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Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark one)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934.

 

For the quarterly period ended June 29, 2014

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934.

 

For the transition period from            to

 

Commission file number 333-171547

 


 

Colt Defense LLC

Colt Finance Corp.

(Exact name of Registrant as specified in its charter)

 

Delaware

 

32-0031950

Delaware

 

27-1237687

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

547 New Park Avenue, West Hartford, CT

 

06110

(Address of principal executive offices)

 

(Zip Code)

 

(860) 232-4489

(Registrant’s telephone number, including area code)

 

Indicate by a check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and 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  x   No o

 

Indicate by check mark whether the Registrant had submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for shorter period that the Registrant was required to submit and post such files).  Yes  x   No  o

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

Non-accelerated filer x

 

Smaller reporting company o

 

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

 

The number of shares outstanding of the Registrant’s common stock as of September 12, 2014 was none.

 

 

 



Table of Contents

 

COLT DEFENSE LLC

INDEX

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

 

Item 1. Financial Statements (unaudited)

 

 

 

Consolidated Balance Sheets — As of June 29, 2014 and December 31, 2013 (As Restated)

3

 

 

Consolidated Statements of Operations — Three and Six Months Ended June 29, 2014 and June 30, 2013 (As Revised)

4

 

 

Consolidated Statements of Comprehensive Income (Loss) — Three and Six Months Ended June 29, 2014 and June 30, 2013(As Revised)

5

 

 

Consolidated Statements of Changes in Cash Flows — Six Months Ended June 29, 2014 and June 30, 2013 (As Revised)

6

 

 

Notes to Consolidated Financial Statements (Unaudited)

7

 

 

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

31

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

41

 

 

Item 4. Controls and Procedures

41

 

 

PART II. OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings

43

 

 

Item 1A. Risk Factors

43

 

 

Item 6. Exhibits

44

 

 

Signatures

45

 

2



Table of Contents

 

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

 

Colt Defense LLC and Subsidiaries

Consolidated Balance Sheets

(In thousands of dollars)

(Unaudited)

 

 

 

June 29, 2014

 

December 31, 2013

 

 

 

 

 

(As Restated)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,198

 

$

12,594

 

Restricted cash

 

771

 

771

 

Accounts receivable, net

 

15,896

 

22,482

 

Inventories

 

75,507

 

66,674

 

Deferred tax assets

 

173

 

954

 

Other current assets

 

3,787

 

5,962

 

Total current assets

 

98,332

 

109,437

 

 

 

 

 

 

 

Property and equipment, net

 

29,051

 

30,733

 

Goodwill

 

51,188

 

51,225

 

Trademarks

 

50,100

 

50,100

 

Intangible assets with finite lives, net

 

11,766

 

13,415

 

Deferred financing costs

 

6,531

 

7,742

 

Long-term restricted cash

 

572

 

572

 

Other assets

 

1,480

 

1,510

 

Total assets

 

$

249,020

 

$

264,734

 

LIABILITIES AND DEFICIT

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Line of credit

 

$

13,500

 

$

7,083

 

Accounts payable

 

16,444

 

14,038

 

Accrued expenses (Note 10)

 

21,039

 

22,158

 

Pension and retirement liabilities - current portion

 

1,085

 

1,085

 

Customer advances and deferred income

 

17,867

 

19,467

 

Long-term debt - current portion (Note 9)

 

625

 

5,000

 

Accrued distributions to members

 

 

670

 

Total current liabilities

 

70,560

 

69,501

 

 

 

 

 

 

 

Long-term debt

 

294,180

 

289,817

 

Pension and retirement liabilities

 

22,758

 

21,670

 

Long-term deferred tax liability

 

17,808

 

18,715

 

Long-term distribution payable to members

 

2,277

 

2,277

 

Other long-term liabilities

 

3,139

 

2,230

 

Total long-term liabilities

 

340,162

 

334,709

 

Total liabilities

 

410,722

 

404,210

 

Commitments and Contingencies (Note 16)

 

 

 

 

 

Deficit:

 

 

 

 

 

Accumulated deficit

 

(150,755

)

(130,136

)

Accumulated other comprehensive loss

 

(10,947

)

(9,340

)

Total deficit

 

(161,702

)

(139,476

)

Total liabilities and deficit

 

$

249,020

 

$

264,734

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3



Table of Contents

 

Colt Defense LLC and Subsidiaries

Consolidated Statements of Operations

(In thousands of dollars)

(Unaudited)

 

 

 

For the Three Months Ended

 

For the Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

 

 

(As Revised)

 

Net sales

 

$

49,633

 

$

64,212

 

$

99,713

 

$

128,061

 

Cost of sales

 

44,640

 

45,830

 

85,026

 

90,942

 

Gross profit

 

4,993

 

18,382

 

14,687

 

37,119

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling and commissions

 

4,620

 

3,452

 

9,081

 

6,547

 

Research and development

 

1,392

 

1,481

 

2,635

 

2,301

 

General and administrative

 

3,801

 

3,015

 

7,710

 

6,745

 

 

 

9,813

 

7,948

 

19,426

 

15,593

 

Business development

 

9

 

169

 

509

 

244

 

Certain transaction costs

 

 

416

 

 

416

 

Restructuring costs (Note 4)

 

(76

)

 

(76

)

 

Total operating expenses

 

9,746

 

8,533

 

19,859

 

16,253

 

Operating income

 

(4,753

)

9,849

 

(5,172

)

20,866

 

 

 

 

 

 

 

 

 

 

 

Other expense (income):

 

 

 

 

 

 

 

 

 

Interest expense

 

7,859

 

6,069

 

15,543

 

12,063

 

Other income, net

 

(42

)

(685

)

(113

)

(1,472

)

Total other expense, net

 

7,817

 

5,384

 

15,430

 

10,591

 

Income (loss) before provision for income taxes

 

(12,570

)

4,465

 

(20,602

)

10,275

 

Income tax expense

 

19

 

78

 

(67

)

759

 

Net (loss) income

 

$

(12,589

)

$

4,387

 

$

(20,535

)

$

9,516

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



Table of Contents

 

Colt Defense LLC and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(In thousands of dollars)

(Unaudited)

 

 

 

For the Three Months Ended

 

For the Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

 

 

(As Revised)

 

Net income (loss)

 

$

(12,589

)

$

4,387

 

$

(20,535

)

$

9,516

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment:

 

 

 

 

 

Foreign currency translation losses

 

798

 

(1,035

)

(140

)

(1,611

)

 

 

 

 

 

 

 

 

 

 

Pension and postretirement benefit liabilities:

 

 

 

 

 

 

 

 

 

Other comprehensive income arising during the period

 

(1,550

)

 

(1,550

)

 

Reclassification adjustment for unrecognized prior service costs and unrecognized loss included in net income (loss)

 

36

 

117

 

83

 

250

 

 

 

(1,514

)

117

 

(1,467

)

250

 

Comprehensive income (loss)

 

$

(13,305

)

$

3,469

 

$

(22,142

)

$

8,155

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5



Table of Contents

 

Colt Defense LLC and Subsidiaries

Consolidated Statements of Changes in Cash Flows

(In thousands of dollars)

(Unaudited)

 

 

 

For the Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

Operating Activities

 

 

 

 

 

Net income (loss)

 

$

(20,535

)

$

9,516

 

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

4,845

 

2,368

 

Amortization of financing fees

 

1,211

 

828

 

Amortization of debt discount

 

613

 

206

 

Postretirement health plan curtailment

 

(98

)

 

Deferred income taxes

 

(119

)

15

 

Other non-cash items

 

19

 

(17

)

Changes in operating assets and liabilities, net of acquisition:

 

 

 

 

 

Accounts receivable

 

6,407

 

(11,836

)

Inventories

 

(8,856

)

(11,148

)

Prepaid expenses and other current assets

 

2,174

 

(510

)

Accounts payable and accrued expenses

 

801

 

1,922

 

Accrued pension and retirement liabilities

 

(378

)

(546

)

Customer advances and deferred income

 

(1,544

)

(577

)

Other

 

988

 

96

 

Net cash used in operating activities

 

(14,472

)

(9,683

)

Investing Activities

 

 

 

 

 

Purchases of property and equipment

 

(1,541

)

(3,260

)

Change in restricted cash

 

 

5

 

Net cash used in investing activities

 

(1,541

)

(3,255

)

Financing Activities

 

 

 

 

 

Repayments of long-term debt

 

(625

)

 

Line of credit advances

 

13,500

 

74

 

Line of credit repayments

 

(7,083

)

 

Purchase of common units

 

 

(14,000

)

Distributions paid to members

 

(683

)

(1,357

)

Net cash provided by (used in) financing activities

 

5,109

 

(15,283

)

Effect of exchange rates on cash and cash equivalents

 

508

 

(543

)

Change in cash and cash equivalents

 

(10,396

)

(28,764

)

Cash and cash equivalents, beginning of period

 

12,594

 

42,373

 

Cash and cash equivalents, end of period

 

$

2,198

 

$

13,609

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

Cash paid for interest

 

$

12,468

 

$

11,401

 

Cash paid for income taxes

 

576

 

586

 

Non-cash consideration for sale of equipment

 

 

7

 

Accrued purchases of fixed assets

 

126

 

42

 

Accrued distribution to members

 

13

 

3,508

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6



Table of Contents

 

Notes to Consolidated Financial Statements (unaudited)

(in thousands of dollars)

 

Note 1   Nature of Business

 

Colt Defense LLC (“Colt Defense” or the “Company”) is one of the world’s oldest and most renowned designers, developers and manufacturers of firearms for military, personal defense and recreational purposes.  Our founder, Samuel Colt, patented the first commercially successful revolving cylinder firearm in 1836 and, in 1847, began supplying U.S. and international military customers with firearms that have set the standards of their era.  Today, our end customers encompass every segment of the worldwide firearms market, including U.S., Canadian and foreign military forces, global law enforcement and security agencies, consumers seeking personal protection, the hunting and sporting community and collectors.

 

As of January 1, 2014, Colt Defense effected a legal entity restructuring whereby Colt Defense and New Colt Holding Corp. (“New Colt”) (See Note 3, “Acquisition” and Note 11, “Income Taxes”) contributed their assets and operations to Colt’s Manufacturing Company LLC (“Colt’s Manufacturing”), a limited liability corporation.  The contribution created a combined operating entity for the Company’s U.S. based operations.

 

As of December 31, 2013, Colt Defense owned 100% of Colt Finance, New Colt and Colt Defense Technical Services LLC (“CDTS”), New Colt owned 100% of Colt’s Manufacturing and Colt Defense and CDTS collectively owned 100% of Colt International which owned 100% of Colt Canada.  Effective January 1, 2014, Colt Defense, a limited liability corporation, owned 100% of Colt Finance Corp. (“Colt Finance”), New Colt, a C corporation, and CDTS, a limited liability corporation.  Colt Defense and New Colt collectively own 100% of Colt’s Manufacturing as a result of the legal entity restructuring and Colt Defense and CDTS collectively own 100% of Colt International Coöperatief U.A. (“Colt International”), a Dutch cooperatief, which owns 100% of Colt Canada Corporation (“Colt Canada”),  a Canadian C corporation.

 

The company operates on a monthly 4-4-5 week calendar with the end of each month on a Sunday, except for the month of December which ends on the 31st. The first two months of each quarter, with the exception of January, have four weeks and the third month of each quarter, with the exception of December, has five weeks.  The 4-4-5 calendar ensures that the end date of the period is always the same day of the week, which is utilized by the Company for shift and manufacturing planning, and it also ensures that every period is the same length.

 

The following items, which are discussed in further detail in the notes to the consolidated financial statements for the second quarter of 2014 had an impact on the Company’s results as included in the Form 10-Q:

 

The Company restated its Annual Report on Form 10-K/A for the year ended December 31, 2013 and revised the unaudited interim financial statements for the first three quarters in the fiscal year ended December 31, 2013.  (See Note 2, “Summary of Significant Accounting Policies — Restatement of Previously Issued Consolidated Financial Statements”).

 

The Company, as a result of the decrease in demand for commercial rifles, concluded that a triggering event had occurred and an interim impairment test for indefinite lived intangible assets, Goodwill and Trademarks, was conducted as of June 29, 2014.  (See Note 8, “Goodwill, Trademarks and Other Intangible Assets”).  The Company concluded no impairment existed as of June 29, 2014.

 

On August 6, 2014, the Company entered into Amendment No. 1 to the Term Loan (the “Term Loan Amendment”). Absent an amendment to the Term Loan, the Company would have been in violation of certain of its financial covenants as of June 29, 2014.  The Term Loan Amendment eliminated and modified certain covenants and provided for an extension of the time period for delivery of certain financial information to its lenders.  Also, on August 6, 2014, the Company obtained an amendment to its credit agreement that provided an extension of the time period for delivery of certain financial information to its lenders, (See Note 9, “Notes Payable and Long-Term Debt”).  It is possible the Company will not meet one or more of the term loan covenants, as amended, as of December 31, 2014, or subsequent quarters of 2015.

 

On March 30, 2014, Colt Defense through its domestic operating subsidiary Colt’s Manufacturing reached tentative agreement with UAW Local 376 for a new five year contract covering approximately 529 employees, which was ratified by the union membership on March 31, 2014.  The new contract will be in effect from April 1, 2014 through March 31, 2019.

 

In response to, among other factors, the decrease in demand for commercial rifles, the Company initiated actions which resulted in a workforce reduction of 24 salaried and 64 hourly employees in the second quarter of 2014.  In addition, subsequent to June 29, 2014 the Company initiated an additional workforce reduction of 9 salaried employees.  (See Note 16, “Commitments and Contingencies”).

 

7



Table of Contents

 

In conjunction with the workforce reduction, the Company recognized a curtailment of its postretirement health plan. (See Note 12, “Pension and Postretirement Benefits”).

 

During the second quarter of 2014, based upon new additional information, the Company reassessed the M240 machine gun program (the “M240 Program”) accruals and determined an incremental $4,779 contract obligation expense was required. (See Note 16, “Commitments and Contingencies”).  The Company also accrued $480 in connection with the Company’s No-Cost Cancellation of its M249 contract with the U.S. Government.

 

Note 2  Summary of Significant Accounting Policies

 

Restatement of Previously Issued Consolidated Financial Statements

 

In the Company’s 2013 Annual Report on Form 10-K/A, it restated its previously issued consolidated financial statements and the related disclosures for the year ended December 31, 2013 (the “Restated Period”).  The Company also revised the unaudited interim financial statements for the first three quarters in the fiscal year ended December 31, 2013 and the fourth quarter in the fiscal year ended December 31, 2012 (the “Revised Periods”).

 

The restatement is the result of the Company’s correction of a financial statement error attributable to the lack of recognition of the impact of a contract modification related to the M240 Program for the U.S. Government in the Company’s fourth quarter 2013 results.  There was no impact to the Company’s net sales or cost of sales in the three and six month periods ended June 30, 2013 related to the M240 Program error.  In conjunction with the correction of the M240 Program error, other previously recorded, immaterial out-of-period adjustments were also adjusted to be reflected in the proper period, along with the reclassification of business development expenses from other expense (income) to operating income.  Correction of these previously recorded, immaterial out-of-period adjustments had the combined effect on the consolidated statements of operations for the three and six month periods ended June 30, 2013 of increasing net income by $229 and $288, respectively.

 

The impacts of correcting the previously recorded, immaterial out-of-period adjustments and the reclassification of business development expenses for the three and six month periods ended June 30, 2013 were as follows:

 

 

 

Adjustments to

 

 

 

Previously Reported Income

 

 

 

Statement - Income / (Expense)

 

 

 

Three Months Ended

 

Six Months Ended

 

For the years ended

 

June 30, 2013

 

June 30, 2013

 

Net sales

 

$

(23

)

(23

)

Cost of sales

 

65

 

79

 

Gross profit

 

(88

)

(102

)

Selling and commissions (A)

 

(130

)

(209

)

Research and development

 

1

 

2

 

General and administrative (B)

 

(222

)

(217

)

Business development (C) 

 

169

 

244

 

Operating income

 

94

 

78

 

Other (income) / expense (C) 

 

(192

)

(267

)

Income tax expense

 

57

 

57

 

Net income (loss) (B)

 

229

 

288

 

 


(A) Primarily relates to the reclassification of $132 of armorers training expenses from selling and commissions to cost of sales.

(B) Primarily relates to the timing of recognition of certain professional fees.

(C) Primarily relates to the reclassification of transaction costs incurred in connection with contemplated merger and acquisition activities from other expense/(income) to business development.

 

This Quarterly Report on Form 10-Q for the quarter ended June 29, 2014 includes the impact of adjustments to the Restated Period and Revised Periods on the applicable unaudited quarterly financial information for the quarter ended June 29, 2013.  In addition, the Company’s future Quarterly Reports on Form 10-Q for subsequent quarterly periods during 2014 will also include the impact of adjustments to the Restated Period and Revised Periods on applicable 2013 comparable prior quarter and year to date periods.  The

 

8



Table of Contents

 

effect of the revision on previously issued quarterly information as of and for the three and six months ended June 29, 2013 is set forth in this footnote.

 

The Company’s previously filed Annual Reports on Form 10-K for the year ended December 31, 2012 and Quarterly Reports on Form 10-Q for the Revised Periods will not be amended.

 

Comparison of revised financial statements to financial statements as previously reported

 

The following tables compare our previously reported Consolidated Statements of Operations, Comprehensive Income (Loss) and Changes in Cash Flows for the quarter ended June 29, 2013 to the corresponding financial statements for the quarterly period as revised.

 

Colt Defense LLC and Subsidiaries

Consolidated Statement of Operations

(In thousands of dollars)

(Unaudited)

 

 

 

Three months ended June 30, 2013

 

Six months ended June 30, 2013

 

 

 

 

 

 

 

As Revised

 

 

 

 

 

As Revised

 

 

 

As

 

 

 

in this Quarterly

 

As

 

 

 

in this Quarterly

 

 

 

Previously

 

 

 

Report on

 

Previously

 

 

 

Report on

 

 

 

Reported

 

Adjustments

 

Form 10-Q

 

Reported

 

Adjustments

 

Form 10-Q

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

64,235

 

$

(23

)

$

64,212

 

$

128,084

 

$

(23

)

$

128,061

 

Cost of sales

 

45,765

 

65

 

45,830

 

90,863

 

79

 

90,942

 

Gross Profit

 

18,470

 

(88

)

18,382

 

37,221

 

(102

)

37,119

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and commissions

 

3,582

 

(130

)

3,452

 

6,756

 

(209

)

6,547

 

Research and development

 

1,480

 

1

 

1,481

 

2,299

 

2

 

2,301

 

General and administrative

 

3,237

 

(222

)

3,015

 

6,962

 

(217

)

6,745

 

 

 

8,299

 

(351

)

7,948

 

16,017

 

(424

)

15,593

 

Business development

 

 

169

 

169

 

 

244

 

244

 

Certain transaction costs

 

416

 

 

416

 

416

 

 

416

 

Total operating expenses

 

8,715

 

(182

)

8,533

 

16,433

 

(180

)

16,253

 

Operating income

 

9,755

 

94

 

9,849

 

20,788

 

78

 

20,866

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expense/(income):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

6,069

 

 

6,069

 

12,063

 

 

12,063

 

Other (income)/expense, net

 

(493

)

(192

)

(685

)

(1,205

)

(267

)

(1,472

)

Total other expenses, net

 

5,576

 

(192

)

5,384

 

10,858

 

(267

)

10,591

 

Income (loss) before provision for income taxes

 

4,179

 

286

 

4,465

 

9,930

 

345

 

10,275

 

Income tax expense

 

21

 

57

 

78

 

702

 

57

 

759

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

4,158

 

$

229

 

$

4,387

 

$

9,228

 

$

288

 

$

9,516

 

 

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Table of Contents

 

Colt Defense LLC and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(In thousands of dollars)

(Unaudited)

 

 

 

For the Three Months Ended June 30, 2013

 

 

 

 

 

 

 

As Revised

 

 

 

As

 

 

 

in this Quarterly

 

 

 

Previously

 

 

 

Report on

 

 

 

Reported

 

Adjustments

 

Form 10-Q

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

4,158

 

$

229

 

$

4,387

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

Foreign currency translation adjustment:

 

 

 

 

 

 

 

Foreign currency translation gains (losses)

 

(1,020

)

(15

)

(1,035

)

 

 

 

 

 

 

 

 

Pension and postretirement benefit liabilities:

 

 

 

 

 

 

 

Other comprehensive income (loss) arising during the period

 

 

 

 

Reclassification adjustment for unrecognized prior service costs and unrecognized loss included in net income (loss)

 

117

 

 

117

 

 

 

117

 

 

117

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

3,255

 

$

214

 

$

3,469

 

 

Consolidated Statements of Comprehensive Income (Loss)

(In thousands of dollars)

(Unaudited)

 

 

 

For the Six Months Ended June 30, 2013

 

 

 

 

 

 

 

As Revised

 

 

 

As

 

 

 

in this Quarterly

 

 

 

Previously

 

 

 

Report on

 

 

 

Reported

 

Adjustments

 

Form 10-Q

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

9,228

 

$

288

 

$

9,516

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

Foreign currency translation adjustment:

 

 

 

 

 

 

 

Foreign currency translation gains (losses)

 

(1,597

)

(11

)

(1,608

)

 

 

 

 

 

 

 

 

Pension and postretirement benefit liabilities:

 

 

 

 

 

 

 

Other comprehensive income (loss) arising during the period

 

 

 

 

Reclassification adjustment for unrecognized prior service costs and unrecognized loss included in net income (loss)

 

250

 

 

250

 

 

 

250

 

 

250

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

7,881

 

$

277

 

$

8,158

 

 

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Table of Contents

 

Colt Defense LLC and Subsidiaries

Consolidated Statement of Changes in Cash Flows

(In thousands of dollars)

(Unaudited)

 

 

 

For the Six Months Ended June 30, 2013

 

 

 

 

 

 

 

As Revised

 

 

 

As

 

 

 

in this Quarterly

 

 

 

Previously

 

 

 

Report on

 

 

 

Reported

 

Adjustments

 

Form 10-Q

 

Operating Activities

 

 

 

 

 

 

 

Net income (loss)

 

$

9,228

 

$

288

 

$

9,516

 

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

2,368

 

 

2,368

 

Amortization of financing fees

 

828

 

 

828

 

Amortization of debt discount

 

206

 

 

206

 

Deferred income taxes

 

15

 

 

15

 

Other non-cash items

 

(17

)

 

(17

)

Changes in operating assets and liabilites, net of acquisition:

 

 

 

 

 

 

 

Accounts receivable

 

(11,852

)

16

 

(11,836

)

Inventories

 

(11,148

)

 

(11,148

)

Prepaid expense and other current assets

 

(333

)

(177

)

(510

)

Accounts payable and accrued expense

 

2,145

 

(223

)

1,922

 

Accrued pension and retirement liabilities

 

(658

)

112

 

(546

)

Customer advances and deferred income

 

(577

)

 

(577

)

Other

 

96

 

 

96

 

Net cash (used in) provided by operating activities

 

(9,699

)

16

 

(9,683

)

 

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

 

 

Purchase of property and equipment

 

(3,260

)

 

(3,260

)

Change in restricted cash

 

5

 

 

5

 

Net cash used in investing activities

 

(3,255

)

 

(3,255

)

 

 

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

 

 

Line of credit advances

 

74

 

 

74

 

Purchase of common units

 

(14,000

)

 

(14,000

)

Distributions paid to members

 

(1,357

)

 

(1,357

)

Net cash used financing activities

 

(15,283

)

 

(15,283

)

 

 

 

 

 

 

 

 

Effect of exchange rates on cash and cash equivalents

 

(527

)

(16

)

(543

)

Change in cash and cash equivalents

 

(28,764

)

 

(28,764

)

Cash and cash equivalents, beginning of period

 

42,373

 

 

42,373

 

Cash and cash equivalents, end of period

 

$

13,609

 

$

 

$

13,609

 

 

11



Table of Contents

 

Basis of Accounting and Consolidation

 

The accompanying unaudited consolidated financial statements of Colt Defense and Colt Finance (collectively, the “Company”, or “Colt”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  In the opinion of management, all significant adjustments (consisting of normal recurring accruals) considered necessary for a fair statement of the financial position, results of operations and cash flows for the three and six months ended June 29, 2014 and June 30, 2013, as revised, have been included.  The financial information included in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes in the Company’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013, as restated. The consolidated balance sheet dated December 31, 2013, as restated, included in this quarterly report on Form 10-Q has been derived from the audited consolidated financial statements at that time, but does not include all disclosures required by GAAP. Operating results for the three and six months ended June 29, 2014 are not necessarily indicative of the results to be expected for any subsequent interim period or for the year ending December 31, 2014.

 

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated.

 

On July 12, 2013 (the “Merger Date”), the Company acquired 100% ownership (the “Merger”) of New Colt.  The results of New Colt have been included in the unaudited consolidated financial statements from the Merger Date.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include estimates used to determine the fair value of assets acquired and liabilities assumed related to the acquisition of New Colt (see Note 3, “Acquisition”) and accruals for the Company’s M240 Program (see Note 16, “Commitments and Contingencies”), excess and obsolete inventory, income tax expense, deferred tax asset valuation, medical claims payable, and worker’s compensation expense. Actual results could differ materially from those estimates.

 

Cash and Cash Equivalents

 

Cash and cash equivalents consists of cash and short-term, highly liquid investments with original maturities of three months or less at the date of purchase.

 

Restricted Cash

 

Restricted cash at June 29, 2014 and December 31, 2013, consists of funds deposited to secure standby letters of credit primarily for performance guarantees related to the Company’s international business.

 

Revenue

 

The Company recognizes revenue when evidence of an arrangement exists, delivery of the product or service has occurred and title and risk of loss have passed to the customer, the sales price is fixed or determinable, and collectability of the resulting receivable is reasonably assured.

 

The Company accounts for revenues and earnings under two long-term government contracts/programs with interrelated multiple elements (procurement of parts, manufacturing and refurbishment services) using concepts of proportionate performance. These contracts effect reported results for all periods presented. The Company estimates the total profit on each contract as the difference between the total estimated revenue and total estimated cost of the contract and recognizes that profit over the remaining life of the contract using an output measure (the ratio of units completed to the total number of units to be refurbished under the contract). The Company computes an earnings rate for each contract, including general and administrative expense, to determine operating earnings. The Company reviews the earnings rate quarterly to assess revisions in contract values and estimated costs at completion. Any changes in earnings rates and recognized contract to date earnings resulting from these assessments are made in the period the revisions are identified. Contract costs include production costs, related overhead and allocated general and administrative costs. Amounts billed and collected on these contracts in excess of revenue recorded are reflected as customer advances and deferred revenue in the Company’s consolidated balance sheets.

 

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Table of Contents

 

Anticipated contract losses are charged to operations as soon as they are identified. Anticipated losses cover all costs allocable to the contracts, including certain general and administrative expenses. If a contract is cancelled by the government for its convenience, the Company can make a claim against the customer for fair compensation for worked performed plus costs of settling and paying claims by terminated subcontractors, other settlement expenses and a reasonable profit on costs incurred. When the Company has a customer claim, revenue arising from the claims process is either recognized as revenue or as an offset against a potential loss only when the amount of the claim can be estimated reliably and its realization is probable. The Company had no claims recorded at any period-end presented.

 

Prior to the Merger, Colt Defense generated an immaterial amount of royalty income, which it included in other income in its consolidated statements of operations. As a result of the Merger, the Company now generates a higher amount of royalty income on a quarterly basis and has therefore determined that royalty income should now be recorded as net sales in the Consolidated Statements of Operations.

 

The Company recognizes trademark licensing revenue for individual licensees based on historical experience and expected cash receipts from licensees. Licensing revenue consists of minimum royalties and/or a percentage of a licensee’s sales on licensed products. Under most of the Company’s current licensing agreements, royalties are payable in arrears on a calendar quarter basis.

 

Income Taxes

 

The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax basis of assets and liabilities using enacted tax rates in effect for years in which the temporary differences are expected to reverse. The Company provides a valuation allowance when it is more likely than not that deferred tax assets will not be realized. The Company recognizes the benefit of an uncertain tax position that has been taken or it expects to take on income tax returns if such tax position is more likely than not to be sustained.

