Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 29, 2018
OR
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¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 001-36040
Fox Factory Holding Corp.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware | 26-1647258 |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
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915 Disc Drive Scotts Valley, CA | 95066 |
(Address of Principal Executive Offices) | (Zip Code) |
(831) 274-6500
(Registrant’s Telephone Number, Including Area Code)
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. Yes ý 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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Large accelerated filer | ý | Accelerated filer | ¨
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Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Emerging growth company | ¨
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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 ý
As of July 29, 2018, there were 37,822,327 shares of the registrant’s common stock outstanding.
Fox Factory Holding Corp.
FORM 10-Q
Table of Contents
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| Unaudited Condensed Consolidated Balance Sheets as of June 29, 2018 and December 29, 2017 | |
| Unaudited Condensed Consolidated Statements of Income for the Three and Six Months Ended June 29, 2018 and June 30, 2017 | |
| Unaudited Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 29, 2018 and June 30, 2017 | |
| Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 29, 2018 and June 30, 2017 | |
| Notes to Unaudited Condensed Consolidated Financial Statements | |
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOX FACTORY HOLDING CORP.
Condensed Consolidated Balance Sheets
(in thousands, except per share data)
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| | | | | | | |
| As of | | As of |
| June 29, | | December 29, |
| 2018 |
| 2017 |
| | | |
| (Unaudited) | | |
Assets | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 22,686 |
| | $ | 35,947 |
|
Accounts receivable (net of allowances of $542 and $676 at June 29, 2018 and December 29, 2017, respectively) | 77,878 |
| | 61,060 |
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Inventory | 95,374 |
| | 84,841 |
|
Prepaids and other current assets | 16,530 |
| | 21,100 |
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Total current assets | 212,468 |
| | 202,948 |
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Property, plant and equipment, net | 48,393 |
| | 43,636 |
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Deferred tax assets | 8,638 |
| | 2,669 |
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Goodwill | 88,406 |
| | 88,438 |
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Intangibles, net | 86,974 |
| | 90,044 |
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Other assets | 445 |
| | 551 |
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Total assets | $ | 445,324 |
| | $ | 428,286 |
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Liabilities and stockholders’ equity | | | |
Current liabilities: | | | |
Accounts payable | $ | 58,315 |
| | $ | 40,813 |
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Accrued expenses | 32,363 |
| | 32,608 |
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Reserve for uncertain tax positions | 1,491 |
| | 7,787 |
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Current portion of long-term debt | 5,512 |
| | 5,038 |
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Total current liabilities | 97,681 |
| | 86,246 |
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Line of credit | 5,110 |
| | 35,585 |
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Long-term debt, less current portion | 55,263 |
| | 58,020 |
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Deferred rent | 552 |
| | 645 |
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Total liabilities | 158,606 |
| | 180,496 |
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Redeemable non-controlling interest | 14,188 |
| | 12,955 |
|
Stockholders’ equity | | | |
Preferred stock, $0.001 par value — 10,000 authorized and no shares issued or outstanding as of June 29, 2018 and December 29, 2017 | — |
| | — |
|
Common stock, $0.001 par value — 90,000 authorized; 38,649 shares issued and 37,759 outstanding as of June 29, 2018; 38,497 shares issued and 37,607 outstanding as of December 29, 2017 | 38 |
| | 38 |
|
Additional paid-in capital | 112,028 |
| | 112,793 |
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Treasury stock, at cost; 890 common shares as of June 29, 2018 and December 29, 2017 | (13,754 | ) | | (13,754 | ) |
Accumulated other comprehensive loss | (1,021 | ) | | (168 | ) |
Retained earnings | 175,239 |
| | 135,926 |
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Total stockholders’ equity | 272,530 |
| | 234,835 |
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Total liabilities, redeemable non-controlling interest and stockholders’ equity | $ | 445,324 |
| | $ | 428,286 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
FOX FACTORY HOLDING CORP.
Condensed Consolidated Statements of Income
(in thousands, except per share data)
(Unaudited)
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| | | | | | | | | | | | | | | |
| For the three months ended |
| For the six months ended |
| June 29, |
| June 30, | | June 29, |
| June 30, |
| 2018 |
| 2017 | | 2018 |
| 2017 |
Sales | $ | 156,825 |
| | $ | 120,811 |
| | $ | 286,617 |
| | $ | 227,141 |
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Cost of sales | 104,412 |
| | 81,755 |
| | 192,561 |
| | 154,370 |
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Gross profit | 52,413 |
| | 39,056 |
| | 94,056 |
| | 72,771 |
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Operating expenses: | | | | | | | |
Sales and marketing | 9,802 |
| | 7,067 |
| | 18,535 |
| | 13,660 |
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Research and development | 6,058 |
| | 4,982 |
| | 12,254 |
| | 9,464 |
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General and administrative | 10,779 |
| | 8,122 |
| | 19,973 |
| | 16,202 |
|
Amortization of purchased intangibles | 1,499 |
| | 696 |
| | 3,068 |
| | 1,391 |
|
Fair value adjustment of contingent consideration and acquisition-related compensation | — |
| | — |
| | — |
| | 1,447 |
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Total operating expenses | 28,138 |
| | 20,867 |
| | 53,830 |
| | 42,164 |
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Income from operations | 24,275 |
| | 18,189 |
| | 40,226 |
| | 30,607 |
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Other expense, net: | | | | | | | |
Interest expense | 832 |
| | 505 |
| | 1,631 |
| | 1,094 |
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Other (income) expense | (81 | ) | | (78 | ) | | 200 |
| | 467 |
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Other expense, net | 751 |
| | 427 |
| | 1,831 |
| | 1,561 |
|
Income before income taxes | 23,524 |
| | 17,762 |
| | 38,395 |
| | 29,046 |
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Provision for (benefit of) income taxes | 4,711 |
| | 4,036 |
| | (1,868 | ) | | 4,792 |
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Net income | 18,813 |
| | 13,726 |
| | 40,263 |
| | 24,254 |
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Less: net income attributable to non-controlling interest | (444 | ) | | — |
| | (670 | ) | | — |
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Net income attributable to FOX stockholders | $ | 18,369 |
| | $ | 13,726 |
| | $ | 39,593 |
| | $ | 24,254 |
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Earnings per share: | | | | | | | |
Basic | $ | 0.49 |
| | $ | 0.37 |
| | $ | 1.05 |
| | $ | 0.65 |
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Diluted | $ | 0.47 |
| | $ | 0.35 |
| | $ | 1.02 |
| | $ | 0.63 |
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Weighted average shares used to compute earnings per share: | | | | | | | |
Basic | 37,722 |
| | 37,330 |
| | 37,674 |
| | 37,232 |
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Diluted | 38,856 |
| | 38,725 |
| | 38,846 |
| | 38,643 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
FOX FACTORY HOLDING CORP.
Condensed Consolidated Statements of Comprehensive Income
(in thousands)
(Unaudited)
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| For the three months ended | | For the six months ended |
| June 29, | | June 30, | | June 29, | | June 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Net income | $ | 18,813 |
| | $ | 13,726 |
| | $ | 40,263 |
| | $ | 24,254 |
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Other comprehensive (loss) income | | | | | | | |
Foreign currency translation adjustments, net of tax effects | (1,324 | ) | | (36 | ) | | (853 | ) | | 1,217 |
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Other comprehensive (loss) income | (1,324 | ) | | (36 | ) | | (853 | ) | | 1,217 |
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Comprehensive income | 17,489 |
| | 13,690 |
| | 39,410 |
| | 25,471 |
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Less: comprehensive income attributable to non-controlling interest | 444 |
| | — |
| | 670 |
| | — |
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Comprehensive income attributable to FOX stockholders | $ | 17,045 |
| | $ | 13,690 |
| | $ | 38,740 |
| | $ | 25,471 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
FOX FACTORY HOLDING CORP.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited) |
| | | | | | | |
| For the six months ended |
| June 29, 2018 | | June 30, 2017 |
OPERATING ACTIVITIES: | | | |
Net income | $ | 40,263 |
| | $ | 24,254 |
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Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 7,144 |
| | 4,705 |
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Stock-based compensation | 3,831 |
| | 4,289 |
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Deferred taxes and uncertain tax positions | (12,269 | ) | | (6,838 | ) |
Change in fair value of contingent consideration | — |
| | (150 | ) |
Changes in operating assets and liabilities: | | | |
Accounts receivable | (17,762 | ) | | (295 | ) |
Inventory | (10,945 | ) | | (17,422 | ) |
Income taxes payable | (1,037 | ) | | 6,079 |
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Prepaids and other assets | 4,217 |
| | (651 | ) |
Accounts payable | 18,373 |
| | 13,960 |
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Accrued expenses | 1,040 |
| | (6,918 | ) |
Net cash provided by operating activities | 32,855 |
| | 21,013 |
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INVESTING ACTIVITIES: | | | |
Purchases of property and equipment | (9,046 | ) | | (5,347 | ) |
Net cash used in investing activities | (9,046 | ) | | (5,347 | ) |
FINANCING ACTIVITIES: | | | |
Payments on line of credit | (30,476 | ) | | — |
|
Payment of contingent consideration liability | — |
| | (5,382 | ) |
Repayment of debt | (2,344 | ) | | (1,875 | ) |
Repurchases from stock compensation program, net | (4,033 | ) | | (402 | ) |
Net cash used in financing activities | (36,853 | ) | | (7,659 | ) |
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS | (217 | ) | | 58 |
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CHANGE IN CASH AND CASH EQUIVALENTS | (13,261 | ) | | 8,065 |
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CASH AND CASH EQUIVALENTS—Beginning of period | 35,947 |
| | 35,280 |
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CASH AND CASH EQUIVALENTS—End of period | $ | 22,686 |
| | $ | 43,345 |
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SUPPLEMENTAL CASH FLOW INFORMATION: | | | |
Cash paid during the period for: | | | |
Income taxes | $ | 11,681 |
| | $ | 5,484 |
|
Interest | $ | 1,627 |
| | $ | 973 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements
(in thousands, except per share amounts)
(unaudited)
1. Description of the Business, Basis of Presentation and Summary of Significant Accounting Policies
Fox Factory Holding Corp. (the "Company") designs and manufactures performance-defining ride dynamics products primarily for bicycles ("bikes"), side-by-side vehicles ("Side-by-Sides"), on-road vehicles with off-road capabilities, off-road vehicles and trucks, all-terrain vehicles, or ATVs, snowmobiles, specialty vehicles and applications, and motorcycles. The Company is a direct supplier to leading power vehicle original equipment manufacturers ("OEMs"). Additionally, the Company supplies top bicycle OEMs and their contract manufacturers, and provides aftermarket products to retailers and distributors.
Throughout this Form 10-Q, unless stated otherwise or as the context otherwise requires, the "Company," "FOX," "Fox Factory," "we," "us," "our," and "ours" refer to Fox Factory Holding Corp. and its operating subsidiaries on a consolidated basis.
Basis of Presentation - The accompanying condensed consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted (“GAAP”) in the United States of America ("U.S.") and applicable rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the fiscal year ended December 29, 2017 included in the Company’s Annual Report on Form 10-K as filed with the SEC. In management’s opinion, the unaudited interim condensed consolidated financial statements reflect all adjustments, which are of a normal and recurring nature, that are necessary for a fair presentation of financial results for the interim periods presented. Operating results for any quarter are not necessarily indicative of the results for the full fiscal year.
The Company operates on a 52-53 week fiscal calendar. For 2018 and 2017, the Company's fiscal year will end or has ended on December 28, 2018 and December 29, 2017, respectively. The three and six month periods ended June 29, 2018 and June 30, 2017 each included 13 weeks and 26 weeks.
Principles of Consolidation - These condensed consolidated financial statements include the Company and its subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Summary of Significant Accounting Policies - Beginning the first quarter of fiscal year 2018, the Company adopted Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), as updated by ASU 2016-20. There have been no other changes to our significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended December 29, 2017, as filed with the SEC on February 27, 2018, that have had a material impact on our condensed consolidated financial statements and related notes.
Revenue Recognition - Revenues are generated from the sale of ride dynamics products to customers worldwide. The Company’s ride dynamics products are solutions that improve performance of power vehicles and bikes. Power vehicles include Side-by-Sides, on-road vehicles with off-road capabilities, off-road vehicles and trucks, ATVs, snowmobiles, specialty vehicles and applications, and motorcycles.
Revenue is measured based on the consideration specified in a contract with a customer. The Company recognizes revenue when it satisfies a performance obligation by transferring control over a product to a customer, generally at the time of shipment. Contracts are generally in the form of purchase orders and are governed by standard terms and conditions. For larger OEMs, the Company may also enter into master agreements.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
Provisions for discounts, rebates, sales incentives, returns, and other adjustments are generally provided for in the period the related sales are recorded, based on management’s assessment of historical trends and projection of future results. Certain pricing provisions that provide the customer with future discounts are considered a material right. Such material rights result in the deferral of revenue that are recognized when the rights are exercised by the customer. Measuring the material rights requires judgments including forecasts of future sales and product mix. At June 29, 2018, the balance of deferred revenue related to pricing provisions was $241. These amounts are expected to be recognized over the next 12 months.
Segments - The Company has determined that it has a single operating and reportable segment. The Company considers operating segments to be components of the Company for which separate financial information is available that is evaluated regularly by the Company’s chief operating decision maker in deciding how to allocate resources and in assessing performance. The chief operating decision maker for the Company is the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance.
Use of Estimates - The preparation of the Company’s condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. These estimates are based on information available as of the date of the financial statements; therefore, actual results could differ from management’s estimates.
Certain Significant Risks and Uncertainties - The Company is subject to those risks common in manufacturing-driven markets, including, but not limited to, competitive forces, dependence on key personnel, customer demand for its products, the successful protection of its proprietary technologies, compliance with and the impact of government regulations including tariffs, and the possibility of not being able to obtain additional financing when needed.
Fair Value Measurements - The Company uses the fair value hierarchy established in ASC Topic 820, Fair Value Measurements and Disclosures, which requires the valuation of assets and liabilities subject to fair value measurements using a three tiered approach and fair value measurement be classified and disclosed by the Company in one of the following three categories:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2: Quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets and liabilities in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).
The carrying amount of the Company's financial instruments, including cash, receivables, accounts payable, and accrued liabilities approximate their fair values due to their short-term nature.
Recent Accounting Pronouncements - In May 2014, the FASB and International Accounting Standards Board issued their converged standard on revenue recognition, ASU 2014-09, updated December 2016 with the release of ASU 2016-20. This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods and services in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods and services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
The Company adopted this guidance as of the beginning of the first quarter of fiscal year 2018, using the modified retrospective implementation method. The Company applied the guidance to all open contracts at the date of initial application. The primary impact of adopting the standard resulted from certain pricing provisions within contracts that provide the customer with a material right. Under the new standard, revenue attributed to such pricing provisions is deferred and recognized when the right is exercised by the customer. The Company recorded a cumulative effect adjustment of $368 gross and $279 net of taxes, to the opening balance of retained earnings to reflect the cumulative effect of the adoption of the standard.
In February 2016, the FASB issued ASU 2016-02, Leases, which will supersede the existing guidance for lease accounting. This ASU will require lessees to recognize leases with durations greater than 12 months on the balance sheet. This guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2018 and early adoption is permitted. The Company is currently assessing the impact this guidance will have on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments, which clarifies the presentation of certain transactions, including but not limited to contingent consideration payments made after a business combination and debt prepayment and extinguishment costs in the cash flow statement. This standard will be effective for fiscal years, and interim periods within those years, beginning the first quarter of fiscal year 2019. Early adoption is permitted. The Company is currently assessing the impact this guidance will have on its consolidated statement of cash flows.
In October 2016, the FASB issued ASU 2016-16, Income Taxes: Intra-Entity Transfer of Assets Other Than Inventory, which improves the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The Company adopted ASU 2016-16 effective in the first quarter of fiscal year 2018. The adoption of ASU 2016-16 did not have a material impact on the Company's consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, Business Combinations: Clarifying the Definition of a Business, which provides more guidance to an entity when they are assessing if transactions should be accounted for as acquisitions of assets or businesses. The clarification of the definition of a business impacts various areas of accounting such as acquisitions, disposals, goodwill, and consolidations. The Company adopted ASU 2017-01 effective in the first quarter of fiscal year 2018. The adoption of ASU 2017-01 did not have a material impact on the Company's consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07, Improvements to Non-employee Share-Based Payment Accounting, which removes some of the unique requirements related to accounting for share-based payment awards issued to non-employees for non-financing transactions. The Company adopted ASU 2018-07 in the second quarter of fiscal year 2018. The adoption of ASU 2018-07 did not have a material impact on the Company's consolidated financial statements.
2. Revenues
The following table summarizes total sales by product category:
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| | | | | | | | | | | | | | | |
| For the three months ended | | For the six months ended |
| June 29, 2018 |
| June 30, 2017 | | June 29, 2018 |
| June 30, 2017 |
Power vehicle products | $ | 82,247 |
| | $ | 56,039 |
| | $ | 154,381 |
| | $ | 110,094 |
|
Bike products | 74,578 |
| | 64,772 |
| | 132,236 |
| | 117,047 |
|
Total sales | $ | 156,825 |
| | $ | 120,811 |
| | $ | 286,617 |
| | $ | 227,141 |
|
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
The following table summarizes total sales by sales channel:
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| | | | | | | | | | | | | | | |
| For the three months ended | | For the six months ended |
| June 29, 2018 | | June 30, 2017 | | June 29, 2018 |
| June 30, 2017 |
OEM | $ | 86,994 |
| | $ | 73,089 |
| | $ | 160,052 |
| | $ | 133,737 |
|
Aftermarket | 69,831 |
| | 47,722 |
| | 126,565 |
| | 93,404 |
|
Total sales | $ | 156,825 |
| | $ | 120,811 |
| | $ | 286,617 |
| | $ | 227,141 |
|
The following table summarizes total sales generated by geographic location of the customer:
|
| | | | | | | | | | | | | | | |
| For the three months ended | | For the six months ended |
| June 29, 2018 | | June 30, 2017 | | June 29, 2018 | | June 30, 2017 |
North America | $ | 98,565 |
| | $ | 73,182 |
| | $ | 181,734 |
| | $ | 136,987 |
|
Asia | 30,968 |
| | 29,744 |
| | 52,171 |
| | 50,096 |
|
Europe | 25,493 |
| | 16,289 |
| | 49,408 |
| | 36,742 |
|
Rest of the world | 1,799 |
| | 1,596 |
| | 3,304 |
| | 3,316 |
|
Total sales | $ | 156,825 |
| | $ | 120,811 |
| | $ | 286,617 |
| | $ | 227,141 |
|
3. Inventory
Inventory consisted of the following:
|
| | | | | | | |
| June 29, |
| December 29, |
| 2018 | | 2017 |
Raw materials | $ | 62,441 |
| | $ | 51,371 |
|
Work-in-process | 8,170 |
| | 1,233 |
|
Finished goods | 24,763 |
| | 32,237 |
|
Total inventory | $ | 95,374 |
| | $ | 84,841 |
|
4. Property, Plant and Equipment, net
Property, plant and equipment, net consisted of the following: |
| | | | | | | |
| June 29, |
| December 29, |
| 2018 | | 2017 |
Machinery and manufacturing equipment | $ | 34,233 |
| | $ | 33,664 |
|
Leasehold improvements | 11,432 |
| | 9,919 |
|
Internal-use computer software | 11,153 |
| | 7,819 |
|
Building and land | 8,811 |
| | 8,811 |
|
Information systems, office equipment and furniture | 7,197 |
| | 7,715 |
|
Transportation equipment | 3,747 |
| | 3,325 |
|
Total | 76,573 |
| | 71,253 |
|
Less: accumulated depreciation and amortization | (28,180 | ) | | (27,617 | ) |
Property, plant and equipment, net | $ | 48,393 |
| | $ | 43,636 |
|
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
The Company’s long-lived assets by geographic location are as follows:
|
| | | | | | | |
| June 29, | | December 29, |
| 2018 | | 2017 |
United States | $ | 42,887 |
| | $ | 38,450 |
|
International | 5,506 |
| | 5,186 |
|
Total long-lived assets | $ | 48,393 |
| | $ | 43,636 |
|
5. Accrued Expenses
Accrued expenses consisted of the following:
|
| | | | | | | |
| June 29, |
| December 29, |
| 2018 |
| 2017 |
Payroll and related expenses | $ | 12,420 |
| | $ | 13,211 |
|
Warranty | 6,142 |
| | 6,481 |
|
Income tax payable | 5,203 |
| | 6,562 |
|
Other accrued expenses | 8,598 |
| | 6,354 |
|
Total | $ | 32,363 |
| | $ | 32,608 |
|
Activity related to warranties is as follows:
|
| | | | | | | | | | | | | | | |
| For the three months ended | | For the six months ended |
| June 29, 2018 | | June 30, 2017 | | June 29, 2018 | | June 30, 2017 |
Beginning warranty liability | $ | 6,596 |
| | $ | 5,003 |
| | $ | 6,481 |
| | $ | 4,593 |
|
Charge to cost of sales | 503 |
| | 1,391 |
| | 1,797 |
| | 3,053 |
|
Costs incurred | (957 | ) | | (1,317 | ) | | (2,136 | ) | | (2,569 | ) |
Ending warranty liability | $ | 6,142 |
| | $ | 5,077 |
| | $ | 6,142 |
| | $ | 5,077 |
|
6. Debt
Second Amended and Restated Credit Facility
In August 2013, the Company entered into a credit facility with Sun Trust Bank and other named lenders which has been periodically amended and restated; the last restatement occurred on May 11, 2016 and was further amended on August 11, 2016, June 12, 2017 and November 30, 2017 (as most recently amended and restated and as further amended, the “Second Amended and Restated Credit Facility”). The Second Amended and Restated Credit Facility, which matures on May 11, 2021, provides a revolving line of credit and a maturing secured term loan with a refinanced principal balance of $75,000. The term loan is subject to quarterly amortization payments.
The Second Amended and Restated Credit Facility provides for interest at either a rate based on the London Interbank Offered Rate, or LIBOR, plus a margin ranging from 1.50% to 2.50%, or based on the prime rate offered by SunTrust Bank plus a margin ranging from 0.50% to 1.50%. At June 29, 2018, the one-month LIBOR and prime rates were 2.09% and 5.00%, respectively. At June 29, 2018, our weighted average interest rate on outstanding borrowing was 3.96%. The Second Amended and Restated Credit Facility is secured by substantially all of the Company’s assets, restricts the Company's ability to make certain payments and engage in certain transactions, and also requires that the Company satisfy customary financial ratios. The Company was in compliance with the covenants as of June 29, 2018.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
Additionally, the existing credit facility permits up to $15,000 of the aggregate revolving commitment to be used by the Company for issuance of letters of credit. As of June 29, 2018, the Company utilized $5,000 in the form of a standby letter of credit in support of subsidiary operations. The letter of credit expires in November 2018.
The following table summarizes the line of credit under the Second Amended and Restated Credit Facility:
|
| | | | | | | |
| June 29, | | December 29, |
| 2018 | | 2017 |
Amount outstanding | $ | 5,000 |
| | $ | 35,000 |
|
Standby letter of credit | $ | 5,000 |
| | $ | 5,000 |
|
Available borrowing capacity | $ | 90,000 |
| | $ | 60,000 |
|
Maximum borrowing capacity | $ | 100,000 |
| | $ | 100,000 |
|
Maturity date | May 11, 2021 |
As of June 29, 2018, future principal payments for long-term debt, including the current portion, are summarized as follows:
|
| | | |
For fiscal year: | |
2018 (remaining six months) | $ | 2,813 |
|
2019 | 5,625 |
|
2020 | 7,031 |
|
2021 | 45,625 |
|
Total term debt | 61,094 |
|
Debt issuance cost | (319 | ) |
Long-term debt, net of issuance cost | 60,775 |
|
Less: current portion | (5,512 | ) |
Long-term debt less current portion | $ | 55,263 |
|
Other Indebtedness
The Company had $110 and $585 outstanding under a vendor associated line of credit as of June 29, 2018 and December 29, 2017, respectively.
7. Commitments and Contingencies
Operating Leases - The Company has operating lease agreements for administrative, research and development, manufacturing and sales and marketing facilities and equipment that expire at various dates. The Company recognizes rent expense on a straight-line basis over the lease term and records the difference between cash rent payments and the recognition of rent expense as a deferred rent liability. See Note 12 - Related Party Agreements for additional information on related party operating leases. Indemnification Agreements - In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, services to be provided by the Company or intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with directors and certain officers and employees that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. While the outcome of these matters cannot be predicted with certainty, the Company does not believe that the outcome of any claims under indemnification arrangements will have a material effect on the Company’s results of operations, financial position or liquidity.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
Legal Proceedings - A lawsuit was filed on December 17, 2015 by SRAM Corporation (“SRAM”) in the U.S. District Court, Northern District of Illinois, against the Company’s wholly-owned subsidiary, RFE Canada Holding Corp. (“RFE Canada”). The lawsuit alleges patent infringement of U.S. Patent number 9,182,027 ("'027 Patent") and violation of the Lanham Act. SRAM filed a second lawsuit in the same court against RFE Canada on May 16, 2016. That lawsuit alleges patent infringement of U.S Patent number 9,291,250 ("'250 Patent"). The Company believes the lawsuits are without merit and intends to vigorously defend itself. As such, the Company has filed, before the U. S. Patent and Trademark Appeals Board ("PTAB"), for Interparties Reviews ("IPR") of the '027 Patent and separately the same for the '250 Patent. In April 2018, the PTAB issued opinions in the ‘027 Patent petition cases stating that the Company has not shown the claims of the ‘027 Patent to be obvious. Regarding the PTAB ‘027 opinions, the Company has filed a Notice of Appeal to the Court of Appeals for the Federal Circuit The IPR for the ‘250 patent is pending in the PTAB and the PTAB has stayed the ex-parte re-exam of the ‘250 patent.
In a separate action the Company filed a lawsuit on January 29, 2016 in the U.S. District Court, Northern District of California against SRAM. That lawsuit alleges SRAM’s infringement of two separate Company owned patents, specifically U.S. Patent numbers 6,135,434 and 6,557,674. A second lawsuit was filed by the Company on July 1, 2016 in the U.S. District Court, Northern District of California against SRAM alleging infringement of the Company’s U.S. Patent numbers 8,226,172 and 8,974,009. These lawsuits have been moved to U.S. District Court, District of Colorado and are otherwise proceeding. The stay of the SRAM lawsuits against the Company have been lifted by the U.S. District Court, Northern District of Illinois. The Company filed and SRAM filed lawsuits are now moving forward as scheduled by the courts.
Due to the inherent uncertainties of litigation, the Company is not able to predict either the outcome or a range of reasonably possible losses, if any, at this time. Accordingly, no amounts have been recorded in the consolidated financial statements for the settlement of these matters. Were an unfavorable ruling to occur, or if factors indicate that a loss is probable and reasonably estimable, the Company's business, financial condition or results of operations could be materially and adversely affected.
The Company is involved in other legal matters that arise in the ordinary course of business. Based on information currently available, management does not believe that the ultimate resolution of these matters will have a material adverse effect on the Company's financial condition, results of operations or cash flows.
Other Commitments - On November 30, 2017, the Company through FF US Holding Corp. acquired an 80% interest in the business of Flagship, Inc. ("Tuscany"). The stockholders' agreement provides the Company with a call option (the "Call Option") to acquire the remaining 20% of Tuscany any time from November 30, 2019 through November 30, 2024 at a value which approximates fair market value. In addition, if the Call Option has not been exercised as of November 30, 2024, the non-controlling owners shall be entitled to exercise a put option on November 30, 2024 and for a 180 day period thereafter, which would require the Company to purchase all of the remaining shares held by the non-controlling owners at a price that approximates fair market value.
Other Contingencies - On June 21, 2018, the U.S. Supreme Court (the “Court”) decided South Dakota v. Wayfair, Inc., et al., holding that internet retailers do not have to maintain a physical presence in a state in order to be required to collect the state’s sales and use tax. Ultimately, the Court remanded the case to the South Dakota Supreme Court on the question of “whether some other principle in the Court’s Commerce Clause doctrine might invalidate the Act,” which may delay federal legislation on the issue. However, as a result of the Court’s decision, additional states may now begin requiring all remote sellers, primarily those engaged in e-commerce, to register, collect and remit sales and use taxes on transactions with in-state customers. Numerous states have either enacted legislation or informally indicated that they will not assert liability for uncollected taxes on a retroactive basis. Nevertheless, the Company believes that it is possible that it will incur a liability for uncollected sales tax on some portion of its e-commerce sales through June 29, 2018. Any retroactively imposed liability is not expected to be material to the Company’s results of operations or financial position because direct end-user sales in states where the Company is not registered comprise a small portion of total revenues.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
8. Fair Value Measurements
The following table presents the Company's hierarchy for its assets and liabilities measured at fair value on a recurring basis as of the following periods:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| June 29, 2018 | | December 29, 2017 |
| Level 1 | | Level 2 | | Level 3 | | Total | | Level 1 | | Level 2 | | Level 3 | | Total |
Liabilities: | | | | | | | | | | | | | | | |
Credit facility | $ | — |
| | $ | 60,775 |
| | $ | — |
| | $ | 60,775 |
| | $ | — |
| | $ | 63,058 |
| | $ | — |
| | $ | 63,058 |
|
Non-controlling interest subject to put provisions | — |
| | — |
| | 14,188 |
| | 14,188 |
| | — |
| | — |
| | 12,955 |
| | 12,955 |
|
Total liabilities measured at fair value | $ | — |
| | $ | 60,775 |
| | $ | 14,188 |
| | $ | 74,963 |
| | $ | — |
| | $ | 63,058 |
| | $ | 12,955 |
| | $ | 76,013 |
|
There were no transfers of assets or liabilities between Level 1, Level 2, and Level 3 categories of the fair value hierarchy during the three and six month period ended June 29, 2018.
The Company used Level 2 inputs to determine the fair value of its Second Amended and Restated Credit Facility. As of June 29, 2018 and December 29, 2017, the carrying amount of the principal under the Company’s Second Amended and Restated Credit Facility approximates fair value because it has a variable interest rate that reflects market changes in interest rates and changes in the Company’s net leverage ratio.
The Company has potential obligations to purchase non-controlling interests held by third parties in the Tuscany subsidiary. These obligations are in the form of put provisions and are exercisable at the third-party owners' discretion within the specified periods outlined in the put provision within the Tuscany stockholders' agreement. If these put provisions were exercised, the Company would be required to purchase the third-party owners' non-controlling interests at the appraised fair value. The Company measured the fair value of the non-controlling interests using Level 3 unobservable inputs, including the expected growth rate, income tax rate, and discount factor applied to forecasted results. The estimated fair values of the non-controlling interests can fluctuate and the amount at which these obligations may ultimately be settled could vary significantly from our future estimates depending upon market conditions. Changes in fair value measurement of the non-controlling interests are recognized as adjustments to additional paid-in capital on the consolidated balance sheet.
The following table provides a reconciliation of the beginning and ending balances for the Company's liability measured at fair value using Level 3 inputs:
|
| | | |
| Redeemable Non-Controlling Interest (level 3 measurement) |
Balance at December 29, 2017 | $ | 12,955 |
|
Net income attributable to non-controlling interest | 670 |
|
Change in fair value | 563 |
|
Balance at June 29, 2018 | $ | 14,188 |
|
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
9. Stockholders' Equity
Share Repurchase Program and Secondary Stock Offerings
In February 2016, the Company's Board of Directors authorized the Company's 2016 share repurchase program (the "2016 Repurchase Program"), permitting repurchases of up to an aggregate of $40,000 in shares of common stock. The plan expired on December 31, 2017. The Company repurchased 890 shares for a total of $13,754 under both the 2016 Repurchase Program and the prior repurchase program of the Company, which expired on December 31, 2015. Shares of common stock repurchased under such programs are accounted for as treasury stock under the cost method.
In March 2017, the Company closed a secondary offering, whereby the selling stockholders sold an additional 5,574 shares of the Company's common stock at a price of $26.65 per share, less underwriting discounts and commissions. The total shares sold included 466 shares, which were also sold by certain selling stockholders, in connection with the underwriters' option to purchase additional shares. The Company did not sell shares or receive any proceeds from the sales of shares by the selling stockholders. As a result of the March 2017 secondary offering, Compass Group Diversified Holdings LLC ("Compass") no longer holds any equity interest in the Company.
The Company incurred approximately $113 and $249 of expenses in connection with the secondary offering during the three and six months ended June 30, 2017.
Equity Incentive Plans
The following table summarizes the allocation of stock-based compensation in the accompanying consolidated statements of income:
|
| | | | | | | | | | | | | | | |
| For the three months ended | | For the six months ended |
| June 29, 2018 |
| June 30, 2017 | | June 29, 2018 | | June 30, 2017 |
Cost of sales | $ | 131 |
| | $ | 146 |
| | $ | 233 |
| | $ | 180 |
|
Sales and marketing | 139 |
| | 121 |
| | 299 |
| | 268 |
|
Research and development | 154 |
| | 66 |
| | 296 |
| | 178 |
|
General and administrative | 1,361 |
| | 2,047 |
| | 3,003 |
| | 3,663 |
|
Total | $ | 1,785 |
| | $ | 2,380 |
| | $ | 3,831 |
| | $ | 4,289 |
|
The following table summarizes the activity for the Company's unvested restricted stock units ("RSU") for the six months ended June 29, 2018.
|
| | | | | | |
| Unvested RSUs |
| Number of shares outstanding | | Weighted-average grant date fair value |
Unvested at December 29, 2017 | 800 |
| | $ | 23.91 |
|
Granted | 189 |
| | $ | 33.33 |
|
Canceled | (8 | ) | | $ | 17.17 |
|
Vested | (289 | ) | | $ | 20.05 |
|
Unvested at June 29, 2018 | 692 |
| | $ | 28.17 |
|
As of June 29, 2018, the Company had approximately $15,562 of unrecognized stock-based compensation expense related to RSUs, which will be recognized over the remaining weighted-average vesting period of approximately 2.83 years.
During the six months ended June 29, 2018, 11 shares of common stock were issued due to the exercise of stock options, resulting in proceeds of $62. No options to purchase common stock were expired or forfeited during the six months ended June 29, 2018. As of June 29, 2018, stock-based compensation expense related to stock options has been fully recognized.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
10. Income Taxes
|
| | | | | | | | | | | | | | | |
| For the three months ended | | For the six months ended |
| June 29, 2018 | | June 30, 2017 | | June 29, 2018 | | June 30, 2017 |
Provision for income taxes | $ | 4,711 |
| | $ | 4,036 |
| | $ | (1,868 | ) | | $ | 4,792 |
|
Effective tax rates | 20.0 | % | | 22.7 | % | | (4.9 | )% | | 16.5 | % |
The Tax Cuts and Jobs Act (the "TCJA") was enacted on December 22, 2017. The TCJA reduced the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on unremitted earnings of certain foreign subsidiaries, creates a new minimum tax on certain foreign earnings, and provides incentives for U.S. companies to sell and license goods and services abroad, among other changes.
Effective January 1, 2016, the Company sold the net assets of its Taiwan branch operations and its shares of Fox Factory IP Holding Corp. to Fox Factory Switzerland GmbH. The Company’s Taiwan operations were as a result, organized as a branch of the Swiss entity (together, "Fox Switzerland"). Fox Switzerland owns or licenses the Company’s non-U.S. intangible property and generates earnings that, prior to the enactment of the TCJA, were not subject to payment of U.S. income taxes or accrual of deferred tax expense because the Company asserted that such earnings were permanently invested outside the U.S. The unremitted earnings of Fox Switzerland through 2017 became subject to U.S. tax as a result of the one-time transition tax provided for by the TCJA. As a result of the change in U.S. taxation, the Company no longer considers the unremitted earnings of Fox Switzerland to be permanently reinvested, and, as such, has accrued foreign withholding tax due upon remittance of dividends from Fox Switzerland, including a cumulative adjustment of $2,026 in the fourth quarter of the fiscal year 2017.
As permitted by the SEC's Staff Accounting Bulletin 118, the Company has not completed its accounting for the tax effects of the enactment of the TCJA; however, in certain cases, as described below, the Company has made a reasonable estimate of the effects of the new law. In other cases, primarily the impact of grandfathering on limitations of deductibility of executive compensation, the Company has not been able to make a reasonable estimate because clarifying regulations have not been issued, and, as such, continues to account for those items based on its existing accounting under ASC 740, Income Taxes, and the provisions of the tax laws that were in effect immediately prior to the enactment. The Company has recognized provisional amounts for all items for which it was able to determine a reasonable estimate. In all cases, the Company will continue to make and refine its calculations as additional analysis is completed. In addition, the Company's estimates may be affected as interpretations of the law through regulations and common practice emerge.
Provisional amounts
Deferred Tax Assets and Liabilities: In the fourth quarter of fiscal year 2017, the Company remeasured its U.S. deferred tax assets and liabilities that give rise to future tax deductions based on the enacted tax rates in effect for the periods in which the deductions are expected to be taken. However, certain aspects of the TCJA could potentially affect the measurement of these balances or give rise to new deferred tax amounts. For example, differences between the provisional and actual calculations of the one-time transition tax could result in the need for changes to the amount of the valuation allowance on the balance that is not utilized to pay such tax. The provisional amount recorded in the fourth quarter of fiscal year 2017 related to the remeasurement of our deferred tax balance was a net benefit of $2,448. There have been no material changes in the estimated remeasurement of our deferred tax balance in fiscal year 2018.
One-Time Transition Tax: The one-time transition tax is based on the total post-1986 earnings and profits on which U.S. tax were previously deferred. In the fourth quarter of fiscal year 2017, the Company recorded a provisional amount as an increase in income tax expense related to the one-time transition tax of $3,706. Because of the complexities of the TCJA, the Company has estimated the amount of earnings and profits subject to the tax. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. The Company's estimates may change when it finalizes the calculations required to determine the ultimate amount of the transition tax.
For the three months ended June 29, 2018, the difference between the Company's effective tax rate of 20.0% and the 21% federal statutory rate resulted primarily from lower foreign tax rates, lower effective federal rates on foreign derived intangible income, research and development credits, and $880 from excess benefits related to the vesting of RSUs and exercise of stock options. These benefits were partially offset by state taxes, foreign withholding taxes and the impact of non-deductible expenses.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
For the six months ended June 29, 2018, the difference between the Company's effective tax benefit of 4.9% and the 21% federal statutory rate resulted primarily from a $9,838 impact of the favorable conclusion of the 2015 U.S. Internal Revenue Service ("IRS") audit and the recognition of related tax positions with respect to the deductibility of amortization and depreciation expense resulting from the acquisition of the Company in 2008. The benefit of the deductions was not recognized in accounting for the acquisition due to uncertainty about whether the tax position would withstand audit. The results of the audit provided basis for the Company to conclude during the first quarter of 2018 that the amortization and depreciation will likely be deductible for all open tax years. In May 2018, the Company and the IRS entered into a closing agreement that definitively resolves the deductibility and confirms the Company's prior conclusion on the matter. In addition, the effective tax rate benefited from $1,117 of excess benefits related to the vesting of RSUs and exercise of stock options, lower foreign tax rates, lower effective federal rates on foreign derived intangible income, and research and development credits. These benefits were partially offset by state taxes, foreign withholding taxes and the impact of non-deductible expenses.
For the three and six months ended June 30, 2017, the difference between the Company's effective tax rate and the 35% federal statutory rate resulted primarily from lower foreign tax rates on permanently reinvested earnings of the Company's foreign subsidiaries and $1,595 and $4,021, respectively, from excess benefits related to the exercise of stock options and vesting of RSUs. These benefits were partially offset by state taxes and the impact of non-deductible costs.
The Company's federal tax returns for 2013, 2014, 2016 and forward, state tax returns for 2012 forward, and foreign tax returns from 2014 forward are subject to examination by tax authorities.
The Company has obtained tax incentives in Switzerland that are effective through March 2019 that result in a rate reduction provided that the Company meets specified criteria. Upon expiration, the Company may renew the arrangement on demand, as long as the applicable law and operating criteria remain in place. The effect of the tax incentives were not material to the Company's income tax provision for the three and six months ended June 29, 2018 and June 30, 2017.
11. Earnings Per Share
Basic earnings per share ("EPS") amounts are computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. Diluted EPS amounts are computed by dividing net income attributable to stockholders of the Company for the period by the weighted average number of shares of common stock and potentially dilutive common stock outstanding during the period. Potentially dilutive common shares include shares issuable upon the exercise of outstanding stock options and vesting of RSUs, which are reflected in diluted EPS by application of the treasury stock method.
The following table presents the calculation of basic and diluted EPS:
|
| | | | | | | | | | | | | | | |
| For the three months ended | | For the six months ended |
| June 29, 2018 |
| June 30, 2017 | | June 29, 2018 | | June 30, 2017 |
Net income attributable to FOX stockholders | $ | 18,369 |
| | $ | 13,726 |
| | $ | 39,593 |
| | $ | 24,254 |
|
Weighted average shares used to compute basic EPS | 37,722 |
| | 37,330 |
| | 37,674 |
| | 37,232 |
|
Dilutive effect of employee stock plans | 1,134 |
| | 1,395 |
| | 1,172 |
| | 1,411 |
|
Weighted average shares used to compute diluted EPS | 38,856 |
| | 38,725 |
| | 38,846 |
| | 38,643 |
|
EPS: | | | | | | | |
Basic | $ | 0.49 |
| | $ | 0.37 |
| | $ | 1.05 |
| | $ | 0.65 |
|
Diluted | $ | 0.47 |
| | $ | 0.35 |
| | $ | 1.02 |
| | $ | 0.63 |
|
The Company did not exclude any potentially dilutive shares from the calculation of diluted EPS for the three and six months ended June 29, 2018 and June 30, 2017, as none of these shares would have been antidilutive.
FOX FACTORY HOLDING CORP.
Notes to Condensed Consolidated Financial Statements - continued
(in thousands, except per share amounts)
(unaudited)
12. Related Party Agreements
Fox Factory, Inc. has a triple-net building lease for its manufacturing and office facilities in Watsonville, California. The building is owned by a member of our Board of Directors. Rent expense under this lease was $179 and $358 for the three and six months months ended June 29, 2018 and June 30, 2017, respectively. The lease was amended effective April 2016 to extend the term through June 30, 2020, with monthly rental payments of $60, which are adjusted annually for a cost-of-living increase based upon the consumer price index.
On November 30, 2017, the Company acquired an 80% interest in Tuscany, which has building leases for its manufacturing and office facilities in Elkhart, Indiana. The buildings are owned by the non-controlling interest stockholders, who are now employees of the Company. Rent expense under these leases was $86 and $171 for the three and six months ended June 29, 2018, respectively. No rent expense was incurred for these leases for the three and six months ended June 30, 2017, respectively. The leases are effective November 30, 2017 through April 1, 2022, with monthly rental payments of $29, which are subject to annual escalation of 7.5%.
13. Business Combinations
On November 30, 2017, the Company acquired an 80% interest in Tuscany, a designer, manufacturer and distributor of premium aftermarket powered vehicle performance packages in an asset purchase accounted for as a business combination. The purchase price of Tuscany was allocated to the assets acquired and liabilities assumed based on their estimated respective fair values as of November 30, 2017, with the excess purchase price allocated to goodwill. The allocation of the purchase price is preliminary, subject to the completion of the Company's validation of working capital and completion of its intangible valuation procedures, with the assistance of specialists.
The financial results of this subsidiary have been included in our consolidated financial statements since the date of acquisition.
The Company incurred $214 and $463 in transaction costs in conjunction with this acquisition during the three and six months ended June 29, 2018, respectively, which is included in general and administrative expense in the accompanying consolidated statement of income.
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2017, as filed with the U.S. Securities and Exchange Commission ("SEC") on February 27, 2018, and our other reports and registration statements that we file with the SEC from time to time. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in the “Risk Factors” section included in Part II, Item 1A.
Unless the context otherwise requires, the terms “FOX,” the “Company,” “we,” “us,” and “our” in this Quarterly Report on Form 10-Q refer to Fox Factory Holding Corp. and its operating subsidiaries, on a consolidated basis.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements, which are subject to the “safe harbor” created by Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We may make forward-looking statements in our SEC filings, press releases, news articles, earnings presentations and when we are speaking on behalf of the Company. Forward-looking statements generally relate to future events or our future financial or operating performance which involve substantial risks and uncertainties. In some cases, you can identify forward-looking statements because they contain words such as “may,” “might,” “will,” “would,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplate,” “believe,” “estimate,” “predict,” “likely,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q are subject to numerous risks and uncertainties, including but not limited to risks related to:
| |
• | our ability to develop new and innovative products in our current end-markets; |
| |
• | our ability to leverage our technologies and brand to expand into new categories and end-markets; |
| |
• | our ability to increase our aftermarket penetration; |
| |
• | our ability to accelerate international growth; |
| |
• | our exposure to exchange rate fluctuations; |
| |
• | the loss of key customers; |
| |
• | our ability to improve operating and supply chain efficiencies; |
| |
• | our ability to enforce our intellectual property rights; |
| |
• | our future financial performance, including our sales, cost of sales, gross profit or gross margins, operating expenses, ability to generate positive cash flow and ability to maintain our profitability; |
| |
• | our ability to maintain our premium brand image and high-performance products; |
| |
• | our ability to maintain relationships with the professional athletes and race teams we sponsor; |
| |
• | our ability to selectively add additional dealers and distributors in certain geographic markets; |
| |
• | the growth of the markets in which we compete, our expectations regarding consumer preferences and our ability to respond to changes in consumer preferences; |
| |
• | changes in demand for high-end suspension and ride dynamics products; |
| |
• | the loss of key personnel, management and skilled engineers; |
| |
• | our ability to successfully identify, evaluate and manage potential acquisitions and to benefit from such acquisitions; |
| |
• | the outcome of pending litigation; |
| |
• | future disruptions in the operations of our manufacturing facilities; |
| |
• | our ability to adapt our business model to mitigate the impact of certain changes in tax laws including those enacted in the U.S. in December 2017; |
| |
• | changes in tariffs, quotas, trade barriers and other similar restrictions on sales; |
| |
• | changes in the relative proportion of profit earned in the numerous jurisdictions in which we do business and in tax legislation, case law and other authoritative guidance in those jurisdictions; |
| |
• | product recalls and product liability claims; and |
| |
• | future economic or market conditions. |
You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, and prospects and the outcomes of any of the events described in any forward-looking statements are subject to risks, uncertainties, and other factors. In addition to the risks, uncertainties and other factors discussed above and elsewhere in this Quarterly Report on Form 10-Q, the risks, uncertainties and other factors expressed or implied in Part I, Item 1A, "Risk Factors" of our 2017 Annual Report on Form 10-K filed with the SEC on February 27, 2018, could cause or contribute to actual results differing materially from those set forth in any forward-looking statement. Moreover, we operate in a very competitive and challenging environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur. Actual results, events, or circumstances could differ materially from those contemplated by, set forth in, or underlying any forward-looking statements. For all of these forward-looking statements, we claim the protection of the safe harbor for forward-looking statements in Section 27A of the Securities Act, and Section 21E of the Exchange Act.
The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.
Critical Accounting Policies and Estimates
Beginning in the first quarter of fiscal year 2018, the Company adopted Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers. There have been no other changes to our significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended December 29, 2017, as filed with the SEC on February 27, 2018, that have had a material impact on our condensed consolidated financial statements and related notes. See Note 1 - Description of the Business, Basis of Presentation, and Summary of Significant Accounting Policies to the accompanying notes to unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for further details of this update.
Recent Accounting Pronouncements
Seasonality
Certain portions of our business are seasonal; we believe this seasonality is due to the delivery of new products. In each of the last three fiscal years, our quarterly sales have been the lowest in the first quarter and higher in the third or fourth quarter of the year. For example, our sales in our first and third quarters of 2017 represented 22% and 27% of our total sales for the year, respectively. In addition, acquisitions such as Tuscany will affect the seasonality of our business and product mix by quarter; therefore, our 2017 sales are not necessarily reflective of the future.
Results of Operations
The table below summarizes our results of operations:
|
| | | | | | | | | | | | | | | |
| For the three months ended | | For the six months ended |
(in thousands) | June 29, 2018 |
| June 30, 2017 | | June 29, 2018 |
| June 30, 2017 |
Sales | $ | 156,825 |
| | $ | 120,811 |
| | $ | 286,617 |
| | $ | 227,141 |
|
Cost of sales | 104,412 |
| | 81,755 |
| | 192,561 |
| | 154,370 |
|
Gross profit | 52,413 |
| | 39,056 |
| | 94,056 |
| | 72,771 |
|
Operating expenses: | | | | | | | |
Sales and marketing | 9,802 |
| | 7,067 |
| | 18,535 |
| | 13,660 |
|
Research and development | 6,058 |
| | 4,982 |
| | 12,254 |
| | 9,464 |
|
General and administrative | 10,779 |
| | 8,122 |
| | 19,973 |
| | 16,202 |
|
Amortization of purchased intangibles | 1,499 |
| | 696 |
| | 3,068 |
| | 1,391 |
|
Fair value adjustment of contingent consideration and acquisition-related compensation | — |
| | — |
| | — |
| | 1,447 |
|
Total operating expenses | 28,138 |
| | 20,867 |
| | 53,830 |
| | 42,164 |
|
Income from operations | 24,275 |
| | 18,189 |
| | 40,226 |
| | 30,607 |
|
Other expense, net: | | | | | | | |
Interest expense | 832 |
| | 505 |
| | 1,631 |
| | 1,094 |
|
Other (income) expense | (81 | ) | | (78 | ) | | 200 |
| | 467 |
|
Other expense, net | 751 |
| | 427 |
| | 1,831 |
| | 1,561 |
|
Income before income taxes | 23,524 |
| | 17,762 |
| | 38,395 |
| | 29,046 |
|
Provision for (benefit of) income taxes | 4,711 |
| | 4,036 |
| | (1,868 | ) | | 4,792 |
|
Net income | 18,813 |
| | 13,726 |
| | 40,263 |
| | 24,254 |
|
Less: net income attributable to non-controlling interest | (444 | ) | | — |
| | (670 | ) | | — |
|
Net income attributable to FOX stockholders | $ | 18,369 |
| | $ | 13,726 |
| | $ | 39,593 |
| | $ | 24,254 |
|
The following table sets forth selected statement of income data as a percentage of sales for the periods indicated:
|
| | | | | | | | | | | |
| For the three months ended | | For the six months ended |
| June 29, 2018 |
| June 30, 2017 | | June 29, 2018 | | June 30, 2017 |
Sales | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
Cost of sales | 66.6 |
| | 67.7 |
| | 67.2 |
| | 68.0 |
|
Gross profit | 33.4 |
| | 32.3 |
| | 32.8 |
| | 32.0 |
|
Operating expenses: | | | | | | | |
Sales and marketing | 6.3 |
| | 5.8 |
| | 6.5 |
| | 6.0 |
|
Research and development | 3.9 |
| | 4.1 |
| | 4.3 |
| | 4.2 |
|
General and administrative | 6.9 |
| | 6.7 |
| | 7.0 |
| | 7.1 |
|
Amortization of purchased intangibles | 1.0 |
| | 0.6 |
| | 1.1 |
| | 0.6 |
|
Fair value adjustment of contingent consideration and acquisition related compensation | — |
| | — |
| | — |
| | 0.6 |
|
Total operating expenses | 18.1 |
| | 17.2 |
| | 18.9 |
| | 18.5 |
|
Income from operations | 15.3 |
| | 15.1 |
| | 13.9 |
| | 13.5 |
|
Other expense, net: | | | | | | | |
Interest expense | 0.5 |
| | 0.4 |
| | 0.6 |
| | 0.5 |
|
Other (income) expense | (0.1 | ) | | (0.1 | ) | | 0.1 |
| | 0.2 |
|
Other expense, net | 0.4 |
| | 0.3 |
| | 0.7 |
| | 0.7 |
|
Income before income taxes | 14.9 |
| | 14.8 |
| | 13.2 |
| | 12.8 |
|
Provision for (benefit of) income taxes | 3.0 |
| | 3.3 |
| | (0.7 | ) | | 2.1 |
|
Net income | 11.9 |
| | 11.5 |
| | 13.9 |
| | 10.7 |
|
Less: net income attributable to non-controlling interest | (0.3 | ) | | — |
| | (0.2 | ) | | — |
|
Net income attributable to FOX stockholders | 11.7 | % | | 11.5 | % | | 13.8 | % | | 10.7 | % |
Three months ended June 29, 2018 compared to three months ended June 30, 2017
Sales
|
| | | | | | | | | | | | | | |
| For the three months ended | | | | |
(in millions) | June 29, 2018 | | June 30, 2017 | | Change ($) | | Change (%) |
Power vehicle products | $ | 82.2 |
| | $ | 56.0 |
| | $ | 26.2 |
| | 46.8 | % |
Bike products | 74.6 |
| | 64.8 |
| | 9.8 |
| | 15.1 | % |
Total sales | $ | 156.8 |
| | $ | 120.8 |
| | $ | 36.0 |
| | 29.8 | % |
Sales for the three months ended June 29, 2018 increased approximately $36.0 million, or 29.8%, compared to the three months ended June 30, 2017. Powered vehicle sales increased by $26.2 million or 46.8% due to the inclusion of the Company’s acquisition of Tuscany as well as continued high demand for on and off-road suspension products. Bike sales increased by $9.8 million or 15.1% primarily driven by higher OEM sales.
Cost of sales
|
| | | | | | | | | | | | | | |
| For the three months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Cost of sales | $ | 104.4 |
| | $ | 81.8 |
| | $ | 22.6 |
| | 27.6 | % |
Cost of sales for the three months ended June 29, 2018 increased approximately $22.6 million, or 27.6%, compared to the three months ended June 30, 2017. The increase in cost of sales was driven primarily by an increase in sales.
For the three months ended June 29, 2018, our gross margin increased 110 basis points to 33.4% compared to 32.3% for the three months ended June 30, 2017. The improvement in gross margin was primarily due to increased operating leverage on higher volume and improved manufacturing efficiencies.
Operating expenses
|
| | | | | | | | | | | | | | |
| For the three months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Operating expenses: | | | | | | | |
Sales and marketing | $ | 9.8 |
| | $ | 7.1 |
| | $ | 2.7 |
| | 38.0 | % |
Research and development | 6.0 |
| | 5.0 |
| | 1.0 |
| | 20.0 |
|
General and administrative | 10.8 |
| | 8.1 |
| | 2.7 |
| | 33.3 |
|
Amortization of purchased intangibles | 1.5 |
| | 0.7 |
| | 0.8 |
| | 114.3 |
|
Total operating expenses | $ | 28.1 |
| | $ | 20.9 |
| | $ | 7.2 |
| | 34.4 | % |
Total operating expenses for the three months ended June 29, 2018 were $28.1 million compared to $20.9 million for the three months ended June 30, 2017. When expressed as a percentage of sales, operating expenses increased to 18.1% of sales for the three months ended June 29, 2018 compared to 17.2% of sales in the three months ended June 30, 2017. The increase in operating expenses is primarily a result of operating costs relating to our newly acquired Tuscany subsidiary, higher patent litigation-related expenses, investments in research and development to support future growth, and higher amortization expense on acquired intangible assets.
Within operating expenses, our sales and marketing expenses increased approximately $2.7 million primarily due to costs incurred at our recently acquired Tuscany subsidiary of $1.9 million, as well as increased spending in our existing business lines to continue to promote our products and grow our brand. Research and development costs increased approximately $1.0 million primarily due to headcount investments as we continue to pursue product innovation. General and administrative expenses increased by approximately $2.7 million due to an increase of $1.7 million in patent litigation-related expenses, expenses of $0.5 million incurred at Tuscany, and various other items.
Amortization of purchased intangible assets for the three months ended June 29, 2018 increased by approximately $0.8 million as compared to the three months ended June 30, 2017. The increase is primarily due to the amortization of customer relationship assets acquired in the Tuscany acquisition.
Income from operations
|
| | | | | | | | | | | | | | |
| For the three months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Income from operations | $ | 24.3 |
| | $ | 18.2 |
| | $ | 6.1 |
| | 33.5 | % |
As a result of the factors discussed above, income from operations for the three months ended June 29, 2018 increased approximately $6.1 million, or 33.5%, compared to income from operations for the three months ended June 30, 2017.
Other expense, net
|
| | | | | | | | | | | | | | |
| For the three months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Other expense, net: | | | | | | | |
Interest expense | $ | 0.8 |
| | $ | 0.5 |
| | $ | 0.3 |
| | 60.0 | % |
Other income | (0.1 | ) | | (0.1 | ) | | — |
| | — |
|
Other expense, net | $ | 0.7 |
| | $ | 0.4 |
| | $ | 0.3 |
| | 75.0 | % |
Other expense, net for the three months ended June 29, 2018 increased by $0.3 million to $0.7 million compared to $0.4 million for the three months ended June 30, 2017. The increase in other expense, net is primarily due to a $0.3 million increase in interest expense in the three months ended June 29, 2018.
Income taxes
|
| | | | | | | | | | | | | | |
| For the three months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Provision for income taxes | $ | 4.7 |
| | $ | 4.0 |
| | $ | 0.7 |
| | 17.5 | % |
The effective tax rates were 20.0% and 22.7% for the three months ended June 29, 2018 and June 30, 2017, respectively.
For the three months ended June 29, 2018, the difference between our effective tax rate and the 21% federal statutory rate resulted primarily from lower foreign tax rates, lower effective federal rates on foreign derived intangible income, research and development credits, and $0.9 million from excess benefits related to the vesting of restricted stock units ("RSUs") and exercise of stock options. These benefits were partially offset by state taxes, foreign withholding taxes and the impact of non-deductible expenses.
For the three months ended June 30, 2017, the difference between our effective tax rate and the 35% federal statutory rate resulted primarily from lower tax rates in foreign jurisdictions where we do business and a $1.6 million benefit from excess deductions on the exercise of stock options and vesting of RSUs, partially offset by state taxes.
The effective tax rate for the three months ended June 29, 2018, decreased as compared to the same period in 2017 primarily as a result of the reduction in the US tax rate. The reduction in US tax rate was partially offset by a reduction in excess benefits related to the vesting of RSUs and the exercise of stock options, which are recognized in the quarter of occurrence. Because we achieved a 32% increase in pre-tax income, the reduction in the excess benefit disproportionately impacts the effective tax rate.
Net income
|
| | | | | | | | | | | | | | |
| For the three months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Net income | $ | 18.8 |
| | $ | 13.7 |
| | $ | 5.1 |
| | 37.2 | % |
As a result of the factors described above, our net income increased $5.1 million, or 37.2%, to $18.8 million in the three months ended June 29, 2018 from $13.7 million for the three months ended June 30, 2017.
Six months ended June 29, 2018, compared to six months ended June 30, 2017
Sales
|
| | | | | | | | | | | | | | |
| For the six months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Power vehicle products | $ | 154.4 |
| | $ | 110.1 |
| | $ | 44.3 |
| | 40.2 | % |
Bike products | 132.2 |
| | 117.0 |
| | 15.2 |
| | 13.0 | % |
Total sales | $ | 286.6 |
| | $ | 227.1 |
| | $ | 59.5 |
| | 26.2 | % |
Sales for the six months ended June 29, 2018 increased approximately $59.5 million or 26.2%, compared to the same period in fiscal 2017. The sales increase reflects a 40.2% increase in powered vehicle products and a 13.0% increase in bike products for the six months ended June 29, 2018 compared to the six months ended June 30, 2017. The increase in sales of powered vehicle products was due to the inclusion of the Company’s acquisition of Tuscany as well as continued high demand for on and off-road suspension products. The increase in bike product sales is primarily driven by higher OEM sales.
Cost of sales
|
| | | | | | | | | | | | | | |
| For the six months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Cost of sales | $ | 192.6 |
| | $ | 154.4 |
| | $ | 38.2 |
| | 24.7 | % |
Cost of sales for the six months ended June 29, 2018 increased approximately $38.2 million, or 24.7%, compared to the six months ended June 30, 2017. The increase in cost of sales was driven primarily by an increase in sales, partially offset by lower costs associated with various operational improvements and efficiencies.
For the six months ended June 29, 2018, our gross margin increased 80 basis points to 32.8% compared to 32.0% for the six months ended June 30, 2017. The gross margin improved primarily due to increased operating leverage on higher volume and improved manufacturing efficiencies.
Operating expenses
|
| | | | | | | | | | | | | | |
| For the six months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Operating expenses: | | | | | | | |
Sales and marketing | $ | 18.5 |
| | $ | 13.7 |
| | $ | 4.8 |
| | 35.0 | % |
Research and development | 12.3 |
| | 9.5 |
| | 2.8 |
| | 29.5 |
|
General and administrative | 20.0 |
| | 16.2 |
| | 3.8 |
| | 23.5 |
|
Amortization of purchased intangibles | 3.1 |
| | 1.4 |
| | 1.7 |
| | 121.4 |
|
Fair value adjustment of contingent consideration and acquisition-related compensation | — |
| | 1.4 |
| | (1.4 | ) | | (100.0 | ) |
Total operating expenses | $ | 53.9 |
| | $ | 42.2 |
| | $ | 11.7 |
| | 27.7 | % |
Total operating expenses for the six months ended June 29, 2018 increased approximately $11.7 million, or 27.7%, over the six months ended June 30, 2017. When expressed as a percentage of sales, operating expenses increased to 18.9% of sales for the six months ended June 29, 2018 compared to 18.5% of sales in the six months ended June 30, 2017. The increase in operating expenses is primarily a result of operating costs relating to our newly acquired Tuscany subsidiary, higher patent litigation-related expenses, investments in research and development to support future growth, and higher amortization expense on acquired intangible assets.
Within operating expenses, our sales and marketing expenses increased approximately $4.8 million primarily due to costs incurred at our recently acquired Tuscany subsidiary of $3.3 million, as well as increased spending in our existing business lines to continue to promote our products and grow our brands. Research and development expenses increased approximately $2.8 million primarily due to $1.4 million in headcount investments and $0.5 million in prototype costs as we continue to pursue product innovation. General and administrative expenses increased approximately $3.8 million due to an increase of $2.1 million in patent litigation-related expenses, expenses of $1.0 million incurred at Tuscany, and various other items.
Amortization of purchased intangible assets for the six months ended June 29, 2018 increased by approximately $1.7 million as compared to the six months ended June 30, 2017. The increase is primarily due to the amortization of customer relationship assets acquired in the Tuscany acquisition.
During the first quarter of 2017, all acquisition-related compensation arrangements concluded and contingent consideration payment calculations were finalized. Accordingly, we incurred no expense after the first quarter of fiscal 2017 which resulted in a $1.4 million decrease in the expense for the six months ended June 29, 2018 compared to the same period in 2017.
Income from operations
|
| | | | | | | | | | | | | | |
| For the six months ended | | | | |
(in millions) | June 29, 2018 | | June 30, 2017 | | Change ($) | | Change (%) |
Income from operations | $ | 40.2 |
| | $ | 30.6 |
| | $ | 9.6 |
| | 31.4 | % |
As a result of the factors discussed above, income from operations for the six months ended June 29, 2018 increased approximately $9.6 million, or 31.4%, compared to income from operations for the six months ended June 30, 2017.
Other expense, net
|
| | | | | | | | | | | | | | |
| For the six months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
Other expense, net: | | | | | | | |
Interest expense | $ | 1.6 |
| | $ | 1.1 |
| | $ | 0.5 |
| | 45.5 | % |
Other expense | 0.2 |
| | 0.5 |
| | (0.3 | ) | | (60.0 | ) |
Other expense, net | $ | 1.8 |
| | $ | 1.6 |
| | $ | 0.2 |
| | 12.5 | % |
Other expense, net increased by approximately $0.2 million to $1.8 million for the six months ended June 29, 2018, compared to $1.6 million for the six months ended June 30, 2017, primarily due to a $0.5 million increase in interest expense.
Income taxes
|
| | | | | | | | | | | | | | |
| For the six months ended | | | | |
(in millions) | June 29, 2018 |
| June 30, 2017 | | Change ($) | | Change (%) |
(Benefit of) provision for income taxes | $ | (1.9 | ) | | $ | 4.8 |
| | $ | (6.7 | ) | | (139.6 | )% |
We had an effective tax benefit rate of 4.9% for the six months ended June 29, 2018, compared to an effective tax rate of 16.5% for the six months ended June 30, 2017.
For the six months ended June 29, 2018, the difference between our effective tax benefit rate and the 21% federal statutory rate resulted primarily from a $9.8 million one-time impact of the favorable conclusion of our 2015 U.S. Internal Revenue Service ("IRS") audit and the recognition of related tax positions with respect to the deductibility of amortization and depreciation expense resulting from the acquisition of the Company in 2008. The benefit of the deductions was not recognized in accounting for the acquisition of the Company by our former majority shareholder due to uncertainty about whether the tax position would withstand audit. The results of the audit provided a basis for us to conclude that the amortization and depreciation will likely be deductible for all open tax years. In May 2018, the Company and the IRS entered into a closing agreement that definitively resolves the deductibility and confirms our prior conclusion on the matter. In addition, the effective tax rate benefited from $1.1 million of excess benefits related to the vesting of RSUs and exercise of stock options, lower foreign tax rates, lower effective federal rates on foreign derived intangible income, and research and development credits. These benefits were partially offset by state taxes, foreign withholding taxes and the impact of non-deductible expenses.
For the six months ended June 30, 2017, the difference between our effective tax rate and the 35% federal statutory rate resulted primarily from lower tax rates in foreign jurisdiction where we do business and a $4.0 million benefit from excess deductions on the exercise of stock options and vesting of RSUs, partially offset by state taxes.
The change in income tax benefit for the six months ended June 29, 2018 as compared to the tax provision to the six months ended June 30, 2017, was primarily a result of the $9.8 million one-time impact of the favorable conclusion of the 2015 IRS audit and lower US tax rates. Offsetting the audit benefit and favorable rate change, excess benefits related to stock-based compensation were $2.9 million lower for the six months ended June 29, 2018 compared to the six months ended June 30, 2017.
Net income
|
| | | | | | | | | | | | | | |
| For the six months ended | | | | |
(in millions) | June 29, 2018 | | June 30, 2017 | | Change ($) | | Change (%) |
Net income | $ | 40.3 |
| | $ | 24.3 |
| | $ | 16.0 |
| | 65.8 | % |
As a result of the factors described above, our net income increased $16.0 million, or 65.8%, to $40.3 million in the six months ended June 29, 2018 from $24.3 million for the six months ended June 30, 2017.
Liquidity and Capital Resources
Our primary cash needs are to support working capital, capital expenditures, acquisitions, and debt repayments. Historically, we have generally financed our liquidity needs with operating cash flows and borrowings under our credit facilities. These sources of liquidity may be impacted by various factors, including demand for our products, investments made by us in acquired businesses, our plant and equipment and other capital expenditures, and expenditures on general infrastructure and information technology. A summary of our operating, investing and financing activities are shown in the following table:
|
| | | | | | | |
| For the six months ended |
(in thousands) | June 29, 2018 | | June 30, 2017 |
Net cash provided by operating activities | $ | 32,855 |
| | $ | 21,013 |
|
Net cash used in investing activities | (9,046 | ) | | (5,347 | ) |
Net cash used in financing activities | (36,853 | ) | | (7,659 | ) |
Effect of exchange rate changes on cash | (217 | ) | | 58 |
|
(Decrease) increase in cash and cash equivalents | $ | (13,261 | ) | | $ | 8,065 |
|
Operating activities
Cash provided by operating activities consists of net income, adjusted for certain non-cash items, primarily depreciation and amortization, stock-based compensation, changes in deferred income taxes and uncertain tax positions, fair value adjustments of our contingent consideration, and net cash invested in working capital.
In the six months ended June 29, 2018, net cash provided by operating activities was $32.9 million and consisted of net income of $40.3 million, less non-cash items totaling $1.3 million and changes in operating assets and liabilities totaling $6.1 million.
Non-cash items and other adjustments consisted of depreciation and amortization of $7.1 million, stock-based compensation of $3.8 million, offset by a $12.3 million change in deferred taxes and uncertain tax positions that included $9.8 million related to the favorable settlement of our 2015 IRS audit.
Our investment in operating assets and liabilities is a result of an increase in accounts receivable of $17.8 million, an increase in inventory of $10.9 million, and a decrease in income taxes payable of $1.0 million, partially offset by an increase in accounts payable of $18.4 million, an increase in accrued expenses of $1.0 million and a decrease in prepaids and other assets of $4.2 million. The changes in inventory, accounts payable, accrued expenses, accounts receivable and prepaid and other assets are primarily due to seasonal impacts on working capital. The decrease in income taxes payable is primarily due to a reduction in accrued withholding taxes.
In the six months ended June 30, 2017, cash provided by operating activities was $21.0 million and consisted of net income of $24.3 million plus non-cash items totaling $2.0 million less changes in operating assets and liabilities totaling $5.2 million. Non-cash items and other adjustments consisted of depreciation and amortization of $4.7 million, stock-based compensation of $4.3 million, offset by a $6.8 million increase in deferred taxes. Our investment in operating assets and liabilities is primarily a result of an increase an increase in inventory of $17.4 million, and a decrease in accrued expenses and deferred rent of $6.9 million, offset by increases in accounts payable of $14.0 million and income taxes payable of $6.1 million. The increase in inventory and accounts payable are due to the seasonal impact on working capital. The decrease in accrued expenses was due to the payment of $7.9 million of acquisition related compensation, partially offset by an increase in accrued warranty.
Investing activities
Cash used in investing activities relates to investments in our manufacturing and general infrastructure through the procurement of property and equipment and strategic acquisitions.
In the six months ended June 29, 2018 and June 30, 2017, net cash used in investing activities was $9.0 million and $5.3 million, respectively, consisting primarily of purchases of property and equipment.
Financing activities
Cash used in financing activities primarily relates to changes in our capital structure, including the various forms of debt and equity instruments used to finance our business.
In the six months ended June 29, 2018, net cash used in financing activities was $36.9 million, which consisted of $30.5 million paid on our line of credit and $2.3 million paid on our term debt. In addition, we paid $4.0 million to repurchase shares of our common stock, net of proceeds from the exercise of options as part of our stock-based compensation program.
In the six months ended June 30, 2017, net cash used in financing activities was $7.7 million. We paid $5.4 million for the 2016 portion of our contingent consideration liability, $1.9 million in installments on our term debt and $0.4 million of repurchases of our common stock, net of proceeds from the exercise of options as part of our stock-based compensation program.
Second Amended and Restated Credit Facility
In August 2013, we entered into the 2013 Credit Facility with Sun Trust Bank and other named lenders. The 2013 Credit Facility provided a revolving line of credit. On March 31, 2014, in connection with our asset purchase of Sport Truck, we amended and restated the 2013 Credit Facility. The Amended and Restated 2013 Credit Facility provided a maturing secured term loan in the principal amount of $50.0 million, subject to quarterly amortization payments, and extended the term of the 2013 Credit Facility through March 31, 2019. The proceeds of the term loan were used, in part, to fund the acquisition of Sport Truck and to pay down the revolving line of credit provided under the 2013 Credit Facility. On December 12, 2014, we amended the existing Amended and Restated 2013 Credit Facility. The First Amendment increased the term loan by the principal amount of $30.0 million to a total of $56.8 million, subject to quarterly amortization payments, and extended the maturity of the Amended and Restated 2013 Credit Facility through December 12, 2019. The additional proceeds of the term loan made available through the First Amendment were used to partially fund the acquisition of Race Face/Easton. Additional amendments entered into on May 29, 2015 and March 31, 2016, respectively, made minor technical changes to the Amended and Restated 2013 Credit Facility. On May 11, 2016, we amended and restated the existing Amended and Restated 2013 Credit Facility. Further technical amendments were made on August 11, 2016, June 12, 2017 and November 30, 2017 (as most recently amended and restated and as further amended, the "Second Amended and Restated Credit Facility"). The Second Amended and Restated Credit Facility provides a maturing secured term loan in the principal amount of $75.0 million, subject to quarterly amortization payments, increased the availability on the line of credit to $100.0 million, and extended the maturity of the Second Amended and Restated Credit Facility through May 11, 2021.
The Second Amended and Restated Credit Facility is secured by substantially all of our assets, restricts our ability to make certain payments and engage in certain transactions, and also requires that we satisfy customary financial ratios, including a fixed charge coverage ratio of not less than 1.5:1.0 and a leverage ratio of not greater than 3.0:1.0, both ratios calculated as defined in the Second Amended and Restated Credit Facility. Additionally, certain disposal events can trigger prepayments. We were in compliance with the covenants as of June 29, 2018.
Other Commitments
No material contractual obligation has changed since the Company's Annual Report on Form 10-K for the year ended December 29, 2017, as filed with the SEC on February 27, 2018.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements.
Inflation
Historically, inflation has not had a material effect on our results of operations. However, significant increases in inflation, particularly those related to wages and increases in the cost of raw materials could have an adverse impact on our business, financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to the disclosures discussed in the section “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended December 29, 2017, as filed with the SEC on February 27, 2018.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Our management, under the direction and with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 29, 2018. Based on the evaluation of our disclosure controls and procedures as of June 29, 2018, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, believes that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at the reasonable assurance level. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include, but are not limited to, the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A lawsuit was filed on December 17, 2015 by SRAM Corporation (“SRAM”) in the U.S. District Court, Northern District of Illinois, against the Company’s wholly-owned subsidiary, RFE Canada Holding Corp. (“RFE Canada”). The lawsuit alleges patent infringement of U.S. Patent number 9,182,027 ("'027 Patent") and violation of the Lanham Act. SRAM filed a second lawsuit in the same court against RFE Canada on May 16, 2016. That lawsuit alleges patent infringement of U.S Patent number 9,291,250 ("'250 Patent"). The Company believes the lawsuits are without merit and intends to vigorously defend itself. As such, the Company has filed, before the U. S. Patent and Trademark Appeals Board ("PTAB"), for Interparties Reviews ("IPR") of the '027 Patent and separately the same for the '250 Patent. In April 2018, the PTAB issued opinions in the ‘027 Patent petition cases stating that the Company has not shown the claims of the ‘027 Patent to be obvious. Regarding the PTAB ‘027 opinions, the Company has filed a Notice of Appeal to the Court of Appeals for the Federal Circuit The IPR for the ‘250patent is pending in the PTAB ad the PTAB has stayed the ex-parte re-exam of the ‘250 patent.
In a separate action the Company filed a lawsuit on January 29, 2016 in the U.S. District Court, Northern District of California against SRAM. That lawsuit alleges SRAM’s infringement of two separate Company owned patents, specifically U.S. Patent numbers 6,135,434 and 6,557,674. A second lawsuit was filed by the Company on July 1, 2016 in the U.S. District Court, Northern District of California against SRAM alleging infringement of the Company’s U.S. Patent numbers 8,226,172 and 8,974,009. These lawsuits have been moved to U.S. District Court, District of Colorado and are otherwise proceeding. The stay of the SRAM lawsuits against the Company have been lifted by the U.S. District Court, Northern District of Illinois. The Company filed and SRAM filed lawsuits are now moving forward as scheduled by the courts.
Due to the inherent uncertainties of litigation, the Company is not able to predict either the outcome or a range of reasonably possible losses, if any, at this time. Accordingly, no amounts have been recorded in the consolidated financial statements for the settlement of these matters. Were an unfavorable ruling to occur, or if factors indicate that a loss is probable and reasonably estimable, the Company's business, financial condition or results of operations could be materially and adversely affected.
The Company is involved in other legal matters that arise in the ordinary course of business. Based on information currently available, management does not believe that the ultimate resolution of these matters will have a material adverse effect on the Company's financial condition, results of operations or cash flows.
ITEM 1A. RISK FACTORS
Our business, financial condition, operating results and prospects could be materially and adversely affected by various risks and uncertainties that are described herein. In addition to the risks and uncertainties discussed elsewhere in this Quarterly Report on Form 10-Q, you should carefully consider the risks and uncertainties described below. If any of these risks actually occur, our business, financial condition, operating results and prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline.
Risks related to our business
If we are unable to continue to enhance existing products and develop, manufacture and market new products that respond to consumer needs and preferences and achieve market acceptance, we may experience a decrease in demand for our products, and our business and financial results could suffer.
Our growth strategy involves the continuous development of innovative performance products. We may not be able to compete as effectively with our competitors, and ultimately satisfy the needs and preferences of our customers and the end users of our products, unless we can continue to enhance existing products and develop new, innovative products in the global markets in which we compete. In addition, we must continuously compete not only for end users who purchase our products through the dealers and distributors who are our customers, but also for the OEMs, which incorporate our products into their bikes and powered vehicles. These OEMs regularly evaluate our products against those of our competitors to determine if they are allowing the OEMs to achieve higher sales and market share on a cost-effective basis. Should one or more of our OEM customers determine that they could achieve overall better financial results by incorporating a competitor’s new or existing product, they would likely do so, which could harm our business, financial condition or results of operations.
Product development requires significant financial, technological and other resources. While we expended approximately $20.2 million, $18.5 million and $17.0 million for our research and development efforts in 2017, 2016 and 2015, respectively, there can be no assurance that this level of investment in research and development will be sufficient in the future to maintain our competitive advantage in product innovation, which could cause our business, financial condition or results of operations to suffer.
Product improvements and new product introductions require significant planning, design, development and testing at the technological, product and manufacturing process levels, and we may experience unanticipated delays in our introduction of product improvements or new products. Our competitors’ new products may beat our products to market, be more effective and/or less expensive than our products, obtain better market acceptance or render our products obsolete. Any new products that we develop may not receive market acceptance or otherwise generate any meaningful sales or profits for us relative to our expectations. In addition, one of our competitors could develop an unforeseen and entirely new product or technology that renders our products less desirable or obsolete, which could negatively affect our business, financial condition or results of operations.
We face intense competition in all product lines, including from some competitors that may have greater financial and marketing resources. Failure to compete effectively against competitors would negatively impact our business and operating results.
The ride dynamics industry is highly competitive. We compete with a number of other manufacturers that produce and sell ride dynamics products to OEMs and aftermarket dealers and distributors, including OEMs that produce their own lines of products for their own use. Our continued success depends on our ability to continue to compete effectively against our competitors, some of which have significantly greater financial, marketing and other resources than we have. Also, several of our competitors offer broader product lines to OEMs, which they may sell in connection with suspension products as part of a package offering. In the future, our competitors may be able to maintain and grow brand strength and market share more effectively or quickly than we do by anticipating the course of market developments more accurately than we do, developing products that are superior to our products, creating manufacturing or distribution capabilities that are superior to ours, producing similar products at a lower cost than we can or adapting more quickly than we do to new technologies or evolving regulatory, industry or customer requirements, among other possibilities. In addition, we may encounter increased competition if our current competitors broaden their product offerings by beginning to produce additional types of ride dynamics products or through competitor consolidations. We could also face competition from well-capitalized entrants into the performance suspension and ride dynamics product market, as well as aggressive pricing tactics by other manufacturers trying to gain market share. As a result, our products may not be able to compete successfully with our competitors’ products, which could negatively affect our business, financial condition or results of operations.
Our business is sensitive to economic conditions that impact consumer spending. Our suspension and ride dynamics products, and the bike and powered vehicles into which they are incorporated, are discretionary purchases and may be adversely impacted by changes in the economy.
Our business depends substantially on global economic and market conditions. In particular, we believe that currently a significant majority of the end users of our products live in the United States and countries in Europe. These areas are either in the process of recovering from recession or, in some cases, are still struggling with recession, disruption in banking and/or financial systems, economic weakness and uncertainty. In addition, our products are recreational in nature and are generally discretionary purchases by consumers. Consumers are usually more willing to make discretionary purchases during periods of favorable general economic conditions and high consumer confidence. Discretionary spending may also be affected by many other factors, including interest rates, the availability of consumer credit, taxes and consumer confidence in future economic conditions. During periods of unfavorable economic conditions, or periods when other negative market factors exist, consumer discretionary spending is typically reduced, which in turn could reduce our product sales and have a negative effect on our business, financial condition or results of operations.
There could also be a number of secondary effects resulting from an economic downturn, such as insolvency of our suppliers resulting in product delays, an inability of our OEM and distributor and dealer customers to obtain credit to finance purchases of our products, customers delaying payment to us for the purchase of our products due to financial hardship or an increase in bad debt expense. Any of these effects could negatively affect our business, financial condition or results of operations.
If we are unable to maintain our premium brand image, our business may suffer.
Our products are selected by both OEMs and dealers and distributors in part because of the premium brand reputation we hold with them and our end users. Therefore, our success depends on our ability to maintain and build the image of our brands. We have focused on building our brands through producing products or acquiring businesses that produce products that we believe are innovative, high in performance and highly reliable. In addition, our brands benefit from our strong relationships with our OEM customers and dealers and distributors and through marketing programs aimed at bike and powered vehicle enthusiasts in various media and other channels. For example, we sponsor a number of professional athletes and professional race teams. In order to continue to enhance our brand image, we will need to maintain our position in the suspension and ride dynamics products industry and continue to provide high quality products and services. Also, we will need to continue to invest in sponsorships, marketing and public relations.
There can be no assurance, however, that we will be able to maintain or enhance the strength of our brands in the future. Our brands could be adversely impacted by, among other things:
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• | failure to develop new products that are innovative, performance and reliable; |
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• | internal product quality control issues; |
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• | product quality issues on the bikes and powered vehicles on which our products are installed; |
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• | high profile component failures (such as a component failure during a race on a mountain bike ridden by an athlete that we sponsor); |
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• | negative publicity regarding our sponsored athletes; |
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• | high profile injury or death to one of our sponsored athletes; |
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• | inconsistent uses of our brand and our other intellectual property assets, as well as failure to protect our intellectual property; and |
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• | changes in consumer trends and perceptions. |
Any adverse impact on our brand could in turn negatively affect our business, financial condition or results of operations.
A significant portion of our sales are highly dependent on the demand for high-end bikes and a material decline in the demand for these bikes or their suspension components could have a material adverse effect on our business or results of operations.
During 2017, approximately 52% of our sales were generated from the sale of bike products. Part of our success has been attributable to the growth in the high-end bike industry, including increases in average retail sales prices, as better-performing product designs and technologies have been incorporated into these products. If the popularity of high-end or premium-priced bikes does not increase or declines, the number of bike enthusiasts seeking such bikes or premium-priced suspension products, wheels, cranks and other specialty components for their bikes does not increase or declines, or the average price point of these bikes declines, we may fail to achieve future growth or our sales could decrease, and our business, financial condition or results of operations could be negatively affected. In addition, if current bike enthusiasts stop purchasing our products due to changes in preferences, we may fail to achieve future growth or our sales could be decreased, and our business, financial condition or results of operations could be negatively affected.
Our growth in the powered vehicle category is dependent upon our continued ability to expand our product sales into powered vehicles that require performance suspension and the continued expansion of the market for these powered vehicles.
Our growth in the powered vehicle category is in part attributable to the expansion of the market for powered vehicles that require performance suspension products. Such market growth includes the creation of new classes of vehicles that need our products, such as Side-by-Sides, and our ability to create products for these vehicles. In the event these markets stopped expanding or contracted, or we are unsuccessful in creating new products for these markets or other competitors successfully enter into these markets, we may fail to achieve future growth or our sales could decrease, and our business, financial condition or results of operations could be negatively affected.
Changes in our customer, channel and product mix could place more rigorous demands on our infrastructure and cause our profitability percentages to fluctuate.
From time to time, we may experience changes in our customer, channel and product mix from changes in demands from existing customers due to shifts in their products and markets. Additionally, the Company may pursue new customers and markets. Such changes in customers, channel and product mix could place more rigorous demands on our infrastructure and supply chain and could result in changes to our profitability and profitability percentages. If customers begin to require more lower-margin products from us and fewer higher-margin products, or place demands on our performance that increase our costs, our business, results of operations and financial condition may suffer.
A disruption in the operations of our manufacturing facilities could have a negative effect on our business, financial condition or results of operations.
During 2017, we completed the process of moving all of the manufacturing of our bike suspension component products to our facility in Taichung, Taiwan. In connection with this move, we are utilizing, and expect to continue to utilize, suppliers who are located closer to our facility in Taichung, Taiwan for a number of materials and components. With the transition of all of our bike suspension component manufacturing to Taichung, Taiwan, we have converted the Watsonville manufacturing facility to be a powered vehicle suspension products manufacturing location exclusively. In the future, we may move additional manufacturing operations as we re-balance existing facilities or expand to new manufacturing locations. As a result, we have incurred, and may continue to incur, costs associated with some duplication of facilities, equipment and personnel, the amount of which could vary materially from our projections. In addition, we could encounter unforeseen difficulties resulting from the distance and time zone differences between our various facilities.
Equipment failures, delays in deliveries or catastrophic loss at any of our facilities could lead to production or service disruptions, curtailments or shutdowns. In the event of a stoppage in production or a slowdown in production due to high employee turnover or a labor dispute at any of our facilities, even if only temporary, or if we experience delays as a result of events that are beyond our control, delivery times to our customers could be severely affected. If there was a manufacturing disruption in any of our manufacturing facilities, we might be unable to meet product delivery requirements and our business, financial condition or results of operations could be negatively affected, even if the disruption was covered in whole or in part by our business interruption insurance. Any significant delay in deliveries to our customers could lead to increased returns or cancellations, expose us to damage claims from our customers or damage our brand and, in turn, negatively affect our business, financial condition or results of operations.
Work stoppages or other disruptions at seaports could adversely affect our operating results.
A significant portion of our goods move through ports on the Western Coast of the United States. We have a global supply chain and we import products from our third-party vendors as well as our Fox Taiwan facility into the United States largely through ports on the West Coast. Freight arriving at West Coast ports must be offloaded from ships by longshoremen, none of whom are our employees. We do not control the activities of these employees or seaports and we could suffer supply chain disruptions due to any disputes, capacity shortages, slowdowns or shutdowns which may occur, as was experienced in February 2015, in relation to certain West Coast ports. While the West Coast ports labor dispute ended with a five-year agreement, it lasted longer than we forecasted, and any similar labor dispute in the future could potentially have a negative effect on both our financial condition and results of operations.
Our business depends substantially on the continuing efforts of our senior management, and our business may be severely disrupted if we lose their services.
We are heavily dependent upon the contributions, talent and leadership of our senior management team, particularly our Chief Executive Officer, Larry L. Enterline. We do not have a "key person" life insurance policy on Mr. Enterline or any other key employees. We believe that the top eleven members of our senior management team are key to establishing our focus and executing our corporate strategies as they have extensive knowledge of our systems and processes. Given our senior management team’s knowledge of the suspension products industry and the limited number of direct competitors in the industry, we believe that it could be difficult to find replacements should any of the members of our senior management team leave. Our inability to find suitable replacements for any of the members of our senior management team could negatively affect our business, financial condition or results of operations.
We depend on skilled engineers to develop and create our products, and the failure to attract and retain such individuals could adversely affect our business.
We rely on skilled and well-trained engineers for the design and production of our products, as well as in our research and development functions. Competition for such individuals is intense, particularly in Silicon Valley near where our headquarters are located. Our inability to attract or retain qualified employees in our design, production or research and development functions or elsewhere in our Company could result in diminished quality of our products and delinquent production schedules, impede our ability to develop new products and harm our business, financial condition or results of operations.
We may not be able to sustain our past growth or successfully implement our growth strategy, which may have a negative effect on our business, financial condition or results of operations.
We grew our sales from approximately $403.1 million in 2016 to approximately $475.6 million in 2017. This growth rate may be unsustainable. Our future growth will depend upon various factors, including the strength of the image of our brands, our ability to continue to produce innovative suspension and ride dynamics products, consumer acceptance of our products, competitive conditions in the marketplace, our ability to make strategic acquisitions, the growth in emerging markets for products requiring high-end suspension products and, in general, the continued growth of the high-end bike and powered vehicle markets into which we sell our products. Our beliefs regarding the future growth of markets for high-end suspension products are based largely on qualitative judgments and limited sources and may not be reliable. If we are unable to sustain our past growth or successfully implement our growth strategy, our business, financial condition or results of operations could be negatively affected.
The professional athletes and race teams who use our products are an important aspect of the image of our brands. The loss of the support of professional athletes for our products or the inability to attract new professional athletes may harm our business.
If our products are not used by current or future professional athletes and race teams, our brands could lose value and our sales could decline. While our sponsorship agreements typically restrict our sponsored athletes and race teams from promoting, endorsing or using competitors’ products that compete directly within our product categories during the term of the sponsorship agreements, we do not typically have long-term contracts with any of the athletes or race teams whom we sponsor.
If we are unable to maintain our current relationships with these professional athletes and race teams, if these professional athletes and race teams are no longer popular, if our sponsored athletes and race teams fail to have success or if we are unable to continue to attract the endorsement of new professional athletes and race teams in the future, the value of our brands and our sales could decline.
We depend on our relationships with dealers and distributors and their ability to sell and service our products. Any disruption in these relationships could harm our sales.
We sell our aftermarket products to dealers and distributors, and we depend on their willingness and ability to market and sell our products to consumers and provide customer and product service as needed. We also rely on our dealers and distributors to be knowledgeable about our products and their features. If we are not able to educate our dealers and distributors so that they may effectively sell our products as part of a positive buying experience, or if they fail to implement effective retail sales initiatives, focus selling efforts on our competitors’ products, reduce the quantity of our products that they sell or reduce their operations due to financial difficulties or otherwise, our brand and business could suffer.
We do not control our dealers or distributors and many of our contracts allow these entities to offer our competitors’ products. Our competitors may incentivize our dealers and distributors to favor their products. In addition, we do not have long-term contracts with a majority of our dealers and distributors, and our dealers and distributors are not obligated to purchase specified amounts of our products. In fact, the majority of our dealers and distributors buy from us on a purchase order basis. Consequently, with little or no notice, many of these dealers and distributors may terminate their relationships with us or materially reduce their purchases of our products. If we were to lose one or more of our dealers or distributors, we would need to obtain a new dealer or distributor to cover the particular location or product line, which may not be possible on favorable terms or at all.
Alternatively, we could use our own sales force to replace such a dealer or distributor, but expanding our sales force into new locations takes a significant amount of time and resources and may not be successful. Further, many of our international distribution contracts contain exclusivity arrangements, which may prevent us from replacing or supplementing our current distributors under certain circumstances.
We are a supplier in the high-end bike and powered vehicles markets, and our business is dependent in large part on the orders we receive from our OEM customers and from their success.
As a supplier to OEM customers, we are dependent in large part on the success of the business of our OEM customers. Model year changes by our OEM customers may adversely impact our sales or cause our sales to vary from quarter to quarter. In addition, losses in market share individually or a decline in the overall market of our OEM customers or the discontinuance by our OEM customers of their products which incorporate our products could negatively impact our business, financial condition or results of operations. For example, if our bike producing OEM customers reduce production of their high-end bikes, their orders to us for our products would in turn be reduced, which could negatively affect our business, financial condition or results of operations.
A relatively small number of customers account for a substantial portion of our sales. The loss of all or a substantial portion of our sales to any of these customers, whether through the temporary or permanent discontinuation of their products which incorporate our products or otherwise, or the loss of market share by these customers could have a material adverse impact on us and our results of operations.
Sales attributable to our five largest OEM customers, which can vary from year to year, collectively accounted for approximately 32%, 30% and 32% of our sales in fiscal years 2017, 2016 and 2015, respectively. The loss of all or a substantial portion of our sales to any of these OEM customers, whether through the temporary or permanent discontinuation of their products which incorporate our products or otherwise, or the loss of market share by these customers could have a material adverse impact on our business, financial condition or results of operations.
In particular, sales to Giant, an OEM and contract manufacturer used by certain of our bike OEM customers, accounted for approximately 10%, 14% and 12% of our sales in 2017, 2016 and 2015, respectively. In the event Giant were to experience manufacturing or other problems, or were to fail to pay us, it could have a material adverse impact on our business, financial condition or results of operations.
Currency exchange rate fluctuations could impact gross margins and expenses.
Foreign currency fluctuations could in the future have an adverse effect on our business, financial condition or results of operations. We sell our products inside and outside of the United States primarily in U.S. Dollars and New Taiwan Dollars. However, some of the OEMs purchasing products from us sell their products in Europe and other foreign markets using the Euro and other foreign currencies. As a result, as the U.S. Dollar appreciates against these foreign currencies, our products will become relatively more expensive for these OEMs. Accordingly, competitive products that our OEM customers can purchase in other currencies may become more attractive and we could lose sales as these OEMs seek to replace our products with cheaper alternatives. In addition, should the U.S. Dollar depreciate significantly, this could have the effect of decreasing our gross margins and adversely impact our business, financial condition or results of operations.
With a majority of our manufacturing operations for our bike products occurring in Taiwan, a percentage of our sales and expenses are denominated in the New Taiwan Dollar. Should the New Taiwan Dollar appreciate against the U.S. Dollar, this could have the effect of decreasing our sales, increasing our expenses, and decreasing our profitability.
Additionally, with the acquisition of Race Face/Easton in 2014, certain of our operations take place in Canada and a percentage of our sales and expenses are denominated in Canadian Dollars. Our operating profitability could be negatively impacted as a result of changes in the exchange rate between the U.S. Dollar and the Canadian Dollar.
Our international operations are exposed to risks associated with conducting business globally.
As a result of our international presence, we are exposed to increased risks inherent in conducting business outside of the United States. In addition to foreign currency risks, these risks include:
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• | difficulty in transporting materials internationally, including labor disputes at West Coast ports, which handle a large amount of our products; |
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• | increased difficulty in protecting our intellectual property rights and trade secrets; |
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• | changes in tax laws and the interpretation of those laws; |
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• | exposure to local economic conditions; |
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• | unexpected government action or changes in legal or regulatory requirements; |
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• | geopolitical regional conflicts, terrorist activity, political unrest, civil strife, acts of war and other political uncertainty; |
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• | changes in tariffs, quotas, trade barriers and other similar restrictions on sales; |
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• | the effects of any anti-American sentiments on our brands or sales of our products; |
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• | increased difficulty in ensuring compliance by employees, agents and contractors with our policies as well as with the laws of multiple jurisdictions, including but not limited to the U.S. Foreign Corrupt Practices Act, local international environmental, health and safety laws, and increasingly complex regulations relating to the conduct of international commerce; |
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• | increased difficulty in controlling and monitoring foreign operations from the United States, including increased difficulty in identifying and recruiting qualified personnel for our foreign operations; and |
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• | increased difficulty in staffing and managing foreign operations or international sales. |
An adverse change in any of these conditions could have a negative effect upon our business, financial condition or results of operations.
U.S. policies related to global trade and tariffs could have a material adverse effect on our results of operations.
The current domestic and international political environment, including existing and potential changes to U.S. policies related to global trade and tariffs, have resulted in uncertainty surrounding the future state of the global economy. In 2018, the U.S. imposed tariffs of 25 percent on steel and 10 percent on aluminum as well as 25 percent tariffs on certain imports from China. Additionally, the U.S. Government has signaled there may be further action on potential tariffs that could be imposed at a later date. While we have limited exposure to implemented tariffs at this time, any expansion in the types of tariffs implemented has the potential to negatively impact our supply chain costs as well as the operating performance of our customers, thus negatively affecting our sales, gross margin and operating performance. Additionally, there is a risk that the U.S. tariffs on imports are met with tariffs on U.S. produced exports and that a broader trade conflict could ensue. This has the potential to significantly impact global trade and economic conditions in many of the regions where we do business and have a material adverse effect on our results of operations.
Our sales could be adversely impacted by the disruption or cessation of sales by other bike component manufacturers or if other bike component manufacturers enter into the specialty bike component market.
Most of the bikes incorporating our suspension products also utilize products and components manufactured by other bike component manufacturers. If such component manufacturers were to cease selling their products and components on a standalone basis, their sales are disrupted, or their competitive market position or reputation is diminished, customers could migrate to competitors that sell complementary bike products which we do not sell. Moreover, such bike component manufacturers could begin manufacturing bike suspension products, wheels, or cranks, or bundle their bike components with suspension products, wheels or cranks manufactured by competitors. If any of the foregoing were to occur, our sales could decrease and our business, financial condition or results of operations could suffer.
We have been and may become subject to intellectual property disputes that could cause us to incur significant costs or pay significant damages or that could prohibit us from selling our products.
As we develop new products or attempt to utilize our brands in connection with new products, we seek to avoid infringing the valid patents and other intellectual property rights of our competitors. However, from time to time, third parties have alleged, or may allege in the future, that our products and/or trademarks infringe upon their proprietary rights. We will evaluate any such claims and, where appropriate, may obtain or seek to obtain licenses or other business arrangements. To date, there have been no significant interruptions in our business as a result of any claims of infringement, and we do not hold patent infringement insurance. Any claim, regardless of its merit, could be expensive, time consuming to defend and distract management from our business. Moreover, if our products or brands are found to infringe third-party intellectual property rights, we may be unable to obtain a license to use such technology or associated intellectual property rights on acceptable terms. A court determination that our brands, products or manufacturing processes infringe the intellectual property rights of others could result in significant liability and/or require us to make material changes to our products and/or manufacturing processes or preclude our ability to use certain brands. In most circumstances, we are not indemnified for our use of a licensor’s intellectual property, if such intellectual property is found to be infringing. Any of the foregoing results could cause us to redesign our products or defend legal actions, which could cause us to incur substantial costs that could negatively affect our business, financial condition or results of operations.
If we are unable to enforce our intellectual property rights, our reputation and sales could be adversely affected.
Intellectual property is an important component of our business. We patent our proprietary technologies related to vehicle suspension and other products in the U.S. and various foreign patent offices. Additionally, we have registered or have applied for trademarks and service marks with the United States Patent and Trademark Office and a number of foreign countries, including the marks FOX®, FOX RACING SHOX®, RACE FACE® and REDEFINE YOUR LIMITS®, to be utilized with certain goods and services. When appropriate, we may from time to time assert our rights against those who infringe on our patents, trademarks, trade dress, or other intellectual property. We may not, however, be successful in enforcing our patents or asserting trademark, trade name or trade dress protection with respect to our brand names and our product designs, and third parties may seek to oppose or challenge our patents or trademark registrations. Further, these legal efforts may not be successful in reducing sales of suspension products by those infringing. In addition, our pending patent applications may not result in the issuance of patents, and even issued patents may be contested, circumvented or invalidated and may not provide us with proprietary protection or competitive advantages. If our efforts to develop and enforce our intellectual property are unsuccessful, or if a third party misappropriates our rights, this may adversely affect our business, financial condition or results of operations. Additionally, intellectual property protection may be unavailable or limited in some foreign countries where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States, and it may be more difficult for us to successfully challenge the use of our proprietary rights by other parties in these countries. Furthermore, other competitors may be able to successfully produce products which imitate certain of our products without infringing upon any of our patents, trademarks or trade dress. The failure to prevent or limit infringements and imitations could have a permanent negative impact on the pricing of our products or reduce our product sales and product margins, even if we are ultimately successful in limiting the distribution of a product that infringes our rights, which in turn may affect our business, financial condition or results of operations.
Although we enter into non-disclosure agreements with employees, OEMs, distributors and others to protect our confidential information and trade secrets, we may be unable to prevent such parties from breaching these agreements with us and using our intellectual property in an unauthorized manner. If our efforts to protect our intellectual property are unsuccessful, or if a third party misappropriates our rights, our business may be adversely affected. Defending our intellectual property rights can be very expensive and time consuming, and there is no assurance that we will be successful.
If we inaccurately forecast demand for our products, we may manufacture insufficient or excess quantities or our manufacturing costs could increase, which could adversely affect our business.
We plan our manufacturing capacity based upon the forecasted demand for our products. In the OEM channel, our forecasts are based in large part on the number of our product specifications for new bikes and powered vehicles and on projections from our OEM customers. In the aftermarket channel, our forecasts are based partially on discussions with our dealers and distributors as well as our own assessment of markets. If we incorrectly forecast demand, we may incur capacity issues in our manufacturing plant and supply chain, increased material costs, increased freight costs, additional overtime, and costs associated with excess inventory, all of which in turn adversely impact our cost of sales and our gross margin. Economic weakness and uncertainty in the United States, Europe and other countries may make accurate forecasting particularly challenging.
In the future, if actual demand for our products exceeds forecasted demand, the margins on our incremental sales in excess of anticipated sales may be lower due to temporary higher costs, which could result in a decrease in our overall margins. While we generally manufacture our products upon receipt of customer orders, if actual demand is less than the forecasted demand for our products and we have already manufactured the products or committed to purchase materials in support of forecasted demand, we could be forced to hold excess inventories. In short, either excess or insufficient production due to inaccurate forecasting could have a negative effect on our business, financial condition or results of operations.
Product recalls, and significant product repair and/or replacement due to product warranty costs and claims have had, and in the future, could have, a material adverse impact on our business.
Unless otherwise required by law, we generally provide a limited warranty for our products for a one or two-year period beginning on: (i) in the case of OEM sales, the date the bike or powered vehicle is purchased from an authorized OEM where our product is incorporated as original equipment on the purchased bike or powered vehicle; or (ii) in the case of aftermarket sales, the date the product is originally purchased from an authorized dealer. From time to time, our customers may negotiate for longer or different warranty coverage. In the ordinary course of business, we incur warranty costs and reserve against such costs in our financial statements. However, there is a risk that we could become aware of an underperforming product and be forced to make adjustments to our warranty reserves or incur costs in excess of these reserves which could adversely affect our results of operations.
Our products and items where our product is incorporated as original equipment on the purchased item are subject to regulation by various agencies, including the National Highway Traffic Safety Administration ("NHTSA"), the U.S. Consumer Product Safety Commission ("CPSC") and similar state and international regulatory authorities. We have had in the past, and may have in the future, recalls (both voluntary and involuntary) of our products or of items that incorporate our products. For example, in October 2016, we initiated a voluntary recall of certain bicycle Float X2 shock absorber products. Most recently, in May 2017, we announced a voluntary recall of approximately 2,460 of FOX's Harley Davidson specific aftermarket motorcycle shock absorbers. In addition to the direct costs related to these or other recalls, in the future, we may be forced to undertake such recalls which could adversely affect our aftermarket and OEM sales if we or our OEM customer do not have a replacement for such recalled product ready in a timely manner. Such recall events could also adversely affect our brand image and have a negative effect on our relationships with our OEMs, sponsored athletes and race teams, or otherwise have a negative effect on our business, financial condition or results of operations.
An adverse determination in any material product liability claim against us could adversely affect our operating results or financial condition.
The use of our products by consumers, often under extreme conditions, exposes us to risks associated with product liability claims. If our products are defective or used incorrectly by our customers, bodily injury, property damage or other injury, including death, may result in and could give rise to product liability claims against us, which could adversely affect our brand image or reputation. We have encountered product liability claims in the past and carry product liability insurance to help protect us against the costs of such claims, although our insurance may not be sufficient to cover all losses. Any losses that we may suffer from any product liability claims, and the effect that any product liability litigation may have upon the reputation and marketability of our products, may have a negative impact on our business, financial condition or results of operations.
Our Second Amended and Restated Credit Facility places operating restrictions on us and creates default risks.
The Second Amended and Restated Credit Facility contains covenants that place restrictions on our operating activities. These covenants, among other things, limit our ability to:
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• | pay dividends or make distributions to our stockholders or redeem our stock; |
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• | incur additional indebtedness or permit additional encumbrances on our assets; and |
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• | make acquisitions or complete mergers or sales of assets, or engage in new businesses. |
These restrictions may interfere with our ability to obtain financing or to engage in other business activities, which may have a material adverse effect on our business, financial condition or results of operations.
If we are unable to comply with the covenants contained in our Second Amended and Restated Credit Facility, it could constitute an event of default and our lenders could declare all borrowings outstanding, together with accrued and unpaid interest, to be immediately due and payable. If we are unable to repay or otherwise refinance these borrowings when due, our lenders could sell the collateral securing our credit facility, which constitutes substantially all of our assets.
We will continue to have the ability to incur debt and our levels of debt may affect our operations and our ability to pay the principal of and interest on our debt.
In the future, we and our subsidiaries may be able to incur substantial additional debt from further amendments to the Second Amended and Restated Credit Facility, additional lending sources subject to the restrictions contained in the Second Amended and Restated Credit Facility, or as a result of certain debt instruments similar to those described in our Shelf Registration Statement on Form S-3, which was filed with the SEC in March 2015, and expired in April 2018.
As of June 29, 2018, we had $65.9 million of indebtedness and $90.0 million in revolving credit available to borrow under the Second Amended and Restated Credit Facility. Our ability to borrow under the Second Amended and Restated Credit Facility fluctuates from time to time due to, among other factors, our borrowings under the facility.
Our indebtedness could be costly or have adverse consequences, such as:
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• | requiring us to dedicate a substantial portion of our cash flows from operations to payments on our debt; |
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• | limiting our ability to obtain future financing for working capital, capital expenditures, acquisitions, debt obligations and other general corporate requirements; |
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• | making us more vulnerable to adverse conditions in the general economy or our industry and to fluctuations in our operating results, including affecting our ability to comply with and maintain any financial tests and ratios required under our indebtedness; |
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• | limiting our flexibility to engage in certain transactions or to plan for, or react to, changes in our business and industry; |
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• | putting us at a disadvantage compared to competitors that have less relative and/or less restrictive debt; and |
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• | subjecting us to additional restrictive financial and other covenants. |
If we incur substantial additional indebtedness in the future, these higher levels of indebtedness may affect our ability to pay the principal of and interest on existing indebtedness and our creditworthiness generally.
Our outstanding indebtedness under the Second Amended and Restated Credit Facility bears interest at a variable rate, which makes us more vulnerable to increases in interest rates and could cause our interest expense to increase and decrease cash available for operations and other purposes.
Borrowings under our Second Amended and Restated Credit Facility bear interest on a variable rate which increases and decreases based upon changes in the underlying interest rate and/or our leverage ratio. Any such increases in the interest rate or increases of our borrowings under the Second Amended and Restated Credit Facility will increase our interest expense.
As of June 29, 2018, we had $65.9 million of indebtedness, bearing interest at a variable rate, outstanding under the Second Amended and Restated Credit Facility. Recent interest rates in the United States have been at historically low levels, and any increase in these rates would increase our interest expense and reduce our funds available for operations and other purposes. Although from time to time we may enter into agreements to hedge a portion of our interest rate exposure, these agreements may be costly and may not protect against all interest rate fluctuations. Accordingly, we may experience material increases in our interest expense as a result of increases in interest rate levels generally. Based on the $65.9 million of variable interest rate indebtedness that was outstanding as of June 29, 2018, a hypothetical 100 basis point increase or decrease in the interest rate would have resulted in an approximately $0.7 million change to our interest expense for the three months ended June 29, 2018.
Unanticipated changes in our tax provisions, the adoption of new tax legislation or exposure to additional tax liabilities could affect our financial performance.
Recently enacted U.S. tax legislation has significantly changed the U.S. federal income taxation of U.S. corporations by reducing the U.S. corporate income tax rate, adopting elements of a territorial tax system, imposing a one-time transition tax (or "deemed repatriation tax") on all undistributed earnings and profits of certain U.S. owned foreign corporations, revising the rules governing net operating losses and the rules governing foreign tax credits, repealing the performance-based compensation exception to the $1 million deduction limit on executive compensation and expanding the scope of employees to whom the limit applies, eliminating the deductibility of certain fringe benefits, permitting immediate expensing of certain capital expenditures, limiting interest deductions, modifying the tax treatment of like kind exchanges, and introducing new anti-base erosion provisions. Many of these changes were effective immediately upon the passage of the legislation, without any transition periods or grandfathering for existing transactions. The legislation is unclear in many respects and could be subject to potential amendments and technical corrections, as well as interpretations and implementation of regulations by the Treasury and IRS, any of which could lessen or increase certain adverse impacts of the legislation. In addition, it is unclear how these U.S. federal income tax changes will affect state and local taxation, which often uses federal taxable income as a starting point for computing state and local tax liabilities, or how the changes will be viewed by foreign governments.
Our analysis and interpretation of this legislation is preliminary and ongoing, and the financial statement impact of the elements of tax reform is incomplete. We asserted permanent reinvestment of the earnings of certain of our foreign subsidiaries in 2016 and 2017 and discontinued this assertion as a result of the December 2017 changes in legislation. As a result, we have identified the deemed repatriation tax, the accrual of state income and foreign withholding taxes on unremitted earnings, and certain other changes to U.S. taxation of amounts earned abroad as having an impact on our financial statements. Additionally, the reduction in the U.S. corporate tax rate, the revision of rules governing foreign tax credits, and changes in the rules regarding the sourcing of income are expected to have an impact on our ability to utilize our existing and future foreign tax credits, and, as such, we have provided a partial valuation allowance on these tax assets. A full valuation allowance was avoided primarily due to the decision to implement a prudent and feasible tax planning strategy to restructure business functions such that both U.S. taxable income and foreign sourced income will increase in future years, allowing a portion of the foreign tax credits to be utilized. However, there can be no assurance that we will be able to implement such a plan. Our potential inability to utilize the net book value of our foreign tax credits could have a material impact on our tax provision, net income and cash flows.
There may be other material adverse effects resulting from the legislation that we have not yet identified. While some of the changes made by the tax legislation may adversely affect the Company in one or more reporting periods and prospectively, other changes may be beneficial. We continue to work with our tax advisors to determine the full impact that the recent tax legislation as a whole will have on us.
We are subject to income and other taxes in the United States and numerous foreign jurisdictions. Our tax liabilities in the United States and abroad are affected by the amounts we charge in intercompany transactions for inventory, services, licenses, funding and other items. We are subject to ongoing tax audits in various jurisdictions. Tax authorities may disagree with our intercompany charges, cross-jurisdictional transfer pricing or other matters, and may assess additional taxes as a result. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the amounts ultimately paid upon resolution of audits could be materially different from the amounts previously included in our income tax expense and therefore could have a material impact on our tax provision, net income and cash flows.
We are subject to certain risks in our manufacturing and in the testing of our products.
As of June 29, 2018, we employed approximately 2,000 full-time employees worldwide, a large percentage of which work at our manufacturing facilities. Our business involves complex manufacturing processes that can be inherently dangerous. Although we employ safety procedures in the design and operation of our facilities, there is a risk that an accident or death could occur in one of our facilities. Also, prior to the introduction of new products, our employees test the products under rigorous conditions, which involve the risk of injury or death. Any accident could result in manufacturing or product delays, which could negatively affect our business, financial condition or results of operations. The outcome of litigation is difficult to assess or quantify and the cost to defend litigation can be significant. As a result, the costs to defend any action or the potential liability resulting from any such accident or death or arising out of any other litigation, and any negative publicity associated therewith, could have a negative effect on our business, financial condition or results of operations.
We are subject to extensive United States federal and state, foreign and international safety, environmental, employment practices and other government regulations that may require us to incur expenses or modify product offerings in order to maintain compliance with such regulation, which could have a negative effect on our business and results of operations.
We are subject to extensive laws and regulations relating to safety, environmental, and other laws and regulations promulgated by the United States federal and state governments, as well as foreign and international regulatory authorities. Although we believe that our products, policies and processes comply with applicable safety, environmental, and other standards and related regulations, future regulations may require additional safety standards that would require additional expenses and/or modification of product offerings in order to maintain such compliance. Failure to comply with applicable regulations could result in fines, increased expenses to modify our products and harm to our reputation, all of which could have an adverse effect on our business, financial condition or results of operations.
Moreover, certain of our customer contracts require us to comply with the standards of voluntary standard-setting organizations, such as the CPSC, the NHTSA, and the European Committee for Standardization ("CEN"). Failure to comply with the voluntary requirements of such organizations could result in the loss of certain customer contracts, which could have an adverse effect on our business, financial condition or results of operations.
Unpredictability in the adoption, implementation and enforcement of increasingly stringent emission standards by multiple jurisdictions could adversely affect our business.
Certain of our products are subject to extensive statutory and regulatory requirements governing emission and noise, including standards imposed by the EPA, the EU, state regulatory agencies (such as the CARB) and other regulatory agencies around the world. We have made, and continue to make, capital and research expenditures to ensure our certain of our products comply with these emission standards. Developing products to meet numerous changing government regulatory requirements, with different implementation timelines and emission requirements, makes developing products efficiently for multiple markets complicated and could result in additional costs that may be difficult to recover in certain markets. In some cases, we may be required to develop new products to comply with new regulations, particularly those relating to air emissions. The successful development and introduction of new and enhanced products in order to comply with new regulatory requirements are subject to other risks, such as delays in product development, cost over-runs and unanticipated technical and manufacturing difficulties.
In addition to these risks, the nature and timing of government implementation and enforcement of increasingly stringent emission standards is unpredictable. Any delays in implementation or enforcement could result in the products we developed or modified to comply with these standards becoming unnecessary or becoming necessary later than expected, which in turn could delay, diminish or eliminate the expected return and may adversely affect our business.
Increasing focus on environmental, social and governance responsibility, may impose additional costs on us and expose us to new risks
Regulators, stockholders and other interested constituencies have focused increasingly on the environmental, social and governance practices of companies. Our customers may require us to implement environmental, social or governance responsibility procedures or standards before they will continue to do business with us. Additionally, we may face reputational challenges in the event our environmental, social or governance responsibility procedures or standards do not meet the standards set by certain constituencies. The occurrence of any of the foregoing could have a material adverse effect on the price of our shares and our business, financial condition and results of operations.
We are subject to employment practice laws and regulations, and as, such are exposed to litigation risks.
We are subject to extensive laws and regulations relating employment practices, including wage and hour, wrongful termination and discrimination. Complying with such laws and regulations, and defending against allegations of our failure to comply (including meritless allegations), can be expensive and time consuming. We believe that our policies and processes comply with applicable employment standards and related regulations, however, we are subject to risks of litigation by employees and others which might involve allegations of illegal, unfair or inconsistent employment practices, including wage and hour violations and employment discrimination, misclassification of independent contractors as employees, wrongful termination and other concerns, which could require additional expenditures.
We are subject to environmental laws and regulation and potential exposure for environmental costs and liabilities.
Our operations, facilities and properties are subject to a variety of foreign, federal, state and local laws and regulations relating to health, safety and the protection of the environment. These environmental laws and regulations include those relating to the use, generation, storage, handling, transportation, treatment and disposal of solid and hazardous materials and wastes, emissions to air, discharges to waters and the investigation and remediation of contamination. Many of these laws impose strict, retroactive, joint and several liability upon owners and operators of properties, including with respect to environmental matters that occurred prior to the time the party became an owner or operator. In addition, we may have liability with respect to third party sites to which we send waste for disposal. Failure to comply with such laws and regulations can result in significant fines, penalties, costs, liabilities or restrictions on operations that could negatively affect our business, financial condition or results of operations. From time to time, we have been involved in administrative or legal proceedings relating to environmental, health or safety matters and have incurred expenditures relating to such matters in the past.
We believe that our operations are in substantial compliance with applicable environmental laws and regulations. However, additional environmental issues relating to presently known or unknown matters could give rise to currently unanticipated investigation, assessment or expenditures. Compliance with more stringent laws or regulations, as well as different interpretations of existing laws, more vigorous enforcement by regulators or unanticipated events, could require additional expenditures that may materially affect our business, financial condition or results of operations.
Federal, state, local, foreign and international laws and regulations relating to land-use, and noise and air pollution may have a negative impact on our future sales and results of operations.
The products in our powered vehicles line are used in vehicles which are subject to numerous federal, state, local, foreign and international laws and regulations relating to noise and air pollution. Powered vehicles, and even bikes, have become subject to laws and regulations prohibiting their use on certain lands and trails. For example, in San Mateo County, California, mountain bikes are not allowed on county trails, and ATV and Side-by-Side riding is not allowed in Zion National Park, among many other national and state parks. In addition, recreational snowmobiling has been restricted in some national parks and federal lands in Canada, the United States and other countries. If more of these laws and regulations are passed and the users of our products lose convenient locations to ride their mountain bikes and powered vehicles, our sales could decrease and our business, financial condition or results of operations could suffer.
Fuel shortages, or high prices for fuel, could have a negative effect on the use of powered vehicles that use our products.
Gasoline or diesel fuel is required for the operation of the powered vehicles that use our products. There can be no assurance that the supply of these fuels will continue uninterrupted, that rationing will not be imposed or that the price of or tax on these petroleum products will not significantly increase in the future. Future shortages of