UFP Technologies, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are to December 31, 2017. The interim financial statements are unaudited.
Business context and results
UFP designs and manufactures custom products from foams, plastics, composites and natural fibers, primarily for medical, consumer, automotive, electronics, industrial, and aerospace and defense markets. It reports one operating segment. On February 1, 2018, UFP acquired medical-device manufacturer Dielectrics, Inc. for $80 million in cash, subject to a $250,000 working-capital adjustment; after acquired cash, the reported net acquisition cash outflow was $76.978 million.
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $42.931 million | $37.053 million |
| Gross profit / gross margin | $10.185 million / 23.7% | $9.516 million / 25.7% |
| Operating income | $2.564 million | $3.205 million |
| Net income | $1.777 million | $2.171 million |
| Diluted EPS | $0.24 | $0.30 |
| Operating cash flow | $(1.992) million | $4.138 million |
| Capital expenditures | $1.494 million | $1.463 million |
Performance and material changes
- Sales increased 15.9% (approximately 16%); Dielectrics contributed about $6.0 million of revenue and $1.1 million of net income after its February acquisition. Medical sales rose 38% and consumer sales 23%; automotive sales declined 20% and aerospace and defense sales 19%.
- Gross margin fell 2.0 percentage points. Management attributed the pressure principally to the Georgia plant, which had little sales and about $0.5 million of overhead, as well as higher material, labor, and overhead costs as a share of sales.
- Operating income and EPS declined despite sales growth. The quarter included approximately $1.1 million of Dielectrics acquisition costs and approximately $630,000 of Georgia-plant losses. Management said neither item was expected to affect earnings going forward.
- SG&A was $6.592 million, up 4.4% year over year, but declined to 15.4% of sales from 17.0%. Interest expense rose with acquisition financing. The effective tax rate was 24.9%, versus 32.8%, principally reflecting the lower federal statutory rate and share-based-payment tax benefits.
- Dielectrics’ unaudited pro forma results, as if acquired at the beginning of each period, were sales of $45.986 million and net income of $2.375 million in Q1 2018, versus sales of $47.428 million and net income of $2.681 million in Q1 2017. The filing cautions that these illustrative figures may not reflect actual results.
Cash, debt, and liquidity
- Cash declined to $7.064 million from $37.978 million at year-end. Operating activities used $1.992 million, with working-capital uses including higher receivables, inventory, prepaid expenses, and lower accounts payable and accrued expenses.
- Investing activities used $78.432 million, mainly for the Dielectrics acquisition. Financing activities provided $49.510 million, including $56.0 million of credit-facility borrowings, partly offset by repayments and other payments.
- Long-term debt was $49.286 million, including $30.0 million drawn on the revolver and a $19.286 million term loan; $2.857 million was classified as current. The amended unsecured facilities comprise a $20 million term loan and a revolving facility of up to $50 million, maturing February 1, 2023. The reported applicable interest rate was approximately 2.88%; UFP was in covenant compliance.
- A $20 million, five-year interest-rate swap converts the term loan’s rate exposure to a fixed 2.7% plus the applicable margin. Standby letters of credit totaled approximately $0.6 million.
- Management said existing resources, operating cash generation, the revolver, and potential equipment financing or additional bank borrowing were expected to fund requirements, including capital spending, for the next 12 months. It also noted future liquidity depends on operating performance and that it cannot guarantee future operating cash generation.
Outlook, accounting, and risks
- No specific earnings or revenue guidance was provided. Management planned to add manufacturing capacity and pursue organic growth and strategic acquisitions. It expected aerospace and defense sales weakness to reflect order timing rather than the balance-of-year pattern, and said Georgia plant closure-related costs were not expected to recur.
- The Georgia plant closed in April 2018 following the phase-out of the Mercedes-Benz door-panel program. Management cited risks involving plant consolidation, customer-part requalification and relocation, equipment implementation, acquisition integration, and the ability to realize efficiencies and use production capacity.
- Dielectrics’ purchase-price allocation was preliminary and included $44.516 million of goodwill and $22.555 million of customer-list intangibles; valuations could change. The company leased Dielectrics’ Chicopee facility for five years, with two five-year renewal options.
- UFP adopted ASC 606 on January 1, 2018 using the modified retrospective method. The adoption reduced opening retained earnings by $95,000; Q1 net sales were $57,000 higher than under legacy GAAP. Certain tooling revenue is deferred and recognized over the estimated production period, approximately two years. The filing also notes that results for the quarter are not necessarily indicative of full-year results.
- Management reported effective disclosure controls. Dielectrics’ internal control over financial reporting was excluded from the assessment in the acquisition year; the filing states the acquired business represented 43.1% of consolidated assets and 14.0% of quarterly revenue.
Important facts for investors to verify
- Whether Dielectrics integration and its contribution to revenue, earnings, and cash generation meet expectations.
- Whether gross margins recover after the Georgia closure and whether the Mercedes-Benz program phase-out and part requalification affect subsequent periods.
- Whether receivables and inventory growth convert to cash, given negative Q1 operating cash flow and the decline in cash balances.
- Debt levels, borrowing costs, covenant headroom, and available capacity under the $50 million revolver following acquisition financing.
- Final Dielectrics purchase accounting, including goodwill and intangible-asset valuations, and any subsequent acquisition-related or integration costs.