 

The Company follows the authoritative guidance regarding accounting for uncertainty in income taxes, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. These unrecognized tax benefits relate primarily to issues common among multinational corporations in its industry. The Company applies a variety of methodologies in making these estimates, which include studies performed by independent economists, advice from industry and subject experts, evaluation of public actions taken by the Internal Revenue Service and other taxing authorities, as well as its own industry experience. The Company provides estimates for unrecognized tax benefits which may be subject to material adjustments until matters are resolved with taxing authorities or statutes expire. If its estimates are not representative of actual outcomes, its results of operations could be materially impacted.

 

The Company continues to maintain a valuation allowance against certain deferred tax assets where realization is not certain. The Company periodically evaluates the likelihood of the realization of deferred tax assets and reduces the carrying amount of these deferred tax assets by a valuation allowance to the extent it believes a portion will not be realized. The Company considers many factors when assessing the likelihood of future realization of deferred tax assets, including its recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, carryforward periods available to it for tax reporting purposes, various income tax strategies and other relevant factors. Significant judgment is required in making this assessment and, to the extent future expectations change; the Company would assess the recoverability of its deferred tax assets at that time. If the Company determines that the deferred tax assets are not realizable in a future period, the Company would record material adjustments to income tax expense in that period.

 

Recent Accounting Pronouncements

 

Revenue from Contracts with Customers - In May 2014, the FASB issued ASU No. 2014-09, that requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

 

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists - In July 2013, the FASB issued ASU 2013-11 to provide guidance on the presentation of unrecognized tax benefits. ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting

 

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Table of Contents

 

date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU 2013-11 is effective for interim and annual periods beginning after December 15, 2013 with earlier adoption permitted. ASU 2013-11 should be applied prospectively with retroactive application permitted. The Company has adopted ASU 2013-11 in the first quarter of 2014.

 

Note 3   Acquisition

 

On the Merger Date, the Company consummated the Merger with New Colt, a privately-held company, which is a world leader in the design, development and manufacture of pistols and revolvers. As a result of the Merger, the two manufacturers of Colt-branded firearms were consolidated into a single enterprise providing Colt Defense direct access to the commercial market for Colt Defense’s rifles and carbines, ownership of the Colt brand name and other related trademarks, and the technology and production facilities for the full line of Colt handguns.

 

Prior to determining the purchase price allocation of the Merger consideration, Colt Defense recorded the effective settlement of a pre-existing relationship with New Colt related to Colt Defense’s license agreement (the “License”) with New Colt for the use of certain Colt trademarks. As a result of the effective settlement of the pre-existing relationship, Colt Defense recorded a gain in the third quarter of 2013 of $15,264 (“Settlement Gain”), which equals the calculated gain of $16,320 reduced by the write-off of Colt Defense’s prepaid license balance of $1,056. A third-party valuation firm assisted management’s calculation of the gain by comparing the value of the royalty rate in the License to the current market rate for such a license.

 

The Company acquired New Colt for an aggregate purchase price of $82,543, which included the Settlement Gain of $15,264. The cash portion of the purchase price was funded by the proceeds from a new $50,000 senior secured term loan (“Term Loan”), cash on hand and $9,000 of consideration from the issuance and sale of the Company’s common units, of which $5,000 was paid in cash and $4,000 was related to Merger consideration reinvested by certain New Colt investors into Colt Defense.

 

The following table summarizes the fair values of the assets acquired and the liabilities assumed at the Merger Date:

 

Cash and cash equivalents

 

$

3,791

 

Accounts receivable

 

3,318

 

Inventories

 

7,585

 

Property and equipment

 

5,182

 

Other assets

 

3,090

 

Intangible assets with finite lives

 

9,340

 

Trademarks

 

50,100

 

Goodwill

 

36,974

 

Total assets acquired

 

119,380

 

 

 

 

 

Accounts payable and accrued expenses

 

8,808

 

Customer advances and deferred revenue

 

1,832

 

Capital lease obligations

 

393

 

Pension and retirement liabilities

 

9,357

 

Deferred tax liabilities

 

16,447

 

Total liabilities assumed

 

36,837

 

Net assets acquired

 

$

82,543

 

 

The Company believes that this information is a reasonable estimate of the fair values of assets acquired and liabilities assumed.

 

The Company, with the assistance of a third party valuation firm, valued the Colt brand and related trademarks by comparing the value of the royalty rate inherent in the prepaid license fee to the current market rate for such a license based upon both the value of the Colt brand and related trademarks in both the defense and commercial marketplace utilizing a relief from royalty methodology.

 

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Table of Contents

 

The Company, with the assistance of a third party valuation firm, determined the fair value of the finite-lived intangible assets which includes $5,240 of existing license agreements, valued based on a discounted cash flow approach, which represents the estimated fair value of New Colt license agreements for licensing the Colt trade marks to various third parties, $2,970 of developed technology, valued based on a relief from royalty method, which represents the estimated fair value of designs, trade secrets, materials, specifications and other proprietary intellectual property included in the technical data packages and related manufacturing processes and know-how and $1,130 of backlog, valued based on an excess earnings method, which represents the estimated fair value of unfilled contractual orders from customers.  The weighted average useful lives of the acquired existing license agreements, developed technology and backlog were 6 years, 20 years, and 3 years respectively.  In addition, the Company, with the assistance of a third party valuation firm, valued the Colt brand and related trade marks by comparing the value of the royalty rate inherent in the license (see Note 8,”Goodwill, Trademarks and Other Intangible Assets”) to the current market rate for such a license based upon both the value of the Colt brand and related trade marks in both the defense and the commercial marketplace utilizing a relief from royalty methodology.

 

Deferred income taxes arise from temporary differences between tax and financial statement recognition of revenue and expense.  In evaluating the Company’s ability to recover the deferred tax assets acquired through the acquisition of New Colt, the Company considered all available positive and negative evidence, including scheduled reversals of deferred tax assets and liabilities, projected future taxable income, tax-planning strategies and results of recent operations.  In projecting future taxable income for New Colt, the Company began with historical results adjusted to include the $50,000 Term Loan (see Note 9, “Notes Payable and Long-Term Debt”) and related interest expense, incorporated assumptions including the amount of future state and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax-planning strategies.  These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates the Company is using to manage the underlying business.  Based on the analysis performed, the Company believes, as of the acquisition date, that it is more likely than not that the benefit from New Colt’s deferred tax assets will not be realized.  In recognition of this risk, the Company provided a valuation allowance against New Colt’s deferred tax assets as part of the Company’s purchase accounting adjustments.

 

Goodwill is the excess of the purchase price of an acquired business over the fair value of net assets acquired. Goodwill will not be amortized but instead will be tested for impairment at least annually or more frequently if indicators of impairment arise. The $36,974 of goodwill is not deductible for federal income tax purposes.

 

The following table reflects the unaudited pro forma operating results of the Company for three and six months ended June 30, 2013, which gives effect to the Merger with New Colt as if it had occurred on January 1, 2012. The pro forma results are based on assumptions that the Company believes are reasonable under the circumstances. The pro forma results are not necessarily indicative of the operating results that would have occurred had the Merger been effective January 1, 2012, nor are they intended to be indicative of results that may occur in the future. The underlying pro forma information includes historical financial results of the Company and New Colt adjusted for certain items including depreciation and amortization expense associated with the assets acquired, the Company’s expense related to financing arrangements and the elimination of intercompany transactions. The pro forma information does not include the effects of any synergies or cost reduction initiatives related to the Merger.

 

 

 

Unaudited Pro Forma

 

Unaudited Pro Forma

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2013

 

June 30, 2013

 

 

 

(As Revised)

 

(As Revised)

 

Net sales

 

$

85,209

 

$

167,022

 

Net income (loss)

 

4,709

 

10,254

 

 

Pro forma net income for the three and six months ended June 30, 2013 were adjusted to include $1,579 and $3,208, respectively,  of additional interest expense related to the Company’s $50,000 Term Loan and to include $664 and $1,328, respectively, of additional expense related to the amortization of finite-lived intangible assets.

 

Note 4   Restructuring Costs

 

During the third and fourth quarters of the year ended December 31, 2013, as restated, the Company recorded restructuring costs of $1,118 for restructuring actions that were initiated as a result of the Merger with New Colt.  Of these costs, $336 is being reimbursed from an escrow established at the time of the Merger and $782 was recorded as operating expenses.  The costs consist of severance, continuation of benefits and other compensation-related expenses.  These actions, which have been completed, resulted in a workforce

 

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Table of Contents

 

reduction of 10 salaried employees. Restructuring accruals are included in accounts payable, accrued expenses and other long-term liabilities on the Consolidated Balance Sheets.

 

The following table summarizes the Company’s restructuring activity for the six months ended June 29, 2014:

 

Restructuring accruals at December 31, 2013

 

$

706

 

Accrual reversal

 

(76

)

Utilization

 

(442

)

Balance at June 29, 2014

 

$

188

 

 

Subsequent to June 29, 2014 the Company received the remaining $268 for the reimbursement of restructuring costs from an escrow established at the time of the Merger.

 

Note 5   Accounts Receivable

 

Accounts receivable are net of an allowance for doubtful accounts of $84 and $78 at June 29, 2014 and December 31, 2013, respectively.

 

Note 6    Inventories

 

The following table sets forth a summary of inventories, net of reserves at the lower of cost or market:

 

 

 

June 29, 2014

 

December 31, 2013

 

Raw materials

 

$

44,877

 

$

43,469

 

Work in process

 

13,938

 

9,476

 

Finished products

 

16,692

 

13,729

 

 

 

$

75,507

 

$

66,674

 

 

Note 7   Property and Equipment

 

Property and equipment are recorded at cost. Depreciation of building and equipment (including assets recorded under capital leases) and amortization of leasehold improvements are computed using the straight-line method over the estimated useful life of the assets, or for leasehold improvements, over the remaining life of the lease term if shorter.

 

Expenditures that improve or extend the lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred.

 

The fair value of the property and equipment acquired as a result of the Merger are allocated to machinery and equipment, furniture, fixtures and leasehold improvements and construction in process was $4,420, $30 and $732, respectively.

 

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Table of Contents

 

Property and equipment consist of the following as of:

 

 

 

 

 

 

 

Estimated

 

 

 

June 29, 2014

 

December 31, 2013

 

Useful Life

 

Land

 

$

337

 

$

338

 

 

Building

 

2,643

 

2,653

 

33

 

Machinery and equipment

 

51,652

 

47,476

 

7-10

 

Furniture, fixtures and leasehold improvements

 

7,150

 

7,081

 

3-5

 

 

 

61,782

 

57,548

 

 

 

Less accumulated depreciation and amortization

 

(34,953

)

(32,152

)

 

 

 

 

26,829

 

25,396

 

 

 

Construction in process

 

2,222

 

5,337

 

 

 

Property and equipment, net

 

$

29,051

 

$

30,733

 

 

 

 

Note 8   Goodwill, Trademarks and Other Intangible Assets

 

Goodwill

 

Goodwill is tested for impairment annually as of the beginning of the Company’s fourth fiscal quarter, or when events or circumstances indicate that its value may have declined. Impairment exists when the carrying amount of goodwill exceeds its fair market value. Management estimates the fair value of each reporting unit primarily using the income approach. Specifically the discounted cash flow (“DCF”) model was utilized for the valuation of each reporting unit. Management develops cash flow forecasts based on existing firm orders, expected future orders, contracts with suppliers, labor agreements and general market conditions. The Company discounts the cash flow forecasts using the weighted-average cost of capital method at the date of evaluation. The Company also calculates the fair value of its reporting units using the market approach in order to corroborate its DCF model results. These methodologies used in the current year are consistent with those used in the prior year.

 

The following table sets forth the changes in the carrying amount of goodwill for the Company as of and for the six months ended June 29, 2014:

 

 

 

Total

 

Balance at December 31, 2013

 

$

51,225

 

Effect of foreign currency translation

 

(37

)

Balance at June 29, 2014

 

$

51,188

 

 

Trademarks

 

In connection with the Merger, the Company recorded an indefinite-lived intangible asset of $50,100 for the Colt brand and related trademarks.  The Company, with the assistance of a third party valuation firm, valued the Colt brand and related trademarks by comparing the value of the royalty rate inherent in the prepaid license fee to the current market rate for such a license based upon both the value of the Colt brand and related trademarks in both the defense and the commercial marketplace utilizing a relief from royalty methodology.

 

Impairment Evaluation

 

During the first six months of 2014, the Company has seen a continued decrease in the demand for commercial rifles.  The Company concluded that a triggering event had occurred and an interim impairment test for indefinite lived intangible assets, Goodwill and Trademarks, was required as of June 29, 2014.  Management developed cash flow forecasts based on existing firm orders, expected future orders, contracts with suppliers, labor agreements and general market conditions.  The Company, with the assistance of a third party valuation firm, discounted the cash flow forecasts using the weighted-average cost of capital method as of June 29, 2014.  The Company also calculated the fair value of its reporting units using the market approach in order to corroborate its DCF model results.  Based on completion of Step 1 of the impairment analysis for indefinite lived intangible assets the fair value of the Company’s indefinite lived intangible assets exceeds the book value and therefore the Company concluded no impairment existed as of June 29,

 

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2014.  While the Company concluded there was no current impairment to the extent that demand for commercial rifles continues to decline, or does not recover when we have predicted it will, impairment charges may be required in the future.

 

Intangible Assets

 

The Company reviews long-lived assets, including intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Impairment losses, where identified, are determined as the excess of the carrying value over the estimated fair value of the long-lived asset. The Company assesses the recoverability of the carrying value of assets held for use based on a review of projected, undiscounted cash flows. When long-lived assets are reclassified to “held for sale”, the Company compares the asset’s carrying amount to its estimated fair value less cost to sell to evaluate impairment. No long-lived assets have been reclassified to held for sale for any period presented.

 

In connection with the Merger, the Company recorded finite-lived intangible assets of $9,340 which includes $5,240 of existing license agreements which represents the estimated fair value of New Colt license agreements for licensing the Colt trademarks to various third parties, $2,970 of developed technology which represents the estimated fair value of designs, trade secrets, materials, specifications and other proprietary intellectual property included in the technical data packages and related manufacturing processes and know-how and $1,130 of backlog which represents the estimated fair value of unfilled contractual orders from customers.  The weighted average useful lives of the acquired existing license agreements, developed technology and backlog were 6 years, 20 years and 3 years, respectively.

 

The net carrying value of the Company’s intangible assets with finite lives follows:

 

 

 

As of June 29, 2014

 

 

 

 

 

Gross

 

 

 

 

 

Estimated

 

 

 

Carrying

 

Accumulated

 

 

 

Useful

 

 

 

Amount

 

Amortization

 

Net

 

Life

 

Customer relationship Canadian Government

 

$

2,360

 

$

(714

)

$

1,646

 

30

 

Customer relationships other

 

6,137

 

(4,229

)

1,908

 

20

 

License agreements

 

5,240

 

(1,614

)

3,626

 

6

 

Backlog

 

1,720

 

(916

)

804

 

3

 

Technology-based intangibles

 

6,580

 

(2,798

)

3,782

 

15-20

 

 

 

$

22,037

 

$

(10,271

)

$

11,766

 

 

 

 

 

 

As of December 31, 2013

 

 

 

 

 

Gross

 

 

 

 

 

Estimated

 

 

 

Carrying

 

Accumulated

 

 

 

Useful

 

 

 

Amount

 

Amortization

 

Net

 

Life

 

Customer relationship Canadian Government

 

$

2,369

 

$

(678

)

$

1,691

 

30

 

Customer relationships other

 

6,160

 

(4,077

)

2,083

 

20

 

License agreements

 

5,240

 

(805

)

4,435

 

6

 

Backlog

 

1,722

 

(604

)

1,118

 

3

 

Technology-based intangibles

 

6,580

 

(2,492

)

4,088

 

15 - 20

 

 

 

$

22,071

 

$

(8,656

)

$

13,415

 

 

 

 

The Company expects to record annual amortization expense of $3,270, $2,783, $1,926, $1,186, and $871 for 2014, 2015, 2016, 2017 and 2018, respectively.

 

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Note 9   Notes Payable and Long-Term Debt

 

Term Loan

 

On July 12, 2013, in connection with the Merger, the Company entered into the Term Loan agreement, which matures on November 15, 2016. The Term Loan bears interest at a variable rate of 9.75% plus the greater of the three month LIBOR rate or 1%. Interest is payable quarterly in arrears on the first day of the subsequent calendar quarter. Under the Term Loan, the Company’s obligations are secured by a first priority security interest in the Company’s intellectual property and a second priority security interest in substantially all other assets. The Term Loan was issued at a discount of $2,293, which represents the lenders fees and legal expenses. The Company also incurred $2,120 in financing fees. The discount and the financing fees are being amortized as additional interest expense over the life of the indebtedness.

 

On August 6, 2014, the Company entered into Amendment No. 1 to the Term Loan (the “Term Loan Amendment”).  Absent an amendment to the Term Loan, the Company would have been in violation of certain of its financial covenants as of June 29, 2014.  The Term Loan Amendment is discussed in more detail in the following paragraph.  The Company was in compliance with its Term Loan covenants, as amended, as of June 29, 2014 and December 31, 2013.  It is possible the Company will not meet one or more of the Term Loan covenants, as amended, as of December 31, 2014, or subsequent quarters of 2015.  If the Company were not to meet certain of the Term Loan covenants, as amended, in the future, the Company would likely seek a waiver from the Term Loan lenders.  There is no assurance that such a waiver could be obtained from the Term Loan lenders in a timely basis, or at all, in which case the Company would be in default under the Term Loan and the Term Loan would become a current liability.

 

The “Term Loan Amendment”, provided that, (i) the financial covenants were eliminated for the rolling four quarter periods ended June 29, 2014 and September 30, 2014 and modified for the rolling four quarter period ended December 31, 2014, (ii) the Company was granted the option to not pay principal installment payments of $1,875 due on September 30, 2014, December 31, 2014 and March 31, 2015, (iii) the applicable prepayment premium was increased from 2% to 6% of the outstanding principal balance of the Term Loan, (iv) the date of the applicable prepayment determination was extended to July 31, 2016 and (v) the Company has been granted a 30 day extension to deliver financial information to the Term Loan lenders to allow for completion of the restatement of the Company’s 2013 10-K (see Note 2. Summary of Significant Accounting Policies).  Additionally, the Company agreed to pay an amendment fee of $0.5 million that will be capitalized and paid-in-kind by being added to the outstanding principal balance of the Term Loan.

 

The Term Loan Amendment fee of $0.5 million, along with Term Loan lenders legal fees to be paid by the Company in conjunction with the Term Loan Amendment, will be recorded as additional debt discount in the third quarter of 2014 and amortized as interest expense over the remaining term of the Term Loan.  The Company will expense costs incurred by the Company in conjunction with the Term Loan Amendment in the third quarter of 2014.  The Company currently intends to not pay principal installment payments due on September 30, 2014, December 31, 2014 and March 31, 2015 and, therefore, the long term debt — current portion on the consolidated balance sheet as of June 29, 2014, has been adjusted accordingly, to reflect anticipated Term Loan principal installment payments over the next twelve months.

 

On March 31, 2014 and on June 30, 2014, the Company made Term Loan principal installment payments of $625 and interest payments of $1,310 and $1,308, respectively.

 

The Term Loan agreement also contains non-financial covenants and other restrictions which limit the Company’s ability to incur additional indebtedness, make investments or certain payments, pay dividends (other than member distributions to support the Company’s member related taxes) enter into a merger and acquire or sell assets.

 

Principal repayments, which are due quarterly on the last day of each calendar quarter, are as follows:

 

 

 

Amount

 

Remaining 2014

 

$

625

 

2015

 

5,625

 

2016

 

41,875

 

Total

 

$

48,125

 

 

Credit Agreement

 

On September 29, 2011, the Company entered into a credit agreement (“Credit Agreement”) with Wells Fargo Capital Finance, LLC (“WFCF”).  Under the terms of the Credit Agreement, senior secured revolving loans are available up to $50,000, inclusive of $20,000 available for letters of credit.  Revolving loans are subject to, among other things, the borrowing base, which is calculated monthly

 

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based on specified percentages of eligible accounts receivable and inventory and specified values of fixed assets.  Under the Credit Agreement, the Company’s obligations are secured by a first-priority security interest in substantially all of its assets (other than intellectual property), including accounts receivable, inventory and certain other collateral, and a second-priority security interest in its intellectual property. The Credit Agreement matures on September 28, 2016.

 

Borrowings under the Credit Agreement bear interest at a variable rate based on the London Inter-Bank Offered Rate (“LIBOR”), the Canadian Banker’s Acceptance Rate or the lender’s prime rate, as defined in the Credit Agreement, plus a spread. The interest rate spread on borrowing varies based on both the rate option selected and Colt’s quarterly average excess availability under the Credit Agreement. There is an unused line fee of .50% per annum, payable quarterly on the unused portion under the facility and a $40 annual servicing fee.

 

On August 6, 2014, the Company entered into Amendment No. 5 to the Credit Agreement, whereby WFCF consented to, among other things, extending the delivery date to September 15, 2014 for the Company to deliver financial statements for the month and fiscal quarter ended June 29, 2014.

 

The Credit Agreement limits the Company’s ability to incur additional indebtedness, make investments or certain payments, pay dividends (other than for member distributions to support member LLC-related taxes) and merge, acquire or sell assets. In addition, certain covenants would be triggered if excess availability were to fall below a specified level. Excess availability is determined as the lesser of our borrowing base or $50,000, reduced by outstanding obligations under the Credit Agreement and trade payables that are more than 60 days past due. Furthermore, if excess availability falls below $11,000 or an event of default occurs, the Company would be required to provide WFCF with more frequent compliance reporting and the WFCF may also assume certain other contractual privileges.  The Credit Agreement contains customary events of default. As of June 29, 2014 and December 31, 2013, the Company was in compliance with all covenants and restrictions, as amended, and the Company monitors its future compliance based on current and anticipated financial results.

 

As of June 29, 2014, there were advances of $13,500 and $3,906 of letters of credit outstanding under the Credit Agreement. As of December 31, 2013, there was a $7,083 line advance and $3,486 of letters of credit outstanding under the Credit Agreement.  As of September 12, 2014, there were advances of $13,000 outstanding under the Credit Agreement.

 

On March 22, 2013, the Company entered into Amendment No. 2 to the Credit Agreement, whereby, among other things, WFCF consented to the transaction pursuant to the Unit Repurchase Agreement. For additional information about this transaction, see Note 13, “Accumulated Deficit” in this Form 10-Q.

 

On June 19, 2013, the Company entered into Amendment No. 3 to the Credit Agreement, whereby WFCF consented to the contribution of all the issued and outstanding equity interests issued by Colt Canada to Colt International so that Colt Canada would become a wholly-owned subsidiary of Colt International, and providing for Colt International to become a guarantor under the Credit Agreement.

 

On July 12, 2013, the Company entered into Amendment No. 4 to the Credit Agreement, which provided for New Colt to become a guarantor and Colt’s Manufacturing Company LLC (“Colt’s Manufacturing”) to become a borrower under the Credit Agreement in connection with the Merger.

 

Senior Notes

 

On November 10, 2009, Colt Defense LLC and Colt Finance Corp., the Company’s 100%-owned subsidiary, jointly and severally co-issued $250,000 of unsecured senior notes (“Senior Notes”) under an indenture (“Indenture”). The Senior Notes bear interest at 8.75% and mature on November 15, 2017. Interest is payable semi-annually in arrears on May 15 and November 15. The Company issued the Senior Notes at a discount of $3,522 from par value. This discount is being amortized as additional interest expense over the life of the indebtedness. No principal repayments are required until maturity.

 

The Senior Notes do not contain financial covenants that require the Company to maintain compliance with any financial ratios or measurements on a periodic basis. The Senior Notes do contain non-financial covenants that, among other things, limit the Company’s ability to incur additional indebtedness, enter into certain mergers or consolidations, incur certain liens and engage in certain transactions with its affiliates. In addition, the Indenture restricts the Company’s ability to pay dividends or make other Restricted Payments (as defined in the Indenture) to its members, subject to certain exceptions. Such restrictions are not expected to affect the Company’s ability to meet its cash obligations for the next twelve months.  Additionally, the Senior Notes contain certain cross-default provisions with other indebtedness if such indebtedness in default aggregates to $20,000 or more.

 

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On June 19, 2013, the Company entered into a supplement to the Indenture by which Colt International, Colt Canada and CDTS became new subsidiary guarantors to the Senior Notes. As such, each agreed to jointly and severally guarantee the obligations under the Indenture.

 

On July 12, 2013, the Company entered into a supplement to the Indenture, by which New Colt and Colt’s Manufacturing became parties to the Indenture and each agreed to jointly and severally guarantee the obligations under the Indenture.

 

The outstanding loan balances at June 29, 2014 and December 31, 2013 were as follows:

 

 

 

June 29, 2014

 

December 31, 2013

 

Senior Notes

 

$

248,204

 

$

247,984

 

Term Loan

 

46,601

 

46,833

 

Credit Agreement

 

13,500

 

7,083

 

Total debt

 

308,305

 

301,900

 

Less: current portion

 

(14,125

)

(12,083

)

Long-term debt

 

$

294,180

 

$

289,817

 

 

Long-term debt was recorded net of unamortized original issue and debt discounts of $3,319 at June 29, 2014 and $3,932 at December 31, 2013.

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

Amortization of discount

 

$

308

 

$

102

 

$

613

 

$

206

 

Amortization of deferred financing costs

 

604

 

414

 

1,211

 

828

 

 

Note 10   Accrued Expenses

 

Accrued expenses consisted of:

 

 

 

June 29, 2014

 

December 31, 2013

 

 

 

 

 

(As Restated)

 

Accrued compensation and benefits

 

$

4,811

 

$

7,154

 

Accrued contract obligation expense

 

2,411

 

1,194

 

Accrued federal, excise and other taxes

 

3,009

 

4,902

 

Accrued interest

 

4,111

 

2,879

 

Accrued commissions

 

1,129

 

929

 

Other accrued expenses

 

5,568

 

5,100

 

 

 

$

21,039

 

$

22,158

 

 

Note 11   Income Taxes

 

Colt Defense is a limited liability company organized under the laws of Delaware. Colt Defense is treated as a partnership for federal and state income tax purposes and is not subject to U.S. federal or state income taxes. Consequently, all taxable income (loss) of Colt Defense is reported to its members for inclusion in their respective income tax returns. The limited liability company agreement of Colt Defense requires distributions to the members in any year in which there is U.S. taxable income. The member’s distribution is equal to the product of the highest combined marginal federal, state, or local income tax rate applicable to any member and the highest taxable income allocated to any one unit, to the extent that the Governing Board determines that sufficient funds are available.

 

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As a result of the Merger with New Colt effective July 12, 2013, Colt Defense owns 100% of New Colt, a C corporation organized under the laws of Delaware. New Colt is taxed as a corporation for U.S. federal and state income tax purposes. Through December 31, 2013, New Colt owned 100% of Colt’s Manufacturing, New Colt’s operating entity.

 

Effective January 1, 2014 (see Note 1, “Nature of Business”), Colt Defense and New Colt each contributed their assets and operations to Colt’s Manufacturing.  As a result, Colt Defense and New Colt collectively own 100% of Colt’s Manufacturing, the combined domestic operating entity of the Company. The Company estimated the fair value of the Colt Defense and New Colt contributions to determine the respective ownership percentages of Colt Defense and New Colt. The allocation of the fair value of the contributions to the individual assets and liabilities contributed is preliminary and subject to change.

 

The combined operations of Colt’s Manufacturing are treated as a partnership for federal income tax purposes. Consequently, taxable income is computed at the partnership level to determine New Colt’s income tax expense and Colt Defense’s member distribution payable.  In conjunction with the transaction, New Colt acquired a preferred investment in Colt’s Manufacturing and a common equity interest in exchange for its contribution. Colt Defense acquired the remaining common equity interest in exchange for its contribution. Since each member contributed assets, the Company is allocating the built in gain (the difference between fair market value and tax basis) back to the contributing member in accordance with a permitted method under Section 704(c) of the Internal Revenue Code.

 

Colt Defense and CDTS, a wholly owned subsidiary, collectively own 100% of Colt International, a Dutch cooperatