Middleby - 10-Q quarterly report FY2010 Q3

(Mark One)

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended October 2, 2010

or

¨Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File No. 1-9973

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

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).  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “accelerated filer, large accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x          Accelerated filer o          Non-accelerated filer o          Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).       Yes o No x

As of November 5, 2010, there were 18,454,934 shares of the registrant's common stock outstanding.

 

Item 1.   Condensed Consolidated Financial Statements

(In Thousands, Except Share Data)

(Unaudited)

See accompanying notes

(In Thousands, Except Per Share Data)

(Unaudited)

See accompanying notes

(In Thousands)

(Unaudited)

See accompanying notes

(Unaudited)

The condensed consolidated financial statements have been prepared by The Middleby Corporation (the "company"), pursuant to the rules and regulations of the Securities and Exchange Commission. The financial statements are unaudited and certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the company believes that the disclosures are adequate to make the information not misleading. These financial statements should be read in conjunction with the financial statements and related notes contained in the company's 2009 Form 10-K.

 

In the opinion of management, the financial statements contain all adjustments necessary to present fairly the financial position of the company as of October 2, 2010 and January 2, 2010, and the results of operations for the three and nine months ended October 2, 2010 and October 3, 2009 and cash flows for the nine months ended October 2, 2010 and October 3, 2009.

On December 31, 2006, the company adopted the provisions of Accounting Standards Codification (“ASC”) 740 “Income Taxes”. This interpretation prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. ASC 740 states that a tax benefit from an uncertain tax position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with a taxing authority having full knowledge of all relevant information.

As of January 2, 2010, the total amount of liability for unrecognized tax benefits related to federal, state and foreign taxes was approximately $20.3 million (of which $12.9 would impact the effective tax rate if recognized) plus approximately $2.0 million of accrued interest and $2.2 million of penalties. As of October 2, 2010, there were no significant changes in the total amount of liability for unrecognized tax benefits. During the second quarter, the IRS completed its audit of the company's 2007 federal tax return resulting in a $1.3 million benefit to the provision. The results of this audit were reflected in the company's second quarter financial statements.

 

It is reasonably possible that the amounts of unrecognized tax benefits associated with state, federal and foreign tax positions may decrease over the next twelve months due to expiration of a statute or completion of an audit. While a reasonable range of the amount cannot be determined, the company believes such decrease would not be material.

The company operates in multiple taxing jurisdictions, both within the United States and outside of the United States, and faces audits from various tax authorities. The company remains subject to examination until the statute of limitations expires for the respective tax jurisdiction. Federal tax years 2006 and 2007 were examined by competent IRS agents. Therefore the company believes the tax years to be effectively settled and closed for ASC 740 purposes. Within specific countries, the company and its operating subsidiaries may be subject to audit by various tax authorities and may be subject to different statute of limitations expiration dates. A summary of the tax years that remain subject to examination in the company’s major tax jurisdictions are:

 

 

D)        Fair Value Measures

On December 30, 2007 (first day of fiscal year 2008), the company adopted the provisions of ASC 820 “Fair Value Measurements and Disclosures”. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosure about fair value measurements.

 

ASC 820 defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into the following levels:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs, other than quoted prices in active markets, that are observable either directly or indirectly.

Level 3 – Unobservable inputs based on our own assumptions.

The company’s financial assets and liabilities that are measured at fair value and are categorized using the fair value hierarchy at October 2, 2010 are as follows (in thousands):

The contingent consideration relates to earnout provisions recorded in conjunction with the acquisitions of CookTek LLC and the food processing equipment division of Cozzini, Inc. See Note 2 for more information.

 

The company operates in a highly fragmented industry and has completed numerous acquisitions over the past several years as a component of its growth strategy. The company has acquired industry leading brands and technologies to position itself as a leader in the commercial foodservice equipment and food processing equipment industries.

The company has accounted for all business combinations using the purchase method to record a new cost basis for the assets acquired and liabilities assumed. The difference between the purchase price and the fair value of the assets acquired and liabilities assumed has been recorded as goodwill in the financial statements. The results of operations are reflected in the consolidated financial statements of the company from the date of acquisition.

On April 26, 2009, the company completed its acquisition of substantially all of the assets and operations of CookTek LLC (“CookTek”), the leading manufacturer of induction cooking and warming systems for a purchase price of $8.0 million in cash. An additional deferred payment of $1.0 million was made during the second quarter of 2010 as provided for in the purchase agreement. Additional contingent payments are also payable over the course of four years upon the achievement of certain sales targets as described below.

The final allocation of cash paid for the CookTek acquisition is summarized as follows (in thousands):

 

 

The CookTek purchase agreement included an earnout provision providing for contingent payments due to the sellers to the extent certain financial targets are exceeded. The earnout amounts are payable in the four consecutive years subsequent to the acquisition date if CookTek exceeds certain sales targets for each of those years. The earnout payment will amount to 10% of the sales in excess of the target for each of the respective years. There is no cap on the potential earnout payment, however, the company’s estimated probable range of the contingent consideration is between $0 and $8 million. The contractual obligation associated with the contingent earnout provision recognized on the acquisition date was $4.7 million. This amount was determined based on an income approach.

 

The goodwill and $3.5 million of other intangibles associated with the trade name are subject to the non-amortization provisions of ASC 350 “Intangibles – Goodwill and Other.” Other intangibles also include less than $0.1 million allocated to backlog, $0.7 million allocated to developed technology and $2.4 million allocated to customer relationships which are to be amortized over periods of 3 months, 6 years and 5 years, respectively. Goodwill and other intangibles of CookTek are allocated to the Commercial Foodservice Equipment Group for segment reporting purposes. These assets are expected to be deductible for tax purposes.

On April 30, 2009, the company completed its acquisition of substantially all of the assets and operations of Anetsberger Brothers, Inc. (“Anets”), a leading manufacturer of griddles, fryers and dough rollers, for a purchase price of $3.4 million. An additional deferred payment of $0.5 million was made in the second quarter of 2010 upon the achievement of certain transition objectives.

The goodwill and $0.9 million of other intangibles associated with the trade name are subject to the non-amortization provisions of ASC 350. Other intangibles also include less than $0.1 million allocated to developed technology and $0.2 million allocated to customer relationships, both of which are to be amortized over the period of 3 years. Goodwill and other intangibles of Anets are allocated to the Commercial Foodservice Equipment Group for segment reporting purposes. These assets are expected to be deductible for tax purposes.

On December 14, 2009, the company completed its acquisition of Doyon Equipment, Inc. (“Doyon”), a leading Canadian manufacturer of baking ovens for the commercial foodservice industry, for a purchase price of approximately $5.8 million. During the three month period ended October 2, 2010, the company finalized the working capital provision resulting in an additional payment of $577,000.

The following estimated fair values of assets acquired and liabilities assumed are provisional and are based on the information that was available as of the acquisition date to estimate the fair value of assets acquired and liabilities assumed. Measurement period adjustments reflect new information obtained about facts and circumstances that existed as of the acquisition date (in thousands):

 

The goodwill and $1.4 million of other intangibles associated with the trade name are subject to the non-amortization provisions of ASC 350. Other intangibles also include $0.1 million allocated to developed technology and $0.8 million allocated to customer relationships which are to be amortized over the periods of 5 years. Goodwill and other intangibles of Doyon are allocated to the Commercial Foodservice Equipment Group for segment reporting purposes. These assets are not expected to be deductible for tax purposes.

On July 13, 2010, the company completed its acquisition of substantially all of the assets and operations of PerfectFry Company LTD (“PerfectFry”), a leading manufacturer of ventless countertop frying units for the commercial foodservice industry for a purchase price of approximately $4.6 million. The purchase price is subject to adjustment based upon a working capital provision within the purchase agreement.

The goodwill and $1.2 million of other intangibles associated with the trade name are subject to the non-amortization provisions of ASC 350. Other intangibles also include $0.1 million allocated to developed technology and $0.3 million allocated to customer relationships which are to be amortized over the periods of 5 years. Goodwill and other intangibles of PerfectFry are allocated to the Commercial Foodservice Equipment Group for segment reporting purposes. These assets are expected to be deductible for tax purposes.

The company believes that information gathered to date provides a reasonable basis for estimating the fair values of assets acquired and liabilities assumed but the company is waiting for additional information necessary to finalize those fair values. Thus, the provisional measurements of fair value set forth above are subject to change. Such changes are not expected to be significant. The company expects to complete the purchase price allocation as soon as practicable but no later than one year from the acquisition date.

On September 21, 2010, the company completed its acquisition of the food processing equipment business of Cozzini, Inc. (“Cozzini”), a leading manufacturer of equipment solutions for the food processing industry, for an aggregate purchase price of approximately $19.5 million, including $17.4 million in cash and 34,263 shares of Middleby common stock valued at $2.1 million. An additional contingent payment is also payable upon the achievement of certain sales targets. The purchase price is subject to adjustment based upon a working capital provision within the purchase agreement.

The goodwill and $3.2 million of other intangibles associated with the trade name are subject to the non-amortization provisions of ASC 350. Other intangibles also includes $0.6 million allocated to developed technology, $2.4 million allocated to customer relationships and $0.4 million allocated to backlog which are to be amortized over the periods of 5 years, 7 years and 3 months respectively. Goodwill and other intangibles of Cozzini are allocated to the Food Processing Group for segment reporting purposes. These assets are expected to be deductible for tax purposes.

The company believes that information gathered to date provides a reasonable basis for estimating the fair values of assets acquired and liabilities assumed but the company is waiting for additional information necessary to finalize those fair values. Thus, the provisional measurements of fair value set forth above are subject to change. Such changes are not expected to be significant. The company expects to complete the purchase price allocation as soon as practicable but no later than one year from the acquisition date.

 

The Cozzini purchase agreement included an earnout provision providing for a contingent payment due to the sellers to the extent certain financial targets are exceeded. This earnout payment is payable within the first quarter of 2011 if Cozzini exceeds certain sales targets for fiscal 2010. The contractual obligation associated with the contingent earnout provision recognized on the acquisition date was $2.0 million.

 

From time to time, the company is subject to proceedings, lawsuits and other claims related to products, suppliers, employees, customers and competitors. The company maintains insurance to partially cover product liability, workers compensation, property and casualty, and general liability matters.  The company is required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses.  A determination of the amount of accrual required, if any, for these contingencies is made after assessment of each matter and the related insurance coverage.  The reserve requirement may change in the future due to new developments or changes in approach such as a change in settlement strategy in dealing with these matters.  The company does not believe that any pending litigation will have a material adverse effect on its financial condition, results of operations or cash flows.

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820), “Improving Disclosures about Fair Value Measurements” (“ASU No. 2010-06”). ASU No. 2010-06 requires new disclosures about significant transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for such transfers and to disclose separately information about purchases, sales, issuances and settlements in the reconciliation for Level 3 fair value measurements. The company adopted the provisions of ASU No. 2010-06 on January 3, 2010, except for disclosures about purchases, sales, issuances and settlements in the reconciliation for Level 3 fair value measurements. These disclosures will be effective for financial statements issued for fiscal years beginning after December 15, 2010. The company does not expect that the adoption of ASU No. 2010-06 will have a material impact on the company’s financial position, results of operations or cash flows.

 

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605), “Multiple-Deliverable Revenue Arrangements” (“ASU No. 2009-13”). ASU No. 2009-13 establishes the accounting and reporting guidance for arrangements including multiple revenue-generating activities.  The amendments in ASU No. 2009-13 are effective prospectively for revenue arrangements entered into or materially modified in the fiscal years beginning on or after June 15, 2010.  The company will adopt the provisions of ASU No. 2009-13 as required. The company does not expect that the adoption of ASU No. 2009-13 will have a material impact on the company’s financial position, results of operations or cash flows.

 

The company reports changes in equity during a period, except those resulting from investments by owners and distributions to owners, in accordance with ASC 220, "Comprehensive Income."

 

Components of other comprehensive income were as follows (in thousands):

Accumulated other comprehensive income is comprised of unrecognized pension benefit costs of $2.3 million, net of taxes of $0.6 million as of October 2, 2010 and January 2, 2010, foreign currency translation adjustments of $0.9 million as of October 2, 2010 and $1.1 million as of January 2, 2010 and an unrealized loss on interest rate swaps of $1.5 million, net of taxes of $1.0 million as of October 2, 2010 and January 2, 2010.

Inventories are composed of material, labor and overhead and are stated at the lower of cost or market. Costs for inventory at two of the company's manufacturing facilities have been determined using the last-in, first-out ("LIFO") method. These inventories under the LIFO method amounted to $16.0 million at October 2, 2010 and $15.6 million at January 2, 2010 and represented approximately 15% and 17% of the total inventory in each respective period. Costs for all other inventory have been determined using the first-in, first-out ("FIFO") method. The company estimates reserves for inventory obsolescence and shrinkage based on its judgment of future realization. Inventories at October 2, 2010 and January 2, 2010 are as follows:

 

Changes in the carrying amount of goodwill for the nine months ended October 2, 2010 are as follows (in thousands):

 

In the normal course of business the company issues product warranties for specific product lines and provides for the estimated future warranty cost in the period in which the sale is recorded.  The estimate of warranty cost is based on contract terms and historical warranty loss experience that is periodically adjusted for recent actual experience. Because warranty estimates are forecasts that are based on the best available information, actual claims costs may differ from amounts provided. Adjustments to initial obligations for warranties are made as changes in the obligations become reasonably estimable.

 

A rollforward of the warranty reserve is as follows:

Terms of the company’s senior credit agreement provide for $497.8 million of availability under a revolving credit line. As of October 2, 2010, the company had $235.9 outstanding under this facility. The company also has $6.9 million in outstanding letters of credit as of October 2, 2010, which reduces the borrowing availability under the revolving credit line. Remaining borrowing availability under this facility, which is also reduced by the company’s foreign borrowings, was $247.2 million at October 2, 2010.

 

At October 2, 2010, borrowings under the senior secured credit facility are assessed at an interest rate of 1.25% above LIBOR for long-term borrowings or at the higher of the Prime rate and the Federal Funds Rate. At October 2, 2010 the average interest rate on the senior debt amounted to 1.55%. The interest rates on borrowings under the senior secured credit facility may be adjusted quarterly based on the company’s indebtedness ratio on a rolling four-quarter basis. Additionally, a commitment fee based upon the indebtedness ratio is charged on the unused portion of the revolving credit line. This variable commitment fee amounted to 0.25% as of October 2, 2010.

In August 2006, the company completed its acquisition of Houno A/S in Denmark. This acquisition was funded in part with locally established debt facilities with borrowings in Danish Krone.  On October 2, 2010 these facilities amounted to $2.7 million in U.S. dollars, including $0.9 million outstanding under a revolving credit facility and $1.8 million of a term loan.  The interest rate on the revolving credit facility is assessed at 1.25% above Euro LIBOR, which amounted to 3.85% on October 2, 2010. The term loan matures in 2013 and the interest rate is assessed at 5.146%.

 

In April 2008, the company completed its acquisition of Giga Grandi Cucine S.r.l (“Giga”) in Italy. This acquisition was funded in part with locally established debt facilities with borrowings denominated in Euro.  On October 2, 2010 these facilities amounted to $4.1 million in U.S. dollars.  The interest rate on the credit facilities is tied to six-month Euro LIBOR. At October 2, 2010, the average interest rate on these facilities was approximately 3.5%. The facilities mature in April of 2015.

 

In December 2009, the company completed its acquisition of Doyon in Canada. This acquisition was funded in part with locally established debt facilities with borrowings denominated in Canadian dollars. On October 2, 2010, these facilities amounted to $0.9 million U.S. dollars. The borrowings under these facilities are collateralized by the assets of the company. The interest rate on these credit facilities is assessed at 0.75% above the prime rate. At October 2, 2010, the average interest rate on these facilities amounted to 3.0%. These facilities mature in 2017.

 

The company estimated the fair value of its loans by calculating the upfront cash payment a market participant would require to assume the company’s obligations. The upfront cash payment is the amount that a market participant would be able to lend at October 2, 2010 to achieve sufficient cash inflows to cover the cash outflows under the company’s senior revolving credit facility assuming the facility was outstanding in its entirety until maturity. Since the company maintains its borrowings under a revolving credit facility and there is no predetermined borrowing or repayment schedule, for purposes of this calculation the company calculated the fair value of its obligations assuming the current amount of debt at the end of the period was outstanding until the maturity of the company’s senior revolving credit facility in December 2012. Although borrowings could be materially greater or less than the current amount of borrowings outstanding at the end of the period, it is not practical to estimate the amounts that may be outstanding during future periods. The fair value of the company’s senior debt obligations as estimated by the company based upon its assumptions is approximately $238.2 million at October 2, 2010, as compared to the carrying value of $243.6 million.

The carrying value and estimated aggregate fair value, based primarily on market prices, of debt is as follows (in thousands):

 

The company believes that its current capital resources, including cash and cash equivalents, cash generated from operations, funds available from its revolving credit facility and access to the credit and capital markets will be sufficient to finance its operations, debt service obligations, capital expenditures, product development and integration expenditures for the foreseeable future.

The company has historically entered into interest rate swap agreements to effectively fix the interest rate on its outstanding debt. The agreements swap one-month LIBOR for fixed rates. As of October 2, 2010 the company had the following interest rate swaps in effect:

 

 

ASC 815 “Derivatives and Hedging” requires an entity to recognize all derivatives as either assets or liabilities and measure those instruments at fair value. Derivatives that do not qualify as a hedge must be adjusted to fair value in earnings. If the derivative does qualify as a hedge under ASC 815, changes in the fair value will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments or recognized in other accumulated comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a hedge's change in fair value will be immediately recognized in earnings.

Foreign Exchange: The company has entered into derivative instruments, principally forward contracts to reduce exposures pertaining to fluctuations in foreign exchange rates. As of October 2, 2010, the company had no forward contracts outstanding.

 

Interest Rate: The company has entered into interest rate swaps to fix the interest rate applicable to certain of its variable-rate debt. The agreements swap one-month LIBOR for fixed rates. The company has designated these swaps as cash flow hedges and all changes in fair value of the swaps are recognized in accumulated other comprehensive income. As of October 2, 2010, the fair value of these instruments was a loss of $2.9 million. The change in fair value of these swap agreements in the first nine months of 2010 was a gain of less than $0.1 million, net of taxes.

 

The following tables summarize the company’s fair value of interest rate swaps (in thousands):

 

The impact on earnings from interest rate swaps was as follows (in thousands):

Interest rate swaps are subject to default risk to the extent the counterparties are unable to satisfy their settlement obligations under the interest rate swap agreements. The company reviews the credit profile of the financial institutions and assesses its creditworthiness prior to entering into the interest rate swap agreements. The interest rate swap agreements typically contain provisions that allow the counterparty to require early settlement in the event that the company becomes insolvent or is unable to maintain compliance with its covenants under its existing debt agreements.

 

The company operates in two reportable operating segments defined by management reporting structure and operating activities.

