality Rates – based upon the Society of Actuaries PRI-2012 base tables for annuitants and non-annuitants, adjusted for generational mortality improvement based on the Society of Actuaries MP-2019 projection scale.

Health Care Cost Trend Rates – developed based upon historical cost data, near-term outlook and an assessment of likely long-term trends.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis