UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2017
Commission File No. 1-15579
MSA SAFETY INCORPORATED
(Exact name of registrant as specified in its charter)
Pennsylvania | 46-4914539 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
1000 Cranberry Woods Drive Cranberry Township, Pennsylvania | 16066-5207 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code: (724) 776-8600
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
(Do not check if a smaller reporting company) | Emerging growth company ¨ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of October 17, 2017, 38,031,977 shares of common stock, of the registrant were outstanding.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MSA SAFETY INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF INCOME
Unaudited
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(In thousands, except per share amounts) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
Net sales | $ | 296,129 | $ | 278,233 | $ | 850,669 | $ | 853,499 | ||||||||
Cost of products sold | 163,630 | 149,471 | 464,842 | 468,177 | ||||||||||||
Gross profit | 132,499 | 128,762 | 385,827 | 385,322 | ||||||||||||
Selling, general and administrative | 72,409 | 72,945 | 222,334 | 227,856 | ||||||||||||
Research and development | 12,351 | 13,116 | 35,282 | 34,623 | ||||||||||||
Restructuring charges (Note 4) | 3,214 | 1,889 | 16,920 | 3,697 | ||||||||||||
Currency exchange losses, net | 562 | 790 | 3,994 | 2,498 | ||||||||||||
Other operating expense (Note 18) | 3,346 | — | 32,956 | — | ||||||||||||
Operating income | 40,617 | 40,022 | 74,341 | 116,648 | ||||||||||||
Interest expense | 3,961 | 4,412 | 10,566 | 12,515 | ||||||||||||
Other income, net | (981 | ) | (2,041 | ) | (2,061 | ) | (3,704 | ) | ||||||||
Total other expense, net | 2,980 | 2,371 | 8,505 | 8,811 | ||||||||||||
Income from continuing operations before income taxes | 37,637 | 37,651 | 65,836 | 107,837 | ||||||||||||
Provision for income taxes (Note 10) | 5,411 | 11,329 | 6,306 | 38,866 | ||||||||||||
Income from continuing operations | 32,226 | 26,322 | 59,530 | 68,971 | ||||||||||||
(Loss) income from discontinued operations (Note 19) | — | (1,300 | ) | — | 55 | |||||||||||
Net income | 32,226 | 25,022 | 59,530 | 69,026 | ||||||||||||
Net income attributable to noncontrolling interests | (160 | ) | (836 | ) | (519 | ) | (2,006 | ) | ||||||||
Net income attributable to MSA Safety Incorporated | $ | 32,066 | $ | 24,186 | $ | 59,011 | $ | 67,020 | ||||||||
Amounts attributable to MSA Safety Incorporated common shareholders: | ||||||||||||||||
Income from continuing operations | $ | 32,066 | $ | 25,486 | $ | 59,011 | $ | 67,475 | ||||||||
Loss from discontinued operations (Note 19) | — | (1,300 | ) | — | (455 | ) | ||||||||||
Net income | $ | 32,066 | $ | 24,186 | $ | 59,011 | $ | 67,020 | ||||||||
Earnings per share attributable to MSA Safety Incorporated common shareholders: | ||||||||||||||||
Basic | ||||||||||||||||
Income from continuing operations | $ | 0.84 | $ | 0.68 | $ | 1.55 | $ | 1.80 | ||||||||
Loss from discontinued operations (Note 19) | $ | — | $ | (0.04 | ) | $ | — | $ | (0.01 | ) | ||||||
Net income | $ | 0.84 | $ | 0.64 | $ | 1.55 | $ | 1.79 | ||||||||
Diluted | ||||||||||||||||
Income from continuing operations | $ | 0.83 | $ | 0.67 | $ | 1.52 | $ | 1.77 | ||||||||
Loss from discontinued operations (Note 19) | $ | — | $ | (0.04 | ) | $ | — | $ | (0.01 | ) | ||||||
Net income | $ | 0.83 | $ | 0.63 | $ | 1.52 | $ | 1.76 | ||||||||
Dividends per common share | $ | 0.35 | $ | 0.33 | $ | 1.03 | $ | 0.98 | ||||||||
The accompanying notes are an integral part of the consolidated financial statements.
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MSA SAFETY INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Unaudited
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(In thousands) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
Net income | $ | 32,226 | $ | 25,022 | $ | 59,530 | $ | 69,026 | ||||||||
Other comprehensive income (loss), net of tax: | ||||||||||||||||
Foreign currency translation adjustments (Note 6) | 10,021 | (2,411 | ) | 34,888 | (3,519 | ) | ||||||||||
Pension and post-retirement plan adjustments, net of tax (Note 6) | 2,180 | 1,893 | 6,321 | 5,679 | ||||||||||||
Reclassification from accumulated other comprehensive (loss) into earnings (Note 6) | — | — | — | 4,125 | ||||||||||||
Total other comprehensive income (loss), net of tax | 12,201 | (518 | ) | 41,209 | 6,285 | |||||||||||
Comprehensive income | 44,427 | 24,504 | 100,739 | 75,311 | ||||||||||||
Comprehensive income attributable to noncontrolling interests | (4,289 | ) | (1,021 | ) | (3,185 | ) | (3,271 | ) | ||||||||
Comprehensive income attributable to MSA Safety Incorporated | $ | 40,138 | $ | 23,483 | $ | 97,554 | $ | 72,040 | ||||||||
The accompanying notes are an integral part of the consolidated financial statements.
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MSA SAFETY INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEET
Unaudited
(In thousands) | September 30, 2017 | December 31, 2016 | ||||||
Assets | ||||||||
Cash and cash equivalents | $ | 112,185 | $ | 113,759 | ||||
Trade receivables, less allowance for doubtful accounts of $6,181 and $5,610 | 226,780 | 209,514 | ||||||
Inventories (Note 3) | 160,280 | 103,066 | ||||||
Prepaid income taxes | 20,618 | 16,378 | ||||||
Notes receivable, insurance companies (Note 18) | 19,295 | 4,180 | ||||||
Prepaid expenses and other current assets | 37,381 | 25,909 | ||||||
Total current assets | 576,539 | 472,806 | ||||||
Property, plant and equipment, net (Note 5) | 152,475 | 148,678 | ||||||
Prepaid pension cost | 58,954 | 62,916 | ||||||
Deferred tax assets (Note 10) | 36,094 | 23,240 | ||||||
Goodwill (Note 13) | 417,949 | 333,276 | ||||||
Intangible assets (Note 13) | 185,356 | 77,015 | ||||||
Notes receivable, insurance companies, noncurrent (Note 18) | 59,151 | 63,147 | ||||||
Insurance receivable (Note 18) and other noncurrent assets | 108,699 | 172,842 | ||||||
Total assets | $ | 1,595,217 | $ | 1,353,920 | ||||
Liabilities | ||||||||
Notes payable and current portion of long-term debt, net (Note 12) | $ | 26,667 | $ | 26,666 | ||||
Accounts payable | 65,589 | 62,734 | ||||||
Employees’ compensation | 36,848 | 39,880 | ||||||
Insurance and product liability (Note 18) | 72,739 | 19,438 | ||||||
Income taxes payable (Note 10) | — | 3,889 | ||||||
Other current liabilities | 71,245 | 68,803 | ||||||
Total current liabilities | 273,088 | 221,410 | ||||||
Long-term debt, net (Note 12) | 445,717 | 363,836 | ||||||
Pensions and other employee benefits | 172,851 | 157,927 | ||||||
Deferred tax liabilities (Note 10) | 37,347 | 34,044 | ||||||
Other noncurrent liabilities | 45,007 | 15,491 | ||||||
Total liabilities | $ | 974,010 | $ | 792,708 | ||||
Commitments and contingencies (Note 18) | ||||||||
Equity | ||||||||
Preferred stock, 4 1/2% cumulative, $50 par value (Note 7) | 3,569 | 3,569 | ||||||
Common stock, no par value (Note 7) | 189,145 | 172,681 | ||||||
Treasury shares, at cost (Note 7) | (299,583 | ) | (289,254 | ) | ||||
Accumulated other comprehensive loss (Note 6) | (191,703 | ) | (230,246 | ) | ||||
Retained earnings | 915,311 | 901,415 | ||||||
Total MSA Safety Incorporated shareholders' equity | 616,739 | 558,165 | ||||||
Noncontrolling interests | 4,468 | 3,047 | ||||||
Total shareholders’ equity | 621,207 | 561,212 | ||||||
Total liabilities and shareholders’ equity | $ | 1,595,217 | $ | 1,353,920 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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MSA SAFETY INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Unaudited
Nine Months Ended September 30, | ||||||||
(In thousands) | 2017 | 2016 | ||||||
Operating Activities | ||||||||
Net income | $ | 59,530 | $ | 69,026 | ||||
Depreciation and amortization | 27,665 | 26,651 | ||||||
Restructuring charges (Note 4) | 11,384 | — | ||||||
Stock-based compensation (Note 11) | 9,668 | 8,292 | ||||||
Pension expense (Note 15) | 5,307 | 5,094 | ||||||
Deferred income tax benefit | (9,590 | ) | (184 | ) | ||||
Loss (gain) on asset dispositions, net | 65 | (1,512 | ) | |||||
Pension contributions (Note 15) | (4,425 | ) | (4,700 | ) | ||||
Currency exchange losses, net | 3,994 | 2,516 | ||||||
Other operating expense (Note 18) | 32,956 | — | ||||||
Changes in: | ||||||||
Trade receivables | 10,108 | 16,215 | ||||||
Inventories (Note 3) | (36,894 | ) | (9,961 | ) | ||||
Income taxes receivable, prepaid expenses and other current assets | 19,248 | (2,635 | ) | |||||
Accounts payable and accrued liabilities | (16,096 | ) | (81,856 | ) | ||||
Other noncurrent assets and liabilities | 76,326 | 4,491 | ||||||
Cash Flow From Operating Activities | 189,246 | 31,437 | ||||||
Investing Activities | ||||||||
Capital expenditures | (11,730 | ) | (16,146 | ) | ||||
Acquisition, net of cash acquired (Note 14) | (213,990 | ) | (18,261 | ) | ||||
Property disposals and other investing (Note 19) | 729 | 17,932 | ||||||
Cash Flow Used in Investing Activities | (224,991 | ) | (16,475 | ) | ||||
Financing Activities | ||||||||
Proceeds from short-term debt, net | — | 75 | ||||||
Proceeds from long-term debt (Note 12) | 491,500 | 332,664 | ||||||
Payments on long-term debt (Note 12) | (415,600 | ) | (316,656 | ) | ||||
Restricted cash | 472 | 1,304 | ||||||
Cash dividends paid | (39,200 | ) | (36,675 | ) | ||||
Company stock purchases | (16,656 | ) | (1,881 | ) | ||||
Exercise of stock options | 12,392 | 6,105 | ||||||
Employee stock purchase plan | 282 | 252 | ||||||
Excess tax benefit related to stock plans | — | (434 | ) | |||||
Other, net | (590 | ) | (1,008 | ) | ||||
Cash Flow From (Used in) Financing Activities | 32,600 | (16,254 | ) | |||||
Effect of exchange rate changes on cash and cash equivalents | 1,571 | 1,400 | ||||||
(Decrease) increase in cash and cash equivalents | (1,574 | ) | 108 | |||||
Beginning cash and cash equivalents | 113,759 | 105,925 | ||||||
Ending cash and cash equivalents | $ | 112,185 | $ | 106,033 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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MSA SAFETY INCORPORATED
CONSOLIDATED STATEMENT OF CHANGES IN RETAINED EARNINGS,
ACCUMULATED OTHER COMPREHENSIVE LOSS AND NONCONTROLLING INTERESTS
Unaudited
(In thousands) | Retained Earnings | Accumulated Other Comprehensive (Loss) | |||||
Balances June 30, 2016 | $ | 877,103 | $ | (202,476 | ) | ||
Net income | 25,022 | — | |||||
Foreign currency translation adjustments | — | (2,411 | ) | ||||
Pension and post-retirement plan adjustments, net of tax of $1,046 | — | 1,893 | |||||
Income attributable to noncontrolling interests | (836 | ) | (185 | ) | |||
Common dividends | (12,381 | ) | — | ||||
Preferred dividends | (10 | ) | — | ||||
Balances September 30, 2016 | 888,898 | (203,179 | ) | ||||
Balances June 30, 2017 | 896,621 | (199,775 | ) | ||||
Net income | 32,226 | — | |||||
Foreign currency translation adjustments | — | 10,021 | |||||
Pension and post-retirement plan adjustments, net of tax of $1,009 | — | 2,180 | |||||
(Income) loss attributable to noncontrolling interests | (160 | ) | (4,129 | ) | |||
Common dividends | (13,366 | ) | — | ||||
Preferred dividends | (10 | ) | — | ||||
Balances September 30, 2017 | $ | 915,311 | $ | (191,703 | ) | ||
(In thousands) | Retained Earnings | Accumulated Other Comprehensive (Loss) | |||||
Balances December 31, 2015 | $ | 858,553 | $ | (208,199 | ) | ||
Net income | 69,026 | — | |||||
Foreign currency translation adjustments | — | (3,519 | ) | ||||
Pension and post-retirement plan adjustments, net of tax of $3,132 | — | 5,679 | |||||
Income attributable to noncontrolling interests | (2,006 | ) | (1,265 | ) | |||
Reclassification from accumulated other comprehensive (loss) into earnings | — | 4,125 | |||||
Common dividends | (36,645 | ) | — | ||||
Preferred dividends | (30 | ) | — | ||||
Balances September 30, 2016 | 888,898 | (203,179 | ) | ||||
Balances December 31, 2016 | 901,415 | (230,246 | ) | ||||
Net income | 59,530 | — | |||||
Foreign currency translation adjustments | — | 34,888 | |||||
Pension and post-retirement plan adjustments, net of tax of $3,052 | — | 6,321 | |||||
(Income) loss attributable to noncontrolling interests | (519 | ) | (2,666 | ) | |||
Common dividends | (39,170 | ) | — | ||||
Preferred dividends | (30 | ) | — | ||||
Cumulative effect of the adoption of ASU 2016-16 (Note 2) | (5,915 | ) | — | ||||
Balances September 30, 2017 | $ | 915,311 | $ | (191,703 | ) | ||
The accompanying notes are an integral part of the consolidated financial statements.
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MSA SAFETY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
Note 1—Basis of Presentation
The Condensed Consolidated Financial Statements of MSA Safety Incorporated and its subsidiaries ("MSA" or the "Company") are unaudited. These Condensed Consolidated Financial Statements include all adjustments, consisting of normal recurring adjustments, considered necessary by management to fairly state the Company's results. Intercompany accounts and transactions have been eliminated. The results reported in these Condensed Consolidated Financial Statements are not necessarily indicative of the results that may be expected for the entire year. The December 31, 2016 condensed consolidated balance sheet data was derived from the audited consolidated balance sheet but does not include all disclosures required by generally accepted accounting principles (GAAP). This Form 10-Q report should be read in conjunction with MSA's Form 10-K for the year ended December 31, 2016, which includes all disclosures required by GAAP.
Reclassifications - Certain reclassifications of prior year's data have been made to conform to the current year presentation. These reclassifications relate to how amounts are classified within the operating section of the Condensed Consolidated Statement of Cash Flows but do not change the overall cash flow from operating activities for the prior year as previously reported.
Note 2— Recently Adopted and Recently Issued Accounting Standards
In May 2014, the FASB issued ASU 2014-09, Revenue with Contracts from Customers. This ASU establishes a single revenue recognition model for all contracts with customers based on recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services, eliminates industry specific requirements, and expands disclosure requirements. This ASU is required to be adopted beginning January 1, 2018. Our revenue streams include agreements with distributors and agreements with end users, including governmental entities. The Company continues to evaluate the impact that the adoption of this ASU will have on the consolidated financial statements, including the timing of revenue recognition associated with certain customized products. We have conducted a risk assessment and have provided numerous training sessions to begin educating individuals throughout the business on the requirements of the new standard. We have substantially completed our contract analysis and the adoption of ASU 2014-09 is not expected to have a material impact on our consolidated financial position or results of operations. Based on the evaluation of our current contracts and revenue streams, we anticipate they will be recorded consistently under both existing GAAP and the new standard. As such, we do not expect to record an adjustment on January 1, 2018 under the modified retrospective method of adoption. The majority of our revenue transactions are not accounted for under industry-specific guidance that will be superseded by the ASU and generally consist of a single performance obligation to transfer promised goods or services. We will continue to hold training sessions throughout the rest of 2017 and have drafted a new accounting policy to incorporate the guidance within the new standard into our revenue recognition policies to be applied in 2018 upon adoption of the new standard and going forward. The FASB has issued, and may issue in the future, interpretive guidance which may cause our evaluation to change. We are currently drafting enhanced disclosures surrounding revenue recognition.
In April 2015, the FASB issued ASU 2015-04, Retirement Benefits - Practical Expedient for the Measurement Date of an Employer's Defined Benefit Obligation and Plan Assets. This ASU allows entities with a fiscal year end that does not coincide with a month end to use the closest month end for measurement purposes. This ASU also allows entities that have a significant event in an interim period that calls for a remeasurement of defined benefit plan assets and obligations to use the month end date that is closest to the date of the significant event. This ASU was adopted on January 1, 2016. The adoption of this ASU did not have a material effect on our consolidated financial statements.
In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. This ASU was adopted on January 1, 2017. This ASU applies only to inventory measured using the first-in, first-out (FIFO) or average cost methods and requires inventory to be measured at the lower of cost and net realizable value (NRV). This ASU replaces market with NRV, defined as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This eliminates the need to determine and consider replacement cost or NRV less an approximately normal profit margin when measuring inventory. The adoption of this ASU did not have a material effect on our consolidated financial statements.
-7-
In February 2016, the FASB issued ASU 2016-02, Leases. This ASU requires lessees to record a right of use asset and a liability for virtually all leases. This ASU will be effective beginning January 1, 2019. The Company is working to develop a transition plan and continues to evaluate the impact that the adoption of this ASU will have on the consolidated financial statements. During the third quarter of 2017, we conducted a survey to identify all leases across the organization and are currently working to obtain all lease contracts to accumulate the necessary information for adoption. We have identified that a majority of our leases fall into one of three categories: office equipment, real estate and vehicles. We have also identified that most office equipment and vehicle leases utilize standard master leasing contracts that have similar terms. At a minimum, total assets and total liabilities will increase in the period the ASU is adopted. At September 30, 2017, the Company's undiscounted future minimum rent commitments under noncancellable operating leases were approximately $41.0 million. We will adopt the standard using the modified retrospective approach and are still evaluating whether we will elect the practical expedients allowed in the standard.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU simplifies the accounting for many aspects associated with share-based payment accounting including income taxes and the use of forfeiture rates. This ASU was adopted on January 1, 2017. The provisions of this ASU which impacted us included a requirement that all excess tax benefits and deficiencies that pertain to share-based payment arrangements be recognized as a component of income tax expense rather than as a component of shareholders’ equity. The Company expects this to create volatility in its effective tax rate on a go-forward basis as the impact is treated as a discrete item within our quarterly tax provision. The extent of excess tax benefits/deficiencies is subject to variation in our stock price and timing/extent of stock-based compensation share vestings and employee stock option exercises. This ASU also removes the impact of the excess tax benefits and deficiencies from the calculation of diluted earnings per share and no longer requires a presentation of excess tax benefits and deficiencies related to the vesting and exercise of share-based compensation as both an operating outflow and financing inflow on the statement of cash flows. We have applied all of these changes on a prospective basis and therefore, prior years were not adjusted. Additionally, this ASU allows for an accounting policy election to estimate the number of awards that are expected to vest or account for forfeitures when they occur. We elected to maintain our current forfeitures policy and will continue to include an estimate of those forfeitures when recognizing stock-based compensation expense. This ASU also requires cash payments to tax authorities when an employer uses a net-settlement feature to withhold shares to meet statutory tax withholding provisions to be presented as a financing activity (eliminating previous diversity in practice). Adoption of this ASU resulted in an additional discrete tax benefit of approximately $6.9 million during the nine months ended ended September 30, 2017.
In June 2016, the FASB issued ASU 2016-13, Allowance for Loan and Lease Losses. This ASU introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments including loans, held-to-maturity debt securities, loan commitments, financial guarantees and net investments in leases as well as reinsurance and trade receivables. This ASU will be effective beginning in 2020. The Company is currently evaluating the impact that the adoption of this ASU will have on the consolidated financial statements and expects that adoption will result in increased disclosure.
In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Payments and Cash Receipts. This ASU clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This ASU will be effective beginning in 2018. The Company is currently evaluating the impact that the adoption of this ASU will have on the consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16, Intra-entity Transfers of Assets Other than Inventory. This ASU states that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This ASU was early adopted on January 1, 2017 using the modified retrospective approach which resulted in a $5.9 million cumulative-effect adjustment directly to retained earnings for any previously deferred income tax effects.
In November 2016, the FASB issued ASU 2016-18, Restricted Cash. This ASU requires that amounts generally described as restricted cash and restricted cash equivalents are included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This ASU is effective beginning in 2018 to be adopted on a retrospective basis and early adoption is permitted. The Company is currently evaluating the impact that the adoption of this ASU will have on the consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, Business Combinations - Clarifying the Definition of a Business. This ASU provides further guidance for identifying whether a set of assets and activities is a business by providing a screen outlining that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This ASU is effective beginning in 2018 and will be applied prospectively. The adoption of this ASU may have a material effect on our consolidated financial statements in the event that we have an acquisition or disposal that falls within this screen.
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In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. This ASU simplifies the accounting for goodwill impairments under Step 2 by eliminating the requirement to perform procedures to determine the fair value of the assets and liabilities of the reporting unit, including previously unrecognized assets and liabilities, in order to determine the fair value of the goodwill and any impairment charge to be recognized. Under this ASU, the impairment charge to be recognized should be the amount by which the reporting unit's carrying value exceeds the reporting unit's fair value as calculated under Step 1 provided that the loss recognized should not exceed the total amount of goodwill allocated to the reporting unit. This ASU is effective beginning in 2019 and early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The adoption of this ASU may have a material effect on our consolidated financial statements in the event that we determine that goodwill for any of our reporting units is impaired.
In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost, to improve the presentation of net periodic pension and net periodic post-retirement benefit cost. This ASU requires companies to present the service cost component of net periodic benefit cost in the same income statement line item as other compensation costs arising from services rendered during the period. Only the service cost component will be eligible for capitalization in assets. Additionally, this ASU requires that companies present the other components of the net periodic benefit cost separately from the line item that includes the service cost and outside of any subtotal of income from operations, if one is presented. This ASU is effective for annual periods beginning after December 15, 2017 and early adoption is permitted. The Company plans to adopt the ASU on January 1, 2018 and is currently evaluating the impact that the adoption of this ASU will have on the consolidated financial statements. If the Company would have applied the provisions of this ASU for the year ended December 31, 2016, operating income would have decreased by $3.5 million.
In May 2017, the FASB issued ASU 2017-09, Stock Compensation - Scope of Modification Accounting, which amends the scope of modification accounting for share-based payment arrangements. This ASU provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. This ASU is effective for periods beginning after December 31, 2017. The Company plans to adopt the ASU on January 1, 2018 and is currently evaluating the impact that the adoption of this ASU will have on the consolidated financial statements.
Note 3—Inventories
The following table sets forth the components of inventory:
(In thousands) | September 30, 2017 | December 31, 2016 | ||||||
Finished products | $ | 70,446 | $ | 54,348 | ||||
Work in process | 12,076 | 6,542 | ||||||
Raw materials and supplies | 119,651 | 84,069 | ||||||
Inventories at current cost | 202,173 | 144,959 | ||||||
Less: LIFO valuation | (41,893 | ) | (41,893 | ) | ||||
Total inventories | $ | 160,280 | $ | 103,066 | ||||
Note 4—Restructuring Charges
During the three and nine months ended September 30, 2017, we recorded restructuring charges, net of adjustments, of $3.2 million and $16.9 million, respectively. Americas segment restructuring charges of $12.5 million during the nine months ended September 30, 2017 related primarily to the voluntary retirement incentive package described below as well as severance from staff reductions in Brazil. International segment restructuring charges of $4.4 million during the nine months ended September 30, 2017 were related to severance costs for staff reductions associated with our ongoing initiatives to drive profitable growth in Europe and right size our operations in Australia and Africa.
In September 2016, certain employees in the Americas segment were offered a voluntary retirement incentive package (“VRIP”). The election window for participation closed on October 17, 2016. The employees were required to render service through January 31, 2017 to receive the VRIP and had until February 6, 2017 to revoke their election. None of the 83 employees who accepted the VRIP revoked their election to retire under the terms of the plan. Non-cash special termination benefit expense of $11.4 million was incurred in the first quarter of 2017 related to these elections. All benefits were paid from our over funded North America pension plan.
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During the three and nine months ended September 30, 2016, we recorded restructuring charges, net of adjustments of $1.9 million and $3.7 million. International segment charges of $3.4 million during the nine months ended September 30, 2016 were related to severance costs for staff reductions associated with ongoing initiatives to right size our operations in Europe and Asia. Americas segment restructuring charges of $1.2 million during the nine months ended September 30, 2016 related primarily to severance from staff reductions in Latin America. Favorable adjustments for changes in estimates on employee restructuring reserves of $1.1 million were made during the nine months ended September 30, 2016.
Activity and reserve balances for restructuring charges by segment were as follows:
(in millions) | Americas | International | Corporate | Total | |||||||||||
Reserve balances at December 31, 2015 | $ | 1.6 | $ | 5.4 | $ | 1.1 | $ | 8.1 | |||||||
Restructuring charges | 1.8 | 5.3 | 0.2 | 7.3 | |||||||||||
Adjustments to estimates on restructuring reserves | (0.5 | ) | (0.6 | ) | (0.5 | ) | (1.6 | ) | |||||||
Cash payments | (2.0 | ) | (7.3 | ) | (0.5 | ) | (9.8 | ) | |||||||
Reserve balances at December 31, 2016 | $ | 0.9 | $ | 2.8 | $ | 0.3 | $ | 4.0 | |||||||
Restructuring charges | 12.5 | 4.5 | — | 17.0 | |||||||||||
Adjustments to estimates on restructuring reserves | — | (0.1 | ) | — | (0.1 | ) | |||||||||
Cash payments/utilization | (12.9 | ) | (2.5 | ) | (0.3 | ) | (15.7 | ) | |||||||
Reserve balances at September 30, 2017 | $ | 0.5 | $ | 4.7 | $ | — | $ | 5.2 | |||||||
Note 5—Property, Plant and Equipment
The following table sets forth the components of property, plant and equipment:
(In thousands) | September 30, 2017 | December 31, 2016 | |||||
Land | $ | 3,299 | $ | 2,684 | |||
Buildings | 119,657 | 111,762 | |||||
Machinery and equipment | 383,642 | 361,010 | |||||
Construction in progress | 9,907 | 10,714 | |||||
Total | 516,505 | 486,170 | |||||
Less: accumulated depreciation | (364,030 | ) | (337,492 | ) | |||
Net property, plant and equipment | $ | 152,475 | $ | 148,678 | |||
-10-
Note 6—Reclassifications Out of Accumulated Other Comprehensive Loss
The changes in Accumulated Other Comprehensive Loss were as follows:
MSA Safety Incorporated | Noncontrolling Interests | |||||||||||||||
Three Months Ended September 30, | Three Months Ended September 30, | |||||||||||||||
(In thousands) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
Pension and other post-retirement benefits (a) | ||||||||||||||||
Balance at beginning of period | $ | (113,927 | ) | $ | (115,603 | ) | $ | — | $ | — | ||||||
Amounts reclassified from Accumulated other comprehensive loss: | ||||||||||||||||
Amortization of prior service cost | (10 | ) | (88 | ) | — | — | ||||||||||
Recognized net actuarial losses | 3,199 | 3,027 | — | — | ||||||||||||
Tax benefit | (1,009 | ) | (1,046 | ) | — | — | ||||||||||
Total amount reclassified from Accumulated other comprehensive loss, net of tax | 2,180 | 1,893 | — | — | ||||||||||||
Balance at end of period | $ | (111,747 | ) | $ | (113,710 | ) | $ | — | $ | — | ||||||
Foreign Currency Translation | ||||||||||||||||
Balance at beginning of period | $ | (85,848 | ) | $ | (86,873 | ) | $ | (3,427 | ) | $ | (2,536 | ) | ||||
Foreign currency translation adjustments | 5,892 | (2,596 | ) | 4,129 | 185 | |||||||||||
Balance at end of period | $ | (79,956 | ) | $ | (89,469 | ) | $ | 702 | $ | (2,351 | ) | |||||
MSA Safety Incorporated | Noncontrolling Interests | |||||||||||||||
Nine Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(In thousands) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
Pension and other post-retirement benefits (a) | ||||||||||||||||
Balance at beginning of period | $ | (118,068 | ) | $ | (119,389 | ) | $ | — | $ | — | ||||||
Amounts reclassified from Accumulated other comprehensive loss: | ||||||||||||||||
Amortization of prior service cost | (228 | ) | (268 | ) | — | — | ||||||||||
Recognized net actuarial losses | 9,601 | 9,079 | — | — | ||||||||||||
Tax benefit | (3,052 | ) | (3,132 | ) | — | — | ||||||||||
Total amount reclassified from Accumulated other comprehensive loss, net of tax | 6,321 | 5,679 | — | — | ||||||||||||
Balance at end of period | $ | (111,747 | ) | $ | (113,710 | ) | $ | — | $ | — | ||||||
Foreign Currency Translation | ||||||||||||||||
Balance at beginning of period | $ | (112,178 | ) | $ | (88,810 | ) | $ | (1,964 | ) | $ | (3,616 | ) | ||||
Reclassification into earnings | — | 3,355 | — | 770 | ||||||||||||
Foreign currency translation adjustments | 32,222 | (4,014 | ) | 2,666 | 495 | |||||||||||
Balance at end of period | $ | (79,956 | ) | $ | (89,469 | ) | $ | 702 | $ | (2,351 | ) | |||||
-11-
Note 7—Capital Stock
Preferred Stock - The Company has authorized 100,000 shares of $50 par value 4.5% cumulative preferred nonvoting stock which is callable at $52.50. There are 71,340 shares issued and 52,878 shares held in treasury at September 30, 2017. There were no treasury purchases of preferred stock during the nine months ended September 30, 2017 or 2016. The Company has also authorized 1,000,000 shares of $10 par value second cumulative preferred voting stock. No shares have been issued as of September 30, 2017.
Common Stock - The Company has authorized 180,000,000 shares of no par value common stock. There were 62,081,391 shares issued as of December 31, 2016. No new shares have been issued in 2017. There were 38,025,521 and 37,736,578 shares outstanding at September 30, 2017 and December 31, 2016, respectively.
Treasury Shares - In 2015, the Board of Directors adopted a stock repurchase program. The program authorizes up to $100.0 million to repurchase MSA common stock in the open market and in private transactions. The share purchase program has no expiration date. The maximum shares that may be purchased is calculated based on the dollars remaining under the program and the respective month-end closing share price. There were 168,941 shares repurchased during nine months ended September 30, 2017 No shares were repurchased during the nine months ended September 30, 2016. We do not have any other share purchase programs. There were 24,055,870 and 24,344,813 Treasury Shares at September 30, 2017 and December 31, 2016, respectively.
The Company issues Treasury Shares for all share based benefit plans. Shares are issued from Treasury at the average Treasury Share cost on the date of the transaction. There were 526,890 Treasury Shares issued for these purposes during the nine months ended September 30, 2017.
Note 8—Segment Information
We are organized into six geographic operating segments based on management responsibilities. The operating segments have been aggregated (based on economic similarities, the nature of their products, end-user markets and methods of distribution) into three reportable segments: Americas, International, and Corporate.
The Americas and International segments were established on January 1, 2016. The Americas segment is comprised of our operations in North America and Latin America geographies. The International segment is comprised of our operations of all geographies outside of the Americas. Certain global expenses are allocated to each segment in a manner consistent with where the benefits from the expenses are derived.
The Company's sales are allocated to each country based primarily on the destination of the end-customer.
Adjusted operating income (loss) and adjusted operating margin are the measures used by the chief operating decision maker to evaluate segment performance and allocate resources. Adjusted operating income (loss) is defined as operating income from continuing operations excluding restructuring charges, currency exchange gains (losses) and other operating expense. Adjusted operating margin is defined as adjusted operating income (loss) divided by segment sales to external customers. Adjusted operating income (loss) and adjusted operating margin are not recognized terms under GAAP and therefore do not purport to be alternatives to operating income or operating margin from continuing operations as a measure of operating performance. Further, the Company's measure of adjusted operating income (loss) and adjusted operating margin may not be comparable to similarly titled measures of other companies. Adjusted operating income (loss) on a consolidated basis is presented in the following table to reconcile the segment operating performance measure to operating income as presented on the Condensed Consolidated Statement of Income.
The accounting principles applied at the operating segment level in determining operating income (loss) are generally the same as those applied at the consolidated financial statement level. Sales and transfers between operating segments are accounted for at market-based transaction prices and are eliminated in consolidation.
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Reportable segment information is presented in the following table:
(In thousands) | Americas | International | Corporate | Reconciling Items1 | Consolidated Totals | |||||||||||||||
Three Months Ended September 30, 2017 | ||||||||||||||||||||
Sales to external customers | $ | 186,898 | $ | 109,231 | $ | — | $ | — | $ | 296,129 | ||||||||||
Intercompany sales | 31,451 | 72,496 | — | (103,947 | ) | — | ||||||||||||||
Operating income | 40,617 | |||||||||||||||||||
Restructuring and other charges | 3,214 | |||||||||||||||||||
Currency exchange losses, net | 562 | |||||||||||||||||||
Other operating expense (Note 18) | 3,346 | |||||||||||||||||||
Adjusted operating income (loss) | 47,256 | 9,077 | (8,594 | ) | — | 47,739 | ||||||||||||||
Adjusted operating margin % | 25.3 | % | 8.3 | % | ||||||||||||||||
Total Assets | $ | 1,037,690 | $ | 542,542 | $ | 10,862 | $ | 4,123 | $ | 1,595,217 | ||||||||||
Nine Months Ended September 30, 2017 | ||||||||||||||||||||
Sales to external customers | $ | 528,426 | $ | 322,243 | $ | — | $ | — | $ | 850,669 | ||||||||||
Intercompany sales | 93,904 | 218,267 | — | (312,171 | ) | — | ||||||||||||||
Operating income | 74,341 | |||||||||||||||||||
Restructuring and other charges | 16,920 | |||||||||||||||||||
Currency exchange losses, net | 3,994 | |||||||||||||||||||
Other operating expense (Note 18) | 32,956 | |||||||||||||||||||
Adjusted operating income (loss) | 130,887 | 26,691 | (29,367 | ) | — | 128,211 | ||||||||||||||
Adjusted operating margin % | 24.8 | % | 8.3 | % | ||||||||||||||||
Total Assets | $ | 1,037,690 | $ | 542,542 | $ | 10,862 | $ | 4,123 | $ | 1,595,217 | ||||||||||
(In thousands) | Americas | International | Corporate | Reconciling Items1 | Consolidated Totals | |||||||||||||||
Three Months Ended September 30, 2016 | ||||||||||||||||||||
Sales to external customers | $ | 165,359 | $ | 112,874 | $ | — | $ | — | $ | 278,233 | ||||||||||
Intercompany sales | 28,324 | 65,098 | — | (93,422 | ) | — | ||||||||||||||
Operating income | 40,022 | |||||||||||||||||||
Restructuring and other charges | 1,889 | |||||||||||||||||||
Currency exchange losses, net | 790 | |||||||||||||||||||
Other operating expense (Note 18) | — | |||||||||||||||||||
Adjusted operating income (loss) | 41,458 | 10,511 | (9,268 | ) | — | 42,701 | ||||||||||||||
Adjusted operating margin % | 25.1 | % | 9.3 | % | ||||||||||||||||
Total Assets | $ | 885,416 | $ | 533,868 | $ | 3,829 | $ | 4,833 | $ | 1,427,946 | ||||||||||
Nine Months Ended September 30, 2016 | ||||||||||||||||||||
Sales to external customers | $ | 510,324 | $ | 343,175 | $ | — | $ | — | $ | 853,499 | ||||||||||
Intercompany sales | 86,194 | 195,435 | — | (281,629 | ) | — | ||||||||||||||
Operating income | 116,648 | |||||||||||||||||||
Restructuring and other charges | 3,697 | |||||||||||||||||||
Currency exchange losses, net | 2,498 | |||||||||||||||||||
Other operating expense (Note 18) | — | |||||||||||||||||||
Adjusted operating income (loss) | 117,475 | 31,659 | (26,291 | ) | — | 122,843 | ||||||||||||||
Adjusted operating margin % | 23.0 | % | 9.2 | % | ||||||||||||||||
Total Assets | $ | 885,416 | $ | 533,868 | $ | 3,829 | $ | 4,833 | $ | 1,427,946 | ||||||||||
1Reconciling items consist primarily of intercompany eliminations and items not directly attributable to reporting segments.
-13-
The percentage of total sales by product group were as follows:
Three Months Ended September 30, | 2017 | 2016 | |
Breathing Apparatus | 22% | 24% | |
Fixed Gas & Flame Detection | 21% | 22% | |
Portable Gas Detection | 12% | 13% | |
Industrial Head Protection | 12% | 11% | |
Fall Protection | 8% | 9% | |
Firefighter Helmets & Protective Apparel | 11% | 4% | |
Other | 14% | 17% | |
Nine Months Ended September 30, | 2017 | 2016 | |
Breathing Apparatus | 24% | 26% | |
Fixed Gas & Flame Detection | 20% | 20% | |
Portable Gas Detection | 13% | 13% | |
Industrial Head Protection | 12% | 10% | |
Fall Protection | 8% | 9% | |
Firefighter Helmets & Protective Apparel | 7% | 5% | |
Other | 16% | 17% | |
-14-
Note 9—Earnings per Share
Basic earnings per share attributable to MSA Safety Incorporated common shareholders is computed by dividing net income, after the deduction of preferred stock dividends and undistributed earnings allocated to participating securities, by the weighted average number of common shares outstanding during the period. Diluted earnings per share attributable to MSA Safety Incorporated common shareholders assumes the issuance of common stock for all potentially dilutive share equivalents outstanding not classified as participating securities. Participating securities are defined as unvested stock-based payment awards that contain nonforfeitable rights to dividends.
Amounts attributable to MSA Safety Incorporated common shareholders: | Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
(In thousands, except per share amounts) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
Net income from continuing operations | $ | 32,066 | $ | 25,486 | $ | 59,011 | $ | 67,475 | ||||||||
Preferred stock dividends | (10 | ) | (11 | ) | (30 | ) | (29 | ) | ||||||||
Income from continuing operations available to common equity | 32,056 | 25,475 | 58,981 | 67,446 | ||||||||||||
Dividends and undistributed earnings allocated to participating securities | (36 | ) | (38 | ) | (62 | ) | (105 | ) | ||||||||
Income from continuing operations available to common shareholders | 32,020 | 25,437 | 58,919 | 67,341 | ||||||||||||
Net loss from discontinued operations | $ | — | $ | (1,300 | ) | $ | — | $ | (455 | ) | ||||||
Preferred stock dividends | — | 1 | — | (1 | ) | |||||||||||
Loss from discontinued operations available to common equity | — | (1,299 | ) | — | (456 | ) | ||||||||||
Dividends and undistributed earnings allocated to participating securities | — | 2 | — | 1 | ||||||||||||
Loss from discontinued operations available to common shareholders | — | (1,297 | ) | — | (455 | ) | ||||||||||
Basic weighted-average shares outstanding | 38,074 | 37,487 | 37,970 | 37,407 | ||||||||||||
Stock options and other stock compensation | 628 | 625 | 722 | 501 | ||||||||||||
Diluted weighted-average shares outstanding | 38,702 | 38,112 | 38,692 | 37,908 | ||||||||||||
Antidilutive stock options | — | — | — | — | ||||||||||||
Earnings per share attributable to continuing operations: | ||||||||||||||||
Basic | $ | 0.84 | $ | 0.68 | $ | 1.55 | $ | 1.80 | ||||||||
Diluted | $ | 0.83 | $ | 0.67 | $ | 1.52 | $ | 1.77 | ||||||||
Loss per share attributable to discontinued operations: | ||||||||||||||||
Basic | $ | — | $ | (0.04 | ) | $ | — | $ | (0.01 | ) | ||||||
Diluted | $ | — | $ | (0.04 | ) | $ | — | $ | (0.01 | ) | ||||||
Note 10—Income Taxes
The Company's effective tax rate for the third quarter of 2017 was 14.4% and differs from the U.S. federal statutory rate of 35% primarily due to a 6.6% benefit associated with the reduction of exit taxes related to our European reorganization, additional manufacturing deduction benefits and the release of valuation allowance on foreign losses. The Company's effective tax rate for the third quarter of 2016 of 30.1% differs from the U.S. federal statutory rate of 35% primarily due to profitability in more favorable tax jurisdictions and benefits associated with U.S. tax credits for research and development and the manufacturing deduction.
The Company's effective tax rate for the nine months ended September 30, 2017 was 9.6% and differs from the U.S. federal statutory rate of 35% primarily due to a significant tax benefit of approximately 10.5% related to certain share-based payments related to the adoption of ASU 2016-09 as well as a 3.8% benefit associated with the reduction of exit taxes related to our European reorganization, additional manufacturing deduction benefits and the release of a valuation allowance on foreign losses. The effective tax rate for the nine months ended September 30, 2016 was 36.0%, inclusive of 3.3% associated with exit taxes related to our European reorganization. The 36.0% rate for the nine month period of 2016 differs from the U.S. federal statutory rate of 35% primarily due to the exit taxes discussed above, partially offset by profitability in more favorable tax jurisdictions and benefits associated with U.S. tax credits for research and development and the manufacturing deduction.
-15-
At September 30, 2017, the Company had a gross liability for unrecognized tax benefits of $15.4 million. The Company has recognized tax benefits associated with these liabilities of $6.8 million at September 30, 2017. The gross liability includes amounts associated with prior period foreign tax exposure.
The Company recognizes interest related to unrecognized tax benefits in interest expense and penalties in operating expenses. The Company's liability for accrued interest related to uncertain tax positions was $1.8 million at September 30, 2017.
Note 11—Stock Plans
The 2016 Management Equity Incentive Plan provides for various forms of stock-based compensation for eligible key employees through May 2026. Management stock-based compensation includes stock options, restricted stock, restricted stock units and performance stock units. The 2017 Non-Employee Directors’ Equity Incentive Plan provides for grants of stock options and restricted stock to non-employee directors through May 2027. We issue treasury shares for stock option exercises, restricted stock grants, restricted stock unit grants, and performance stock unit grants. Please refer to Note 7 for further information regarding stock compensation share issuance.
Stock compensation expense is as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(In thousands) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
Stock compensation expense | $ | 1,435 | $ | 1,341 | $ | 9,668 | $ | 8,292 | ||||||||
Income tax benefit | 543 | 515 | 3,650 | 3,210 | ||||||||||||
Stock compensation expense, net of income tax benefit | $ | 892 | $ | 826 | $ | 6,018 | $ | 5,082 | ||||||||
A summary of stock option activity for the nine months ended September 30, 2017 follows:
Shares | Weighted Average Exercise Price | ||||||
Outstanding at January 1, 2017 | 1,576,092 | $ | 37.63 | ||||
Exercised | (422,711 | ) | 29.32 | ||||
Outstanding at September 30, 2017 | 1,153,381 | 40.68 | |||||
Exercisable at September 30, 2017 | 785,377 | $ | 38.11 | ||||
Restricted stock and restricted stock units are valued at the market value of the stock on the grant date. A summary of restricted stock and unit activity for the nine months ended September 30, 2017 follows:
Shares | Weighted Average Grant Date Fair Value | ||||||
Unvested at January 1, 2017 | 234,592 | $ | 49.76 | ||||
Granted | 65,683 | 74.90 | |||||
Vested | (72,128 | ) | 51.35 | ||||
Forfeited | (3,174 | ) | 50.11 | ||||
Unvested at September 30, 2017 | 224,973 | $ | 57.16 | ||||
Performance stock units have a market condition modifier and are valued on the grant date using a Monte Carlo valuation model to determine fair value. The final number of shares to be issued for performance stock units granted in the first quarter of 2017 may range from 0% to 200% of the target award based on achieving the specified performance targets over the performance period. The following weighted average assumptions were used in the Monte Carlo model for units granted in the first quarter of 2017 with a market condition modifier.
-16-
Fair value per unit | $72.28 |
Risk-free interest rate | 1.45% |
Expected dividend yield | 2.31% |
Expected volatility | 29.1% |
MSA stock beta | 1.272 |
The risk-free interest rate is based on the U.S. Treasury Constant Maturity rates as of the grant date converted into an implied spot rate yield curve. Expected dividend yield is based on the most recent annualized dividend divided by the one year average closing share price. Expected volatility is based on the historical volatility using daily stock prices. Stock beta is calculated with three years of daily price data.
A summary of performance stock unit activity for the nine months ended September 30, 2017 follows:
Shares | Weighted Average Grant Date Fair Value | ||||||
Unvested at January 1, 2017 | 186,621 | $ | 46.18 | ||||
Granted | 98,886 | 72.73 | |||||
Performance adjustments | 27,915 | 57.26 | |||||
Vested | (71,403 | ) | 56.47 | ||||
Unvested at September 30, 2017 | 242,019 | $ | 55.06 | ||||
The performance adjustments above relate to the final number of shares issued for the 2014 Management Performance Units, which were 189.2% of the target award based on Total Shareholder Return during the three year performance period, and vested in the first quarter of 2017.
Note 12—Long-Term Debt
(In thousands) | September 30, 2017 | December 31, 2016 | |||||
2006 Senior Notes payable through 2021, 5.41%, net of debt issuance costs | $ | 33,333 | $ | 33,333 | |||
2010 Senior Notes payable through 2021, 4.00%, net of debt issuance costs | 100,000 | 100,000 | |||||
2016 Senior Notes payable through 2031, 3.40%, net of debt issuance costs | 73,511 | 67,713 | |||||
Senior revolving credit facility maturing in 2020, net of debt issuance costs | 265,540 | 189,456 | |||||
Total | 472,384 | 390,502 | |||||
Amounts due within one year, net of debt issuance costs | 26,667 | 26,666 | |||||
Long-term debt, net of debt issuance costs | $ | 445,717 | $ | 363,836 | |||
Under the 2015 Amended and Restated Credit Agreement associated with our senior revolving credit facility, the Company may elect either a Base rate of interest (“BASE”) or an interest rate based on the London Interbank Offered Rate (“LIBOR”). The BASE is a daily fluctuating per annum rate equal to the highest of (i) the Prime Rate, (ii) the Federal Funds Open Rate plus one half of one percent (0.5%) or (iii) the Daily Libor Rate plus one percent (1.00%). The Company pays a credit spread of 0 to 175 basis points based on the Company’s net EBITDA leverage ratio and elected rate (BASE or LIBOR). The Company has a weighted average interest rate of 2.22% on the senior revolving credit facility as of September 30, 2017. At September 30, 2017, $301.6 million of the existing $575.0 million senior revolving credit facility was unused including letters of credit.
-17-
On January 22, 2016, the Company entered into a multi-currency note purchase and private shelf agreement, pursuant to which MSA issued notes in an aggregate original principal amount of £54.9 million (approximately $73.6 million at September 30, 2017). The notes are repayable in annual installments of £6.1 million (approximately $8.2 million at September 30, 2017), commencing January 22, 2023, with a final payment of any remaining amount outstanding on January 22, 2031. The interest rate on these notes is fixed at 3.4%. The note purchase agreement requires MSA to comply with specified financial covenants including a requirement to maintain a minimum fixed charges coverage ratio of not less than 1.50 to 1.00 and a consolidated leverage ratio not to exceed 3.25 to 1.00; in each case calculated on the basis of the trailing four fiscal quarters. In addition, the note purchase agreement contains negative covenants limiting the ability of MSA and its subsidiaries to incur additional indebtedness or issue guarantees, create or incur liens, make loans and investments, make acquisitions, transfer or sell assets, enter into transactions with affiliated parties, make changes in its organizational documents that are materially adverse to lenders or modify the nature of MSA's or its subsidiaries' business.
The revolving credit facilities and note purchase agreements require the Company to comply with specified financial covenants. In addition, the credit facilities and the note purchase agreements contain negative covenants limiting the ability of the Company and its subsidiaries to enter into specified transactions. The Company was in compliance with all covenants at September 30, 2017.
The Company had outstanding bank guarantees and standby letters of credit with banks as of September 30, 2017 totaling $13.2 million, of which $6.6 million relate to the senior revolving credit facility. The letters of credit serve to cover customer requirements in connection with certain sales orders and insurance companies. No amounts were drawn on these arrangements at September 30, 2017. The Company is also required to provide cash collateral in connection with certain arrangements. At September 30, 2017, the Company has $0.8 million of restricted cash in support of these arrangements.
Note 13—Goodwill and Intangible Assets
Changes in goodwill during the nine months ended September 30, 2017 are as follows:
(In thousands) | Goodwill | ||
Balance at January 1, 2017 | $ | 333,276 | |
Additions (Note 14) | 71,721 | ||
Currency translation | 12,952 | ||
Balance at September 30, 2017 | $ | 417,949 | |
At September 30, 2017, the Company had goodwill of $270.5 million and $147.4 million related to the Americas and International reportable segments, respectively.
Changes in intangible assets, net of accumulated amortization during the nine months ended September 30, 2017 are as follows:
(In thousands) | Intangible Assets | ||
Net balance at January 1, 2017 | $ | 77,015 | |
Additions (Note 14) | 110,680 | ||
Amortization expense | (6,682 | ) | |
Currency translation | 4,343 | ||
Net balance at September 30, 2017 | $ | 185,356 | |
Note 14—Acquisitions
Acquisition of Globe Holding Company, LLC
On July 31, 2017, we acquired 100% of the common stock in Globe Holding Company, LLC ("Globe") in an all-cash transaction valued at $215 million minus a working capital adjustment of $1.0 million. There is no contingent consideration.
Based in Pittsfield, NH, Globe is a leading innovator and provider of firefighter protective clothing and boots. This acquisition aligns with our corporate strategy in that it strengthens our leading position in the North American fire service market. The transaction was funded through borrowings on our unsecured senior revolving credit facility.
-18-
Globe operating results are included in our consolidated financial statements from the acquisition date as part of the Americas reportable segment. The acquisition qualifies as a business combination and will be accounted for using the acquisition method of accounting.
The following table summarizes the preliminary fair values of the Globe assets acquired and liabilities assumed at the date of acquisition:
(In millions) | July 31, 2017 | ||
Current assets (including cash of $58 thousand) | $ | 28.6 | |
Property, plant and equipment and other noncurrent assets | 8.7 | ||
Trade name | 60.0 | ||
Distributor relationships | 40.2 | ||
Acquired technology and other intangible assets | 10.5 | ||
Goodwill | 71.7 | ||
Total assets acquired | 219.7 | ||
Total liabilities assumed | 5.7 | ||
Net assets acquired | $ | 214.0 | |
The amounts in the table above are subject to change upon completion of the valuation of the assets acquired and liabilities assumed. This valuation is expected to be completed by mid-2018.
Assets acquired and liabilities assumed in connection with the acquisition have been recorded at their fair values. Fair values were determined by management, based, in part on an independent valuation performed by a third party valuation specialist. The valuation methods used to determine the fair value of intangible assets included the relief from royalty method for trade name and technology related intangible assets; the excess earnings approach for distributor relationships using distributor inputs and contributory charges; and the cost method for assembled workforce which is included in goodwill. A number of significant assumptions and estimates were involved in the application of these valuation methods, including sales volumes and prices, royalty rates, costs to produce, tax rates, capital spending, discount rates, and working capital changes. Cash flow forecasts were generally based on Globe pre-acquisition forecasts coupled with estimated MSA sales synergies. Identifiable intangible assets with finite lives are subject to amortization over their estimated useful lives. The distributor relationships acquired in the Globe transaction will be amortized over a period of 20 years and the remaining identifiable assets will be amortized over 5 years. The trade name was determined to have an indefinite useful life. We will perform an impairment assessment annually on the trade name, or sooner if there is a triggering event. Additionally, as part of each impairment assessment, we will reassess whether the asset continues to have an indefinite life or whether it should be reassessed with a finite life. Estimated future amortization expense related to the identifiable intangible assets is approximately $1.7 million for the remainder of 2017 and $4.1 million in each of the next four years 2018 through 2021 and $3.2 million in 2022. Estimated future depreciation expense related to Globe property, plant and equipment is approximately $0.3 million for the remainder of 2017 and $1.0 million in each of the next five years.
Goodwill is calculated as the excess of the purchase price over the fair value of net assets acquired and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Among the factors that contributed to a purchase price in excess of the fair value of the net tangible and intangible assets acquired were the acquisition of an assembled workforce, the expected synergies and other benefits that we believe will result from combining the operations of Globe with our operations. Goodwill of $71.7 million related to the Globe acquisition has been recorded in the Americas reportable segment and is deductible for tax purposes.
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Acquisition of Senscient, Inc.
On September 19, 2016, we acquired 100% of the common stock of Senscient, Inc. ("Senscient") for $19.1 million in cash. There is no contingent consideration. Senscient, which is headquartered in the UK, is a leader in laser-based open path gas detection technology. The acquisition of Senscient expands and enhances MSA’s technology offerings in the global market for fixed gas and flame detection systems, as the Company continues to execute its core product growth strategy. The acquisition was funded through borrowings on our unsecured senior revolving credit facility.
The following table summarizes the preliminary fair values of the Senscient assets acquired and liabilities assumed at the date of acquisition:
(In millions) | September 19, 2016 | ||
Current assets (including cash of $0.7 million) | $ | 5.9 | |
Property, plant and equipment and other noncurrent assets | 0.3 | ||
Acquired technology | 1.6 | ||
Customer-related intangibles | 2.8 | ||
Goodwill | 10.5 | ||
Total assets acquired | 21.1 | ||
Total liabilities assumed | 2.0 | ||
Net assets acquired | $ | 19.1 | |
Assets acquired and liabilities assumed in connection with the acquisition have been recorded at their fair values. Fair values were determined by management, based, in part on an independent valuation performed by a third party valuation specialist. The valuation methods used to determine the fair value of intangible assets included the relief from royalty method for the technology related intangible assets and the cost method for assembled workforce which is included in goodwill. A number of significant assumptions and estimates were involved in the application of these valuation methods, including sales volumes and prices, costs to produce, tax rates, capital spending, discount rates, and working capital changes. Cash flow forecasts were generally based on pre-acquisition forecasts coupled with estimated MSA sales synergies. Identifiable intangible assets with finite lives are subject to amortization over their estimated useful lives, which are ten and five years for the technology and customer-related intangibles, respectively. Estimated future amortization expense related to identifiable intangible assets is approximately $0.3 million for the remaining portion of 2017 and $0.7 million each year from 2018 through 2021.
Goodwill is calculated as the excess of the purchase price over the fair value of net assets acquired and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Among the factors that contributed to a purchase price in excess of the fair value of the net tangible and intangible assets acquired were the acquisition of an assembled workforce, the expected synergies and other benefits that we believe will result from combining the operations of Senscient with our operations. Goodwill of $10.5 million related to the Senscient acquisition is included in the International operating segment and is deductible for tax purposes.
Our results for the nine months ended September 30, 2017, include transaction and integration costs of $0.4 million related to the Senscient acquisition and $1.0 million related to the acquisition of Globe Holding Company LLC. These costs are reported in selling, general and administrative expenses.
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The operating results of both acquisitions have been included in our consolidated financial statements from the acquisition date through September 30, 2017. Our results for the nine months ended September 30, 2017 include Globe sales and net income of $19.7 million and $1.7 million, respectively. Excluding transaction and integration costs, Globe provided $2.4 million of net income for the nine months ended September 30, 2017.
The following unaudited pro forma information presents our combined results as if both acquisitions had occurred at the beginning of 2016. The unaudited pro forma financial information was prepared to give effect to events that are (1) directly attributable to the acquisition; (2) factually supportable; and (3) expected to have a continuing impact on the combined company’s results. There were no material transactions between MSA and either Senscient or Globe during the periods presented that are required to be eliminated. Intercompany transactions between Senscient companies as well as the Globe companies during the periods presented have been eliminated in the unaudited pro forma condensed combined financial information. The unaudited pro forma condensed combined financial information does not reflect any cost savings, operating synergies or revenue enhancements that the combined companies may achieve as a result of the acquisitions or the costs to integrate the operations or the costs necessary to achieve cost savings, operating synergies or revenue enhancements.
Pro forma condensed combined financial information (Unaudited)
Three months ended | Nine months ended | ||||||||||||||
(In millions, except per share amounts) | September 30, 2017 | September 30, 2016 | September 30, 2017 | September 30, 2016 | |||||||||||
Net sales | $ | 304.6 | $ | 305.5 | $ | 915.1 | $ | 940.0 | |||||||
Income from continuing operations | 30.8 | 29.9 | 68.4 | 81.7 | |||||||||||
Basic earnings per share from continuing operations | 0.81 | 0.80 | 1.80 | 2.18 | |||||||||||
Diluted earnings per share from continuing operations | 0.80 | 0.78 | 1.77 | 2.15 | |||||||||||
The unaudited pro forma condensed combined financial information is presented for information purposes only and is not intended to represent or be indicative of the combined results of operations or financial position that we would have reported had the acquisitions been completed as of the date and for the period presented, and should not be taken as representative of our consolidated results of operations or financial condition following the acquisitions. In addition, the unaudited proforma condensed combined financial information is not intended to project the future financial position or results of operations of the combined company.
The unaudited pro forma condensed combined financial information was prepared using the acquisition method of accounting under existing GAAP. MSA has been treated as the acquirer.
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Note 15—Pensions and Other Post-retirement Benefits
Components of net periodic benefit cost consisted of the following:
Pension Benefits | Other Benefits | |||||||||||||||
(In thousands) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
Three Months Ended September 30, | ||||||||||||||||
Service cost | $ | 2,721 | $ | 2,634 | $ | 96 | $ | 106 | ||||||||
Interest cost | 4,572 | 4,702 | 204 | 237 | ||||||||||||
Expected return on plan assets | (8,738 | ) | (8,682 | ) | — | — | ||||||||||
Amortization of prior service cost | (4 | ) | 17 | (6 | ) | (105 | ) | |||||||||
Recognized net actuarial losses | 3,184 | 3,010 | 15 | 17 | ||||||||||||
Settlements | 34 | 17 | — | — | ||||||||||||
Net periodic benefit cost | 1,769 | 1,698 | 309 | 255 | ||||||||||||
Nine Months Ended September 30, | ||||||||||||||||
Service cost | $ | 8,163 | $ | 7,902 | $ | 308 | $ | 318 | ||||||||
Interest cost | 13,716 | 14,106 | 678 | 711 | ||||||||||||
Expected return on plan assets | (26,214 | ) | (26,046 | ) | — | — | ||||||||||
Amortization of prior service cost | (12 | ) | 47 | (216 | ) | (315 | ) | |||||||||
Recognized net actuarial losses | 9,552 | 9,028 | 49 | 51 | ||||||||||||
Settlements | 102 | 57 | — | — | ||||||||||||
Net periodic benefit cost, excluding below | 5,307 | 5,094 | 819 | 765 | ||||||||||||
Special termination charge | 11,384 | (a) | — | — | — | |||||||||||
Net periodic benefit cost | 16,691 | 5,094 | 819 | 765 | ||||||||||||
(a) Represents the charge for special termination benefits related to the VRIP which were paid from our over funded North America pension plan and recorded as restructuring charges on the condensed consolidated statement of income. See further details in Note 4.
We made contributions of $4.4 million and $4.7 million to our pension plans during the nine months ended September 30, 2017 and 2016, respectively. We expect to make total contributions of approximately $5.9 million to our pension plans in 2017 which are primarily associated with our International segment.
Note 16—Derivative Financial Instruments
As part of our currency exchange rate risk management strategy, we may enter into certain derivative foreign currency forward contracts that do not meet the U.S. GAAP criteria for hedge accounting, but which have the impact of partially offsetting certain foreign currency exposures. We account for these forward contracts at fair value and report the related gains or losses in currency exchange gains or losses in the condensed consolidated statement of income. The notional amount of open forward contracts was $77.1 million and $75.3 million at September 30, 2017 and December 31, 2016, respectively.
The following table presents the condensed consolidated balance sheet location and fair value of assets associated with derivative financial instruments:
(In thousands) | September 30, 2017 | December 31, 2016 | ||||||
Derivatives not designated as hedging instruments: | ||||||||
Foreign exchange contracts: other current liabilities | $ | 887 | $ | 258 | ||||
Foreign exchange contracts: other current assets | 43 | 566 | ||||||
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The following table presents the condensed consolidated statement of income location and impact of derivative financial instruments:
(Gain) Loss Recognized in Income | ||||||||||
Nine Months Ended September 30, | ||||||||||
(In thousands) | Statement of Income Location | 2017 | 2016 | |||||||
Derivatives not designated as hedging instruments: | ||||||||||
Foreign exchange contracts | Currency exchange (gains) losses | $ | (5,780 | ) | $ | 2,158 | ||||
Note 17—Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are:
• | Level 1—Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets. |
• | Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. |
• | Level 3—Unobservable inputs for the asset or liability. |
The valuation methodologies we used to measure financial assets and liabilities were limited to the derivative financial instruments described in Note 16. We estimate the fair value of the derivative financial instruments, consisting of foreign currency forward contracts, based upon valuation models with inputs that generally can be verified by observable market conditions and do not involve significant management judgment. Accordingly, the fair values of the derivative financial instruments are classified within Level 2 of the fair value hierarchy.
With the exception of fixed rate long-term debt, we believe that the reported carrying amounts of our financial assets and liabilities approximate their fair values. The reported carrying amount of our fixed rate long-term debt (including the current portion) was $207.0 million and $211.3 million at September 30, 2017 and 2016, respectively. The fair value of this debt was $226.1 million and $236.8 million at September 30, 2017 and 2016, respectively. The fair value of this debt was determined using Level 2 inputs by evaluating like rated companies with publicly traded bonds where available or current borrowing rates available for financings with similar terms and maturities.
Note 18—Contingencies
Product Liability
The Company categorizes the product liability claims of its subsidiary MSA LLC into two main categories: single incident and cumulative trauma.
Single incident claims. Single incident product liability claims involve incidents of short duration that are typically known to us when they occur and involve observable injuries, which provide an objective basis for quantifying damages. MSA LLC works with an outside valuation consultant to review its single incident product liability exposure on an annual basis, or more frequently if changing circumstances or developments in existing cases make an interim review appropriate. The review process takes into account the number and composition of asserted claims, expected settlement costs for reported claims, and an estimate of costs for unreported claims (claims incurred but not reported or "IBNR"). The estimate for IBNR claims is based on experience, sales volumes, and other relevant information. Adjustments are made to the reserve as appropriate. The reserve for single incident product liability claims, which includes reported and IBNR claims, was $3.7 million at September 30, 2017 and $3.4 million at December 31, 2016. Single incident product liability expense was $0.3 million during the nine months ended September 30, 2017 and $0.5 million during the nine months ended September 30, 2016.
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Cumulative trauma claims. Cumulative trauma product liability claims involve exposures to harmful substances (e.g., silica, asbestos and coal dust) that occurred many years ago and may have developed over long periods of time into diseases such as silicosis, asbestosis, mesothelioma, or coal worker’s pneumoconiosis. There are two types of cumulative trauma claims, asserted and IBNR claims. MSA LLC is presently named as a defendant in 1,435 lawsuits comprised of 2,271 asserted claims. These lawsuits mainly involve respiratory protection products allegedly manufactured and sold by MSA LLC or its predecessors. The products at issue were manufactured many years ago and are not currently offered by MSA LLC. Although there is year over year variability in the number and quality of asserted claims defended and resolved, MSA LLC’s aggregate spend for cumulative trauma product liability asserted claims (inclusive of settlements and defense costs) for the three years ended December 31, 2016, totaled approximately $150.9 million, substantially all of which was recorded as insurance receivables or notes receivable from insurance companies because the amounts are believed to be recoverable under insurance.
A summary of cumulative trauma product liability lawsuits and asserted claims activity follows:
Nine Months Ended September 30, 2017 | Year Ended December 31, 2016 | |||||
Open lawsuits, beginning of period | 1,794 | 1,988 | ||||
New lawsuits | 304 | 379 | ||||
Settled and dismissed lawsuits | (663 | ) | (573 | ) | ||
Open lawsuits, end of period | 1,435 | 1,794 | ||||
Nine Months Ended September 30, 2017 | Year Ended December 31, 2016 | |||||
Asserted claims, beginning of period | 3,023 | 3,779 | ||||
New claims | 349 | 843 | ||||
Settled and dismissed claims | (1,101 | ) | ||||