The Commercial Foodservice Equipment Group manufactures cooking equipment for the restaurant and institutional kitchen industry. This business segment has manufacturing facilities in California, Illinois, Michigan, New Hampshire, North Carolina, Tennessee, Texas, Vermont, Canada, China, Denmark, Italy and the Philippines. Principal product lines of this group include conveyor ovens, ranges, steamers, convection ovens, combi-ovens, broilers and steam cooking equipment, induction cooking systems, baking and proofing ovens, griddles, charbroilers, catering equipment, fryers, toasters, hot food servers, foodwarming equipment, griddles and coffee and beverage dispensing equipment. These products are sold and marketed under the brand names: Anets, Blodgett, Blodgett Combi, Blodgett Range, Bloomfield, CTX, Carter-Hoffmann, CookTek, Doyon, Frifri, Giga, Holman, Houno, Jade, Lang, MagiKitch’n, Middleby Marshall, Nu-Vu, PerfectFry, Pitco, Southbend, Star, Toastmaster, TurboChef and Wells.

 

The Food Processing Equipment Group manufactures preparation, cooking, packaging and food safety equipment for the food processing industry. This business division has manufacturing operations in Illinois, Iowa, Wisconsin and Mexico. Its principal products include batch ovens, belt ovens and conveyorized cooking systems sold under the Alkar brand name; grinding and slicing equipment and food suspension, reduction and emulstion systems sold under the Cozzini brand name; breading, battering, mixing, slicing and forming equipment sold under the MP Equipment brand name and packaging and food safety equipment sold under the RapidPak brand name.

 

During the second quarter of 2010, the company made a determination that the International Distribution Division, previously reported as a separate business segment, no longer met the criteria requiring it to be reported as separate operating segment. Accordingly, the associated financial information has been incorporated within the Commercial Foodservice Group for the current and prior year periods.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The chief decision maker evaluates individual segment performance based on operating income. Management believes that intersegment sales are made at established arms-length transfer prices.

(dollars in thousands)

 

 

The following table summarizes the results of operations for the company's business segments(1)(in thousands):

 

Net sales by major geographic region were as follows (in thousands):

 

(a)       Pension Plans

The company maintains a non-contributory defined benefit plan for its employees at the Smithville, Tennessee facility, which was acquired as part of the New Star International Holdings, Inc. (“Star”) acquisition. Benefits are determined based upon retirement age and years of service with the company. This defined benefit plan was frozen on April 1, 2008 and no further benefits accrue to the participants beyond this date. Plan participants will receive or continue to receive payments for benefits earned on or prior to April 1, 2008 upon reaching retirement age.

The company maintains a non-contributory defined benefit plan for its union employees at the Elgin, Illinois facility. Benefits are determined based upon retirement age and years of service with the company. This defined benefit plan was frozen on April 30, 2002 and no further benefits accrue to the participants beyond this date. Plan participants will receive or continue to receive payments for benefits earned on or prior to April 30, 2002 upon reaching retirement age. The employees participating in the defined benefit plan were enrolled in a newly established 401K savings plan on July 1, 2002, further described below.

 

The company also maintains a retirement benefit agreement with its Chairman. The retirement benefits are based upon a percentage of the Chairman’s final base salary. Additionally, the company maintains a retirement plan for non-employee directors who served on the Board of Directors prior to 2004. This plan is not available to any new non-employee directors. The plan provides for an annual benefit upon a change in control of the company or retirement from the Board of Directors at age 70 equal to 100% of the director’s last annual retainer, payable for a number of years equal to the director’s years of service up to a maximum of 10 years.

 

In March 2010, the Patient Protection and Affordable Care Act and a reconciliation measure, the Health Care and Education Reconciliation Act of 2010, (collectively, the “Act”) were signed into law. The company is currently evaluating provisions of the Act to determine its potential impact, if any, on health care benefit costs.

(b)       401K Savings Plans

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

 

This report contains forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. The company cautions readers that these projections are based upon future results or events and are highly dependent upon a variety of important factors which could cause such results or events to differ materially from any forward-looking statements which may be deemed to have been made in this report, or which are otherwise made by or on behalf of the company. Such factors include, but are not limited to, volatility in earnings resulting from goodwill impairment losses which may occur irregularly and in varying amounts; variability in financing costs; quarterly variations in operating results; dependence on key customers; international exposure; foreign exchange and political risks affecting international sales; ability to protect trademarks, copyrights and other intellectual property; changing market conditions; the impact of competitive products and pricing; the timely development and market acceptance of the company’s products; the availability and cost of raw materials; and other risks detailed herein and from time-to-time in the company’s Securities and Exchange Commission (“SEC”) filings, including the company’s 2009 Annual Report on Form 10-K.

 

The economic outlook for 2010 continues to be uncertain at this time. As a global business, the company’s operating results are impacted by the health of the North American, European, Asian and Latin American economies. While the response by governments and central banks around the world may reduce volatility in the markets, the depth and duration of economic impact and the timing and strength of the recovery remain unpredictable.

(dollars in thousands)

The following table sets forth certain consolidated statements of earnings items as a percentage of net sales for the periods.

NET SALES. Net sales for the third quarter of fiscal 2010 were $177.8 million as compared to $154.0 million in the third quarter of 2009.

 

GROSS PROFIT. Gross profit increased to $70.7 million in the third quarter of 2010 from $62.0 million in the prior year period, reflecting the impact of higher sales volumes. The gross margin rate was 39.8% in the third quarter of 2010 as compared to 40.3% in the prior year quarter. The net decrease in the gross margin rate reflects:

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Combined selling, general, and administrative expenses increased from $34.0 million in the third quarter of 2009 to $38.7 million in the third quarter of 2010. As a percentage of net sales, operating expenses decreased from 22.1% in the third quarter of 2009 to 21.8% in the third quarter of 2010. Selling expenses increased from $16.4 million in the third quarter of 2009 to $17.8 million in the third quarter of 2010. Selling expenses reflect increased costs of $0.7 million associated with acquisitions of Doyon, PerfectFry and Cozzini and $0.3 million associated with commission expense due to higher sales volumes. General and administrative expenses increased from $17.6 million in the third quarter of 2009 to $20.9 million in the third quarter of 2010. General and administrative expenses reflect $0.6 million of costs associated with the recent acquisitions. The current year period also reflects increased incentive compensation of $4.1 million and $0.8 million associated with severance costs recorded during the third quarter associated with headcount reduction initiatives. The prior year period includes $2.5 million of non-recurring charges associated with manufacturing consolidation initiatives.

 

INCOME TAXES. A tax provision of $9.4 million, at an effective rate of 31%, was recorded during the third quarter of 2010, as compared to a $9.9 million provision at a 39% effective rate in the prior year quarter. The reduced effective rate reflects a one-time benefit associated with the deduction of transaction costs related to the acquisition activities, favorable adjustments to tax reserves related to reduced state exposures, and increased deductions for qualified manufacturing activities.

NET SALES. Net sales for the nine-month period ended October 2, 2010 were $511.9 million as compared to $494.1 million in the nine-month period ended October 3, 2009.

 

 

GROSS PROFIT. Gross profit increased to $203.6 million in the nine-month period ended October 2, 2010 from $192.1 million in the prior year period. The gross margin rate was 39.8% for the nine month period ended October 2, 2010, as compared to 38.9% in the prior year period. The net increase in the gross margin rate reflects:

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Combined selling, general, and administrative expenses increased from $109.0 million in the nine-month period ended October 3, 2009 to $115.4 million in the nine-month period ended October 2, 2010. As a percentage of net sales, operating expenses increased from 22.1% in the nine-month period ended October 3, 2009 to 22.6% in the nine-month period ended October 2, 2010. Selling expenses increased from $49.3 million in the nine-month period ended October 3, 2009 to $54.4 million in the nine-month period ended October 2, 2010. Selling expenses reflect increased costs of $1.9 million associated with recent acquisitions, $1.2 million associated with marketing related expenses and $1.2 million related to compensation expenses. General and administrative expenses increased from $59.7 million in the nine-month period ended October 3, 2009 to $61.0 million in the nine-month period ended October 2, 2010. General and administrative expenses reflect an increase of $1.4 million of costs associated with the acquired operations of CookTek, Anets, Doyon, PerfectFry and Cozzini, and increased incentive compensation of $8.2 million. The prior year nine month period included $4.9 million of non-recurring charges associated with manufacturing facility consolidation initiatives.

 

NON-OPERATING EXPENSES. Interest and deferred financing amortization costs decreased to $6.9 million in the nine-month period ended October 2, 2010 as compared to $8.8 million in the nine-month period ended October 3, 2009, due to lower interest rates on lower average debt balances. Other expense was $0.4 million in the nine-month period ended October 2, 2010 as compared to $0.6 million in the nine-month period ended October 3, 2009. Other expense consists primarily of foreign exchange losses.

During the nine months ended October 2, 2010, cash and cash equivalents decreased by $2.4 million to $6.0 million at October 2, 2010 from $8.4 million at January 2, 2010. Net borrowings decreased from $275.6 million at January 2, 2010 to $243.6 million at October 2, 2010.

OPERATING ACTIVITIES. Net cash provided by operating activities was $66.2 million for the nine month period ended October 2, 2010, compared to $77.2 million for the nine-month period ended October 3, 2009.

 

During the nine months ended October 2, 2010, working capital levels changed due to normal business fluctuations, including the impact of increased seasonal working capital needs. These changes in working capital levels included a $19.3 million increase in accounts receivable, a $5.6 million increase in inventory and a $9.3 million decrease in accounts payable. Prepaid and other assets increased $2.0 million. Accrued expenses and other non-current liabilities increased by $6.9 million.

INVESTING ACTIVITIES. During the nine months ended October 2, 2010, net cash used in investing activities amounted to $28.8 million. Investing activities include the third quarter funding of $4.6 million for the acquisition of PerfectFry and $17.4 million for the acquisition of Cozzini.  Additionally, the company had deferred payments of $3.1 related to the Giga, CookTek, and Anets acquisitions completed in prior years.  During the third quarter of 2010, the company finalized the working capital provision relating to the Doyon acquisition, which resulted in an additional payment of $0.6 million to the sellers. The company also had capital expenditures of $3.0 million primarily associated with additions and upgrades of production equipment.

FINANCING ACTIVITIES. Net cash flows used in financing activities amounted to $39.8 million during the nine months ended October 2, 2010. The company’s borrowing activities included $30.1 million of repayments under its $497.8 million revolving credit faciltiy and $1.5 million of repayments of foreign borrowings. The net borrowings, along with cash generated from operating activities, were utilized to fund acquisition activities and capital expenditures. The company also used $8.8 million to repurchase 161,066 shares of its common stock under a stock repurchase program.

In January 2010, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820), “Improving Disclosures about Fair Value Measurements” (“ASU No. 2010-06”). ASU 2010-06 requires new disclosures about significant transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for such transfers and to disclose separately information about purchases, sales, issuances and settlements the reconciliation for Level 3 fair value measurements. The company adopted the provisions of ASU No. 2010-06 on January 3, 2010, except for disclosures about purchases, sales, issuances and settlements in the reconciliation for Level 3 fair value measurements. These disclosures will be effective for financial statements issued for fiscal years beginning after December 15, 2010. The company does not expect that the adoption of ASU No. 2010-06 will have a material impact on the company’s financial position, results of operations or cash flows.

 

Management's discussion and analysis of financial condition and results of operations are based upon the company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses as well as related disclosures. On an ongoing basis, the company evaluates its estimates and judgments based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

Revenue Recognition: The company recognizes revenue on the sale of its products when risk of loss has passed to the customer, which occurs at the time of shipment, and collectability is reasonably assured. The sale prices of the products sold are fixed and determinable at the time of shipment. Sales are reported net of sales returns, sales incentives and cash discounts based on prior experience and other quantitative and qualitative factors.

At the Food Processing Equipment Group, the company enters into long-term sales contracts for certain products. Revenue under these long-term sales contracts is recognized using the percentage of completion method prescribed by ASC 605-25-25 “Percentage of Completion Method or Recognizing Revenue under Construction Contracts” due to the length of time to fully manufacture and assemble the equipment. The company measures revenue recognized based on the ratio of actual labor hours incurred in relation to the total estimated labor hours to be incurred related to the contract. Because estimated labor hours to complete a project are based upon forecasts using the best available information, the actual hours may differ from original estimates. The percentage of completion method of accounting for these contracts most accurately reflects the status of these uncompleted contracts in the company's financial statements and most accurately measures the matching of revenues with expenses. At the time a loss on a contract becomes known, the amount of the estimated loss is recognized in the consolidated financial statements.

Property and equipment: Property and equipment are depreciated or amortized on a straight-line basis over their useful lives based on management's estimates of the period over which the assets will be utilized to benefit the operations of the company. The useful lives are estimated based on historical experience with similar assets, taking into account anticipated technological or other changes.  The company periodically reviews these lives relative to physical factors, economic factors and industry trends. If there are changes in the planned use of property and equipment or if technological changes were to occur more rapidly than anticipated, the useful lives assigned to these assets may need to be shortened, resulting in the recognition of increased depreciation and amortization expense in future periods.

 

Long-lived assets: Long-lived assets (including goodwill and other intangibles) are reviewed for impairment annually and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In assessing the recoverability of the company's long-lived assets, the company considers changes in economic conditions and makes assumptions regarding estimated future cash flows and other factors.  Estimates of future cash flows are judgments based on the company's experience and knowledge of operations.  These estimates can be significantly impacted by many factors including changes in global and local business and economic conditions, operating costs, inflation, competition, and consumer and demographic trends.  If the company's estimates or the underlying assumptions change in the future, the company may be required to record impairment charges.

Warranty: In the normal course of business the company issues product warranties for specific product lines and provides for the estimated future warranty cost in the period in which the sale is recorded.  The estimate of warranty cost is based on contract terms and historical warranty loss experience that is periodically adjusted for recent actual experience. Because warranty estimates are forecasts that are based on the best available information, actual claims costs may differ from amounts provided. Adjustments to initial obligations for warranties are made as changes in the obligations become reasonably estimable.

Litigation: From time to time, the company is subject to proceedings, lawsuits and other claims related to products, suppliers, employees, customers and competitors. The company maintains insurance to partially cover product liability, workers compensation, property and casualty, and general liability matters.  The company is required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses.  A determination of the amount of accrual required, if any, for these contingencies is made after assessment of each matter and the related insurance coverage.  The reserve requirements may change in the future due to new developments or changes in approach such as a change in settlement strategy in dealing with these matters.  The company does not believe that any pending litigation will have a material adverse effect on its financial condition or results of operations.

 

Income taxes: The company operates in numerous foreign and domestic taxing jurisdictions where it is subject to various types of tax, including sales tax and income tax.  The company's tax filings are subject to audits and adjustments. Because of the nature of the company’s operations, the nature of the audit items can be complex, and the objectives of the government auditors can result in a tax on the same transaction or income in more than one state or country.  The company initially recognizes the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. For tax positions that meet the more-likely-than-not recognition threshold, the company initially and subsequently measures its tax positions as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon effective settlement with the taxing authority. As part of the company's calculation of the provision for taxes, the company has recorded liabilities on various tax positions that are currently under audit by the taxing authorities. The liabilities may change in the future upon effective settlement of the tax positions.

The company's contractual cash payment obligations as of October 2, 2010 are set forth below (in thousands):

The company has obligations to make $7.3 million of purchase price payments to the sellers of Giga, CookTek and Cozzini that were deferred in conjunction with the acquisitions.

The company has contractual obligations under its various debt agreements to make interest payments. These amounts are subject to the level of borrowings in future periods and the interest rate for the applicable periods, and therefore the amounts of these payments is not determinable.

The company has $6.9 million in outstanding letters of credit, which expire on October 1, 2011, to secure potential obligations under various business programs.

Idle facility leases consist of obligations for manufacturing locations that were exited in conjunction with the company's manufacturing consolidation efforts. These lease obligations continue through June 2015. The obligations presented above do not reflect any anticipated sublease income from the facilities.

The projected benefit obligation of the company’s defined benefit plans exceeded the plans’ assets by $10.4 million at the end of 2009.  The unfunded benefit obligations were comprised of a $3.3 million underfunding of the company’s Smithville plan, which was acquired as part of the Star acquisition, $0.9 million underfunding of the company's Elgin union plan and $6.2 million of underfunding of the company's director plans.  The company does not expect to contribute to the director plans in 2010.  The company expects to continue to make minimum contributions to the Smithville and Elgin plan as required by the Employee Retirement Income Security Act of 1974, which are expected to be $0.3 million and $0.1 million, respectively in 2010.

The company places purchase orders with its suppliers in the ordinary course of business. These purchase orders are generally to fulfill short-term manufacturing requirements of less than 90 days and most are cancelable with a restocking penalty. The company has no long-term purchase contracts or minimum purchase obligations with any supplier.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

The company is exposed to market risk related to changes in interest rates. The following table summarizes the maturity of the company’s debt obligations.

Terms of the company’s senior credit agreement provide for $497.8 million of availability under a revolving credit line. As of October 2, 2010, the company had $235.9 million of borrowings outstanding under this facility. The company also has $6.9 million in outstanding letters of credit as of October 2, 2010, which reduces the borrowing availability under the revolving credit line. Remaining borrowing availability under this facility, which is also reduced by the company’s foreign borrowings, was $247.2 million at October 2, 2010.

 

At October 2, 2010, borrowings under the senior secured credit facility are assessed at an interest rate 1.25% above LIBOR for long-term borrowings or at the higher of the Prime rate and the Federal Funds Rate. At October 2, 2010 the average interest rate on the senior debt amounted to 1.55%. The interest rates on borrowings under the senior secured credit facility may be adjusted quarterly based on the company’s indebtedness ratio on a rolling four-quarter basis. Additionally, a commitment fee, based upon the indebtedness ratio is charged on the unused portion of the revolving credit line. This variable commitment fee amounted to 0.25% as of October 2, 2010.

In April 2008, the company completed its acquisition of Giga Grandi Cucine S.r.l in Italy. This acquisition was funded in part with locally established debt facilities with borrowings denominated in Euro.  On October 2, 2010 these facilities amounted to $4.1 million in U.S. dollars.  The interest rate on the credit facilities is tied to nine-month Euro LIBOR. At October 2, 2010, the average interest rate on these facilities was approximately 3.5%. The facilities mature in April of 2015.

In December 2009, the company completed its acquisition of Doyon in Canada. This acquisition was funded in part with locally established debt facilities with borrowings denominated in Canadian dollars. On October 2, 2010, these facilities amounted to $0.9 million U.S. dollars. The borrowings under these facilities are collateralized by the assets of the company. The interest rate on these credit facilities is assessed at 0.75% above the prime rate. At October 2, 2010, the average interest rate on these facilities amounted to 3.0%.These facilities mature in 2017.

The company believes that its current capital resources, including cash and cash equivalents, cash generated from operations, funds available from its revolving credit facility and access to the credit and capital markets will be sufficient to finance its operations, debt service obligations, capital expenditures, product development and integration expenditures for the foreseeable future.

The company has historically entered into interest rate swap agreements to effectively fix the interest rate on its outstanding debt. The agreements swap one-month LIBOR for fixed rates. As of October 2, 2010 the company had the following interest rate swaps in effect: