Cadre Holdings, Inc. (CDRE) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and results of operations of Cadre Holdings, Inc. (D/B/A The Safariland Group) (“Cadre,” “the Company” “we,” “us” and “our”) should be read together with our audited consolidated financial statements as of and for the years ended December 31, 2021 and 2020 in each case together with related notes thereto, included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that reflect future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside of Cadre’s control. Our actual results may differ significantly from those projected in the forward- looking statements. Factors that might cause future results to differ materially from those projected in the forward- looking statements include, but are not limited to, those discussed in the sections entitled “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements” included elsewhere in this Annual Report on Form 10-K. Certain total amounts may not foot due to rounding.
Overview and 2021 Financial Highlights
Cadre is a global leader in the manufacturing and distribution of safety and survivability equipment for first responders. Our equipment provides critical protection to allow its users to safely and securely perform their duties and protect those around them in hazardous or life-threatening situations. Through our dedication to superior quality, we establish a direct covenant with end users that our products will perform and keep them safe when they are most needed. We sell a wide range of products including body armor, explosive ordnance disposal equipment and duty gear through both direct and indirect channels. In addition, through our owned distribution, we serve as a one-stop shop for first responders providing equipment we manufacture as well as third-party products including uniforms, optics, boots, firearms and ammunition. The majority of our diversified product offering is governed by rigorous safety standards and regulations. Demand for our products is driven by technological advancement as well as recurring modernization and replacement cycles for the equipment to maintain its efficiency, effective performance and regulatory compliance.
We service the ever-changing needs of our end users by investing in research and development for new product innovation and technical advancements that continually raise the standards for safety and survivability equipment in the first responder market. Our target end user base includes domestic and international first responders such as state and local law enforcement, fire and rescue, explosive ordnance disposal technicians, emergency medical technicians (“EMT”), fishing and wildlife enforcement and departments of corrections, as well as federal agencies including the U.S. Department of State (“DoS”), U.S. Department of Defense (“DoD”), U.S. Department of Interior (“DoI”), U.S. Department of Justice (“DoJ”), U.S. Department of Homeland Security (“DHS”), U.S. Department of Corrections (“DoC”) and numerous foreign government agencies in over 100 countries.
The following table sets forth a summary of our financial highlights for the periods indicated:
| | | | | | | |
|---|---|---|---|---|---|---|
| | | Year ended December 31, | ||||
| (in thousands) | | 2021 | | 2020 | ||
| Net sales | $ | 427,288 | $ | 404,642 | ||
| Net income | | $ | 12,661 | | $ | 38,453 |
| Adjusted EBITDA(1) | | $ | 71,384 | | $ | 57,982 |
| Column 1 | Column 2 |
|---|---|
| (1) | Adjusted EBITDA is a non-GAAP financial measure. See “Non-GAAP Measures” below for our definition of, and additional information about, Adjusted EBITDA, and for a reconciliation to net income (loss), the most directly comparable U.S. GAAP financial measure. |
Net sales increased by $22.6 million for the year ended December 31, 2021 as compared to December 31, 2020, primarily as a result of fulfilling a large international contract for structural armor, an overall increase for explosive ordinance disposal products largely due to international customer refresh cycles, and higher demand for ammunition and firearm products through our Distribution segment.
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Net income decreased by $25.8 million for the year ended December 31, 2021 as compared to the year ended December 31, 2020, primarily as a result of a loss on extinguishment of debt incurred from the execution of the New Credit Agreement, an increase in provision for income taxes due to the release of a valuation allowance on a portion of our deferred tax assets in December 2020 and the following non-recurring transactions recognized in the period ended December 31, 2020: a gain on the sale of a long-lived asset and receipt of earn-out stock payments. These were offset by improvements in gross profit due to increased sales, favorable pricing and product mix.
Initial Public Offering
On November 3, 2021, the Company completed its initial public offering (“IPO”) in which the Company issued and sold 6,900,000 shares of common stock, which included 900,000 shares that were offered and sold pursuant to the full exercise of the underwriters’ over-allotment option, at a public offering price of $13.00 per share. The Company’s net proceeds from the sale of shares in the IPO were $78.6 million after underwriter discounts and commissions, fees and expenses of $11.1 million, of which $2.3 million was paid to Kanders & Company, Inc., a company controlled by Warren Kanders, our Chief Executive Officer.
COVID-19
The global outbreak of COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the U.S. and European governments in March 2020, with governments world-wide implementing safety measures restricting travel and requiring citizen lockdowns and self-confinements for quarantining purposes. This has negatively affected the U.S. and global economies, disrupted global supply chains, and resulted in significant transport restrictions and disruption of global financial markets.
The COVID-19 pandemic has significantly impacted the global supply chain, with restrictions and limitations on related activities causing disruption and delay, along with increased raw material, storage, and shipping costs. These disruptions and delays have strained domestic and international supply chains, which have affected and could continue to negatively affect the flow or availability of certain critical raw materials and finished good products that the Company relies upon. Furthermore, any negative impacts on our logistical operations, including our fulfillment and shipping functions, could result in periodic delays in the delivery of our products.
KEY PERFORMANCE METRICS
Orders backlog
We monitor our orders backlog, which we believe is a forward-looking indicator of potential sales. Our orders backlog for products includes all orders that have been received and are believed to be firm. Due to municipal government procurement rules, in certain cases orders included in backlog are subject to budget appropriation or other contract cancellation clauses. Consequently, our orders backlog may differ from actual future sales. Orders backlog can be helpful to investors in evaluating the performance of our business and identify trends over time.
The following table presents our orders backlog as of the periods indicated:
| | | | | | | | |
|---|---|---|---|---|---|---|---|
| | | | Year ended December 31, | ||||
| (in thousands) | | | 2021 | | 2020 | ||
| Orders backlog | | $ | 113,840 | $ | 131,814 |
Orders comprising backlog as of a given balance sheet date are typically invoiced in subsequent periods. The majority of our products are generally processed and shipped within one to six weeks of an order being placed, though the fulfillment time for certain products, for example, explosive ordnance disposal equipment, may take three months or longer. Our orders backlog could experience volatility between periods, including as a result of customer order volumes and the speed of our order fulfilment, which in turn may be impacted by the nature of products ordered, the amount of inventory on hand and the necessary manufacturing lead time.
Orders backlog decreased by $18.0 million as of December 31, 2021 compared to December 31, 2020, primarily due to $12.9 million from 2021 shipments of large contractual armor orders, reduction of $4.6 million due to prior year demand of explosive ordnance disposal product, $3.9 million from 2021 shipments of large contractual less lethal orders, and reduction in past dues of $2.6 million from duty gear holsters. This was partially offset by an increase of $5.9 million from the distribution of ammunition and firearms through our company-owned retail locations.
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DESCRIPTION OF CERTAIN COMPONENTS OF FINANCIAL DATA
Net sales
We recognize revenue when a contract exists with a customer that specifies the goods and services to be provided at an agreed upon sales price and when the performance obligation is satisfied by transferring the goods or service to the customer. The performance obligation is considered satisfied when control transfers, which is generally determined when products are shipped or delivered to the customer but could be delayed until the receipt of customer acceptance, depending on the terms of the contract. At the time of revenue recognition we also provide for estimated sales returns and miscellaneous claims from customers as reductions to revenues. Charges for shipping and handling fees billed to customers are included in net sales. Taxes collected from customers and remitted to government authorities are reported on a net basis and are excluded from sales. See Note 1 “Significant Accounting Policies — Revenue Recognition” to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
We generate sales primarily through our four main sales channels: U.S. state and local agencies, international, U.S. federal agencies, and commercial.
Costs and Expenses
Cost of goods sold. Cost of goods sold includes raw material purchases, manufacturing-related labor costs, contracted labor, shipping, reimbursable research and development costs, allocated manufacturing overhead, facility costs, depreciation and amortization, and product warranty costs.
Selling, general and administrative. Selling, general and administrative (“SG&A”) expense includes personnel-related costs, professional services, marketing and advertising expense, research and development, depreciation and amortization, and impairment charges.
Restructuring and transaction costs. Restructuring costs consist primarily of termination benefits and relocation of employees, termination of operating leases and other contracts related to consolidating or closing facilities. Transaction costs consist of legal fees and consulting costs related to one-time transactions.
Related party expense. Related party expense primarily consists of rent expense related to 5 distribution locations owned by related parties and any one-time transaction fees paid to related parties.
Other general expense (income). Other general expense (income) consists primarily of gains from the disposition of a long-lived asset coupled with earn-out stock payments.
Interest expense. Interest expense consists primarily of interest on outstanding debt.
Loss on extinguishment of debt. Loss on extinguishment of debt consists primarily of recorded losses associated with debt restructuring.
Other (expense) income, net. Other (expense) income, net primarily consists of non-operating gains and losses, such as gains or losses on the sale of equity securities and foreign currency impacts.
(Provision) benefit for income taxes. A provision or benefit for income tax is calculated for each of the jurisdictions in which we operate. The provision or benefit for income taxes is determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The benefit or provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the book and tax bases of assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. See Note 14 “Income Taxes” in our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
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RESULTS OF OPERATIONS
In order to reflect the way our chief operation decision maker reviews and assesses the performance of the business, Cadre has determined that it has two reportable segments — the Product segment and the Distribution segment. Segment information is consistent with how the chief operating decision maker, our chief executive officer, reviews the business, makes investing and resource allocation decisions and assesses operating performance.
The following table presents data from our results of operations for the years ended December 31, 2021 and 2020 (in thousands unless otherwise noted):
| | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|
| | | | Year Ended December 31, | | | | ||||
| | | | 2021 | | 2020 | | % Chg | | ||
| Net sales | | | $ | 427,288 | | $ | 404,642 | | 5.6 | % |
| Cost of goods sold | | | 256,598 | | 251,704 | | 1.9 | % | ||
| Gross profit | | | 170,690 | | 152,938 | | 11.6 | % | ||
| | | | | | | | | | | |
| Operating expenses | | | | | | | | | | |
| Selling, general and administrative | | | 114,962 | | 106,627 | | 7.8 | % | ||
| Restructuring and transaction costs | | | 3,430 | | 5,822 | | (41.1) | % | ||
| Related party expense | | | 579 | | 1,635 | | (64.6) | % | ||
| Other general expense (income) | | | — | | (10,950) | | (100.0) | % | ||
| Total operating expenses | | | 118,971 | | 103,134 | | 15.4 | % | ||
| Operating income | | | 51,719 | | 49,804 | | 3.8 | % | ||
| | | | | | | | | | | |
| Other expense | | | | | | | | | | |
| Interest expense | | | (16,425) | | (24,388) | | (32.7) | % | ||
| Loss on extinguishment of debt | | | (15,155) | | (200) | | 7,477.5 | % | ||
| Other (expense) income, net | | | (947) | | 2,659 | | (135.6) | % | ||
| | | | | | | | | | | |
| Total other expense, net | | | (32,527) | | (21,929) | | 48.3 | % | ||
| | | | | | | | | | | |
| Income before provision for income taxes | | | 19,192 | | 27,875 | | (31.1) | % | ||
| (Provision) benefit for income taxes | | | (6,531) | | 10,578 | | (161.7) | % | ||
| | | | | | | | | | | |
| Net income | | | $ | 12,661 | | $ | 38,453 | | (67.1) | % |
The following table presents segment data for the years ended December 31, 2021 and 2020 (in thousands unless otherwise noted):
| | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Year ended December 31, 2021 | |||||||||||
| | | | | | | | | Reconciling | | | | |
| | Products | Distribution | Items(1) | Total | ||||||||
| Net sales | $ | 362,189 | $ | 90,043 | $ | (24,944) | $ | 427,288 | ||||
| Cost of goods sold | | | 213,881 | | | 67,649 | | | (24,932) | | | 256,598 |
| Gross profit | | $ | 148,308 | | $ | 22,394 | | $ | (12) | | $ | 170,690 |
| | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Year ended December 31, 2020 | |||||||||||
| | | | | | | | | Reconciling | | | | |
| | Products | Distribution | Items(1) | Total | ||||||||
| Net sales | $ | 343,689 | $ | 84,922 | $ | (23,969) | $ | 404,642 | ||||
| Cost of goods sold | | | 211,048 | | | 64,761 | | | (24,105) | | | 251,704 |
| Gross profit | | $ | 132,641 | | $ | 20,161 | | $ | 136 | | $ | 152,938 |
| Column 1 | Column 2 |
|---|---|
| (1) | Reconciling items consist primarily of intercompany eliminations and items not directly attributable to operating segments. |
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Comparison of Year Ended December 31, 2021 to Year Ended December 31, 2020
Net sales. Product segment net sales increased by $18.5 million or 5.4%, from $343.7 million to $362.2 million for the year ended December 31, 2021 as compared to 2020, primarily driven by a $38.8 million increase in the international channel due to shipment timing for customer contracts offset in part by a $15.7 million decrease in the U.S. federal agencies channel due to shipment timing for a customer contract for duty gear holsters and explosive ordnance disposals and a $4.8 million reduction for the U.S. state and local agencies channel due to higher demand for crowd control products in prior year. Distribution segment net sales increased by $5.1 million or 6.0%, from $84.9 million to $90.0 million for the year ended December 31, 2021 as compared to 2020, due to an increase in the U.S. state and local agencies channel as a result of higher market demand for ammunition and firearms products. Reconciling items consisting primarily of intercompany eliminations were ($24.9) million and ($24.0) million for year ended December 31, 2021 and 2020, respectively.
Cost of goods sold. Product segment cost of goods sold increased by $2.9 million, or 1.3%, from $211.0 million to $213.9 million for the year ended December 31, 2021 as compared to 2020 primarily due to material and labor costs to manufacture product. Product segment gross profit as a percentage of net sales increased by 2.3% to 40.9% in 2021 from 38.6% in 2020 mainly driven by favorable pricing and product mix. Distribution segment cost of goods sold increased by $2.8 million, or 4.5%, from $64.8 million to $67.6 million for the year ended December 31, 2021 as compared to 2020 primarily due to higher costs to acquire products. Distribution segment gross profit as a percentage of net sales increased by 1.2% to 24.9% in 2021 from 23.7% in 2020 mainly driven by an increase in ammunition and firearms sales and favorable pricing. Reconciling items consisting primarily of intercompany eliminations were ($24.9) million and ($24.1) million for year ended December 31, 2021 and 2020, respectively.
Selling, general and administrative. SG&A increased by $8.3 million, or 7.8%, for the year ended December 31, 2021 as compared to 2020 primarily due to the implementation of a cash-based long-term incentive plan (“LTIP”) and stock-based compensation plan in 2021 and increases in incentive bonus and commissions related to the structural armor order.
Restructuring and transaction costs. Restructuring and transaction costs decreased by $2.4 million, for the year ended December 31, 2021 as compared to 2020 due to lower transactions costs and consulting fees incurred.
Related party expense. Related party expense decreased by $1.1 million for the year ended December 31, 2021 as compared to 2020 primarily due to a $1.0 million transaction fee paid to Kanders & Company, Inc., a company controlled by our Chief Executive Officer in connection with our 2020 debt refinancing.
Other general expense (income). Gains in other general income decreased by $11.0 million, or 100.0%, for the year ended December 31, 2021 as compared to 2020 due to a gain from Ontario facility asset sale of $6.2 million and earn-out stock payments from Axon Enterprise, Inc. (“Axon”) for $4.7 million for the year ended December 31, 2020 compared to no activity for the year ended December 31, 2021.
Interest expense. Interest expense decreased by $8.0 million, or 32.7%, for the year ended December 31, 2021 as compared to 2020 primarily due to an interest rate decrease as a result of our recent refinancing and debt repayments on our outstanding debt.
Loss on extinguishment of debt. Loss on extinguishment of debt increased by $15.0 million due to the refinancing of our long-term debt in August 2021.
Other (expense) income, net. Other (expense) income, net decreased by $3.6 million, for the year ended December 31, 2021 as compared to 2020 primarily due to a $0.7 million loss on foreign currency transactions for the year ended December 31, 2021 compared to $4.5 million realized gains on the appreciation of Axon stock received in connection with the sale of VieVu, LLC, offset in part by a $2.3 million loss on a stock collar transaction for the year ended December 31, 2020.
(Provision) benefit for income taxes. Income tax provision was $6.5 million for the year ended December 31, 2021 compared to a tax benefit of $10.6 million for the year ended December 31, 2020. The effective tax rate was 34.0% for the year ended December 31, 2021 and was higher than the statutory rate due to state taxes, executive compensation, and the tax impact of our foreign earnings, partially offset by research and development tax credits. For the year ended December 31, 2020, the effective tax rate was (37.9)% and was lower than the statutory rate primarily due to the release of a valuation allowance on a portion of our deferred tax assets.
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NON-GAAP MEASURES
This Annual Report on Form 10-K includes EBITDA, Adjusted EBITDA and Adjusted EBITDA Conversion Rate, which are non-GAAP measures that we use to supplement our results presented in accordance with U.S. GAAP. EBITDA is defined as net income before depreciation and amortization expense, interest expense and Provision (benefit) for income tax. Adjusted EBITDA represents EBITDA that excludes restructuring and transaction costs, other general income, other (expense) income, net, contingent consideration and other, long term incentive plan (“LTIP”) bonus, and goodwill impairment as these items do not represent our core operating performance. We also present Adjusted EBITDA Conversion Rate, which we define as Adjusted EBITDA less capital expenditures divided by Adjusted EBITDA. We use Adjusted EBITDA Conversion Rate as a measurement of the cash generation capacity of our underlying operations, exclusive of impacts relating to our capital structure.
EBITDA, Adjusted EBITDA and Adjusted EBITDA Conversion Rate are performance measures that we believe are useful to investors and analysts because they illustrate the underlying financial and business trends relating to our core, recurring results of operations and enhance comparability between periods. Adjusted EBITDA is identical to the financial metric used under our existing credit facilities to measure our covenant compliance and is also considered by our board of directors and management as an important factor in determining performance-based compensation. Adjusted EBITDA Conversion Rate is a liquidity measure that we believe provides investors and analysts with important information about our core, recurring cash generation trends, which are an indication of our ability to make acquisitions, incur additional debt or return capital to investors, after making the capital investments required to support our business operations.
EBITDA, Adjusted EBITDA and Adjusted EBITDA Conversion Rate are not recognized measures under U.S. GAAP and are not intended to be a substitute for any U.S. GAAP financial measure and, as calculated, may not be comparable to other similarly-titled measures of performance of other companies. Investors should exercise caution in comparing our non-GAAP measures to any similarly titled measures used by other companies. These non-GAAP measures exclude certain items required by U.S. GAAP and should not be considered as alternatives to information reported in accordance with U.S. GAAP.
The table below presents our EBITDA, Adjusted EBITDA and Adjusted EBITDA Conversion Rate reconciled to the most comparable GAAP measure for the periods indicated:
| | | | | | | | |
|---|---|---|---|---|---|---|---|
| | Year Ended December 31, | ||||||
| (in thousands) | 2021 | 2020 | |||||
| Net income | | $ | 12,661 | | $ | 38,453 | |
| Add back: | | | |||||
| Depreciation and amortization | | 13,718 | 14,733 | | |||
| Interest expense | | 16,425 | 24,388 | | |||
| Provision (benefit) for income taxes | | 6,531 | (10,578) | | |||
| EBITDA | | $ | 49,335 | $ | 66,996 | | |
| Add back: | | | |||||
| Restructuring and transaction costs(1) | | 3,430 | 5,822 | | |||
| Other general expense (income)(2) | | — | (10,950) | | |||
| Loss on extinguishment of debt(3) | | 15,155 | 200 | | |||
| Other expense (income), net(4) | | 947 | (2,659) | | |||
| Contingent consideration(5) | | — | (1,427) | | |||
| Stock-based compensation expense(6) | | | 355 | | | — | |
| LTIP bonus(7) | | 2,162 | — | | |||
| Adjusted EBITDA | | $ | 71,384 | $ | 57,982 | | |
| Less: Capital expenditures | | (3,029) | (4,708) | | |||
| Adjusted EBITDA less capital expenditures | | $ | 68,355 | $ | 53,274 | | |
| Adjusted EBITDA conversion rate | | 96 | % | 92 | % |
| Column 1 | Column 2 |
|---|---|
| (1) | Reflects the “Restructuring and transaction costs” line item on our consolidated statement of operations, which primarily includes transaction costs composed of legal and consulting fees. |
| Column 1 | Column 2 |
|---|---|
| (2) | Reflects the “Other general income” line item on our consolidated statement of operations and includes a gain from a long-lived asset sale as well as earn-out stock payments for the year ended December 31, 2020. |
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| Column 1 | Column 2 |
|---|---|
| (3) | Reflects losses incurred in connection with the August 2021 debt refinance. |
| Column 1 | Column 2 |
|---|---|
| (4) | Reflects the “Other (expense) income, net” line item on our consolidated statement of operations. For the year ended December 31, 2021, other (expense) income, net primarily includes losses on foreign currency transactions. For the year ended December 31, 2020, other (expense) income, net primarily includes gains on foreign exchange transactions and unrealized gains on an investment in equity securities. |
| Column 1 | Column 2 |
|---|---|
| (5) | Reflects a gain on the settlement of contingent consideration. |
| Column 1 | Column 2 |
|---|---|
| (6) | Reflects stock-based compensation expense related to grants awarded in November 2021. |
| Column 1 | Column 2 |
|---|---|
| (7) | Reflects the cost of a cash-based long-term incentive plan awarded to employees that vests over three years. |
Adjusted EBITDA increased $13.4 million for the year ended December 31, 2021 as compared to 2020, primarily due to increased sales volume and margin rate increases attributable to favorable pricing and product mix.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to our ability to generate sufficient cash flows to meet the cash requirements of our business operations, including working capital needs, capital expenditures, service debt, acquisitions and other commitments. Our principal sources of liquidity have been cash provided by operating activities, cash on hand and amounts available under our revolving credit facility.
In November 2021, upon the completion of our IPO, we received net proceeds of $78.6 million after underwriter discounts and commissions, fees and expenses of $11.1 million. We used a portion of the IPO proceeds to repay $38.9 million and $20.5 million, respectively, that were outstanding under our existing Term Loan and Revolving Loan under the New Credit Agreement.
For the year ended December 31, 2021, net cash provided by operating activities was $40.1 million and as of December 31, 2021, cash and cash equivalents were $33.9 million. We believe that our cash flows from operations and cash on hand, and available borrowing capacity under Debt (as described below) will be adequate to meet our liquidity requirements for at least the 12 months following the date of this Annual Report on Form 10-K. Our future capital requirements will depend on several factors, including future acquisitions and investments in our manufacturing facilities and equipment. We could be required, or could elect, to seek additional funding through public or private equity or debt financings; however, additional funds may not be available on terms acceptable to us, if at all.
In January 2022, the Company acquired Radar Leather Division S.r.l. ("Radar") for approximately $21.0 million. The purchase accounting for this acquisition is in progress.
Debt
As of December 31, 2021 and December 31, 2020, we had $159.7 million and $212.8 million in outstanding debt, net of debt discounts and debt issuance costs, respectively, primarily related to the term loan facilities.
New Credit Agreement
On August 20, 2021 (the “Closing Date”), the Company refinanced its existing credit facilities and entered into a new credit agreement whereby Safariland, LLC, as borrower (the “Borrower”), the Company and certain domestic subsidiaries of the Borrower, as guarantors (the “Guarantors”), closed on and received funding under a credit agreement (initially entered into on July 23, 2021), pursuant to a First Amendment to Credit Agreement (collectively, the “New Credit Agreement”) with PNC Bank, National Association (“PNC”), as administrative agent, and the several lenders from time to time party thereto (together with PNC, the “Lenders”) pursuant to which the Borrower (i) borrowed $200.0 million under a term loan (the “Term Loan”), and (ii) may borrow up to $100.0 million under a revolving credit facility (including up to $15.0 million for letters of credit and up to $10.0 million for swing line loans) (the “Revolving Loan”). Each of the Term Loan and the Revolving Loan mature on July 23, 2026. Commencing December 31, 2021, the New Term Loan requires scheduled quarterly payments in amounts equal to 1.25% per quarter of the original aggregate principal amount of the Term Loan, with the balance due at maturity. The New Credit Agreement is guaranteed, jointly and
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severally, by the Guarantors and, subject to certain exceptions, secured by a first-priority security interest in substantially all of the assets of the Borrower and the Guarantors pursuant to a Security and Pledge Agreement (the “Security Agreement”) and a Guaranty and Suretyship Agreement (the “Guaranty Agreement”), each dated as of the Closing Date.
There were no amounts outstanding under any revolving loans as of December 31, 2021 and 2020. As of December 31, 2021, there were $3.0 million in outstanding letters of credit, and $97.0 million of availability.
The Borrower may elect to have the Revolving Loan and Term Loan under the New Credit Agreement bear interest at a base rate or a LIBOR rate, in each case, plus an applicable margin. The applicable margin for these borrowings will range from 0.50% to 1.50% per annum, in the case of base rate borrowings, and 1.50% to 2.50% per annum, in the case of LIBOR borrowings, in each case based upon the level of the Company’s consolidated total net leverage ratio. The New Credit Agreement also requires the Borrower to pay a commitment fee on the unused portion of the loan commitments. Such commitment fee will range between 0.175% and 0.25% per annum, and is also based upon the level of the Company’s consolidated total net leverage ratio.
The New Credit Agreement also contains customary representations and warranties, and affirmative and negative covenants, including limitations on additional indebtedness, dividends, and other distributions, entry into new lines of business, use of loan proceeds, capital expenditures, restricted payments, restrictions on liens on the assets of the Borrowers or any Guarantor, transactions with affiliates, amendments to organizational documents, accounting changes, sale and leaseback transactions, dispositions, and mandatory prepayments in connection with certain liquidity events. The New Credit Agreement contains certain restrictive debt covenants, which require us to: (i) maintain a minimum fixed charge coverage ratio of 1.25 to 1.00, starting with the quarter ended December 31, 2021, which is to be determined for each quarter end on a trailing four quarter basis and (ii) maintain a quarterly maximum consolidated total net leverage ratio of 3.75 to 1.00 from the quarter ended December 31, 2021 until the quarter ended September 30, 2022, and thereafter 3.50 to 1.00, which is in each case to be determined on a trailing four quarter basis; provided that under certain circumstances and subject to certain limitations, in the event of a material acquisition, we may temporarily increase the consolidated total net leverage ratio by up to 0.50 to 1.00 for four fiscal quarters following such acquisition. The New Credit Agreement contains customary events of default that include, among others, non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations and warranties, failure to make payment on, or defaults with respect to, certain other material indebtedness, bankruptcy and insolvency events, material judgments and change of control provisions. Upon the occurrence of an event of default, and after the expiration of any applicable grace period, payment of any outstanding loans under the New Credit Agreement may be accelerated and the Lenders could foreclose on their security interests in the assets of the Borrowers and the Guarantors. As of March 7, 2022, there were no amounts outstanding under the Revolving Loan.
The foregoing description of the New Credit Agreement does not purport to be complete and is qualified in its entirety by reference to the New Credit Agreement, which is incorporated by reference as exhibit 10.24 to this Annual Report on Form 10-K.
Canadian Credit Facility
On October 14, 2021, Med-Eng Holdings ULC and Pacific Safety Products Inc., the Company’s Canadian subsidiaries, as borrowers (the “Canadian Borrowers”), and Safariland, LLC, as guarantor (the “Canadian Guarantor”), closed on a line of credit pursuant to a Loan Agreement (the “Canadian Loan Agreement”) and a Revolving Line of Credit Note (the “Note”) with PNC Bank Canada Branch (“PNC Canada”), as lender pursuant to which the Canadian Borrowers may borrow up to CDN$10.0 million under a revolving line of credit (including up to $3.0 million for letters of credit) (the “Revolving Canadian Loan”). The Revolving Canadian Loan matures on July 23, 2026. The Canadian Loan Agreement is guaranteed by Safariland, LLC pursuant to a Guaranty and Suretyship Agreement (the “Canadian Guaranty Agreement”).
The Canadian Borrowers may elect to have borrowings either in United States dollars or Canadian dollars under the Canadian Loan Agreement, which will bear interest at a base rate or a LIBOR rate, in each case, plus an applicable margin, in the case of borrowings in United States dollars, or at a Canadian Prime Rate (as announced from time to time by PNC Canada) or a Canadian deposit offered rate (“CDOR”) as determined from time to time by PNC Canada in accordance with the Canadian Loan Agreement. The applicable margin for these borrowings will range from 0.50% to 1.50% per annum, in the case of base rate borrowings and Canadian Prime Rate borrowings, and 1.50% to 2.50% per annum, in the case of LIBOR borrowings and CDOR borrowings. The Canadian Loan Agreement also requires the Canadian Borrowers to pay (i) an unused line fee on the unused portion of the loan commitments in an amount ranging between 0.175% and 0.25% per annum, based upon the level of the Company’s consolidated total net leverage ratio, and (ii) an upfront fee equal to 0.25% of the principal amount of the Note.
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There were no amounts outstanding under the Revolving Canadian Loan as of December 31, 2021.
The Canadian Loan Agreement also contains customary representations and warranties, and affirmative and negative covenants, including, among others, limitations on additional indebtedness, entry into new lines of business, entry into guarantee agreements, making of any loans or advances to, or investments in, any other person, restrictions on liens on the assets of the Canadian Borrowers and mergers, transfers of assets and acquisitions. The Canadian Loan Agreement and Note also contain customary events of default that include, among others, non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations and warranties, failure to make payment on, or defaults with respect to, certain other material indebtedness, bankruptcy and insolvency events, material judgments and change of control provisions. Upon the occurrence of an event of default, and after the expiration of any applicable grace period, payment of any outstanding loans under the Canadian Loan Agreement may be accelerated. As of March 7, 2022, there were no amounts outstanding under the Revolving Canadian Loan.
The foregoing description of the Canadian Loan Agreement does not purport to be complete and is qualified in its entirety by reference to the Canadian Loan Agreement, which is incorporated by reference as exhibit 10.28 to this Annual Report on Form 10-K.
Cash Flows
The following table presents a summary of our cash flows for the periods indicated:
| | | | | | | |
|---|---|---|---|---|---|---|
| | Year Ended December 31, | |||||
| (in thousands) | 2021 | 2020 | ||||
| Net cash provided by operating activities | | $ | 40,094 | $ | 45,419 | |
| Net cash (used in) provided by investing activities | | (2,832) | 19,784 | |||
| Net cash used in financing activities | | (6,596) | (64,902) | |||
| Effects of foreign exchange rates on cash and cash equivalents | | 318 | 52 | |||
| Change in cash and cash equivalents | | 30,984 | 353 | |||
| Cash and cash equivalents, beginning of period | | 2,873 | 2,520 | |||
| Cash and cash equivalents, end of period | | $ | 33,857 | $ | 2,873 |
Net cash provided by operating activities
During the year ended December 31, 2021, net cash provided by operating activities of $40.1 million resulted primarily from net income of $12.7 million, a net add-back of non-cash income statement items of $37.1 million, and a net decrease of $9.7 million from the change in operating assets and liabilities. Included in the non-cash items were $13.7 million in depreciation and amortization, $15.2 million in loss on extinguishment of debt, and an increase in deferred income taxes of $4.8 million.
During the year ended December 31, 2020, net cash provided by operating activities of $45.4 million resulted primarily from net income of $38.5 million, a net deduction of non-cash income statement items of $10.4 million, and a net increase of $17.4 million from the change in operating assets and liabilities. Included in the non-cash items were $14.7 million in depreciation and amortization, $9.2 million in non-cash consideration received from the sale of business, a decrease in deferred income taxes of $12.2 million and $6.2 million gain on sale of fixed assets.
Net cash (used in) provided by investing activities
During the year ended December 31, 2021, we used $2.8 million of cash in investing activities relating to the purchase of property and equipment.
During the year ended December 31, 2020, cash provided by investing activities totaled $19.8 million, primarily consisting of proceeds from disposition of property and equipment of $12.4 million and proceeds from sale of equity securities of $14.4 million.
Net cash used in financing activities
During the year ended December 31, 2021, we used $6.6 million of cash in financing activities, primarily consisting of proceeds from the revolving credit facility of $258.0 million, proceeds from term loans of $198.7 million, and proceeds from the initial public offering, net of underwriter discounts of $83.4 million, offset by principal payments on the revolving credit facility of $258.6 million, principal payments on term loans of $266.0 million and dividends distributed of $12.7 million.
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During the year ended December 31, 2020, we used $64.9 million of cash in financing activities, primarily consisting of proceeds from the revolving credit facility of $382.1 million, proceeds from term loans of $219.6 million, offset by principal payments on the revolving credit facility of $384.2 million and principal payments on term loans of $276.4 million.
Contractual Obligations
The following table summarizes our significant contractual obligations as of December 31, 2021 by period:
| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | Less than | | | | | | | | More than | ||
| (in thousands) | Total | 1 year | 1-3 Years | 3-5 Years | 5 Years | ||||||||||
| Lease obligations(1) | | $ | 12,750 | $ | 4,336 | $ | 6,582 | $ | 1,797 | $ | 35 | ||||
| Debt(2) | | 161,738 | 13,174 | 20,000 | 128,564 | — | |||||||||
| Interest on debt(3) | | 16,523 | 4,095 | 7,406 | 5,022 | — | |||||||||
| Total contractual obligations | | $ | 191,011 | $ | 21,605 | $ | 33,988 | $ | 135,383 | $ | 35 |
| Column 1 | Column 2 |
|---|---|
| (1) | Includes future minimum lease payments required under non-cancelable operating and capital leases. |
| Column 1 | Column 2 |
|---|---|
| (2) | Includes scheduled cash principal payments on our debt, excluding interest, original issuance discount and debt issuance costs. |
| Column 1 | Column 2 |
|---|---|
| (3) | Represents the estimated interest payments on our outstanding debt, assuming a 2.61% interest rate, which was the weighted average interest rate applicable to our borrowings as of December 31, 2021. |
Off-Balance Sheet Arrangements
We do not engage in off-balance sheet financing arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
Critical Accounting Policies and Significant Judgements and Estimates
Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. Preparation of the financial statements requires us to make judgments, estimates and assumptions that impact the reported amount of net sales and expenses, assets and liabilities and the disclosure of contingent assets and liabilities. We consider an accounting judgment, estimate or assumption to be critical when the estimate or assumption is complex in nature or requires a high degree of judgment and when the use of different judgments, estimates and assumptions could have a material impact on our consolidated financial statements. While our significant accounting policies are described in more detail in Note 1 of our consolidated financial statements, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements.
Goodwill
Goodwill is initially recorded at the fair value. Goodwill represents the excess of the purchase price of acquisitions over the fair value of the net assets acquired. Goodwill is not subject to any amortization but is tested for impairment annually as of October 31st, and when events or circumstances indicate that the estimated fair value of a reporting unit may no longer exceed its carrying value. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recognized in an amount equal to the excess, limited to the total amount of goodwill allocated to the reporting unit.
In evaluating goodwill for impairment, qualitative factors are considered to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, through this qualitative assessment, the conclusion is made that it is more likely than not that a reporting unit’s fair value is less than its carrying value, an impairment test is conducted. This quantitative test is performed by comparing the fair value of a reporting unit, determined by a weighted combination of the discounted cash flow method of the income approach and the market approach, to its carrying value. If the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. We had three reporting units as of October 31, 2021: Safariland, Med-Eng, and Distribution.
We determine the fair value of reporting units based on a combination of the income approach and market approach, weighted based on the circumstances, as management believes this is the most direct approach to incorporate the specific
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economic attributes and risk profiles of our reporting units into our valuation model. Under the income approach, the discounted cash flow model determines fair value based on the present value of projected cash flows over a specific projection period and a residual value related to future cash flows beyond the projection period. Both values are discounted using a rate that reflects our best estimate of the weighted average cost of capital of a market participant and is adjusted for appropriate risk factors. We perform sensitivity tests with respect to growth rates and discount rates used in the income approach. Under the market approach, valuation multiples are derived based on a selection of comparable companies and acquisition transactions and applied to projected operating data for each reporting unit to arrive at an indication of fair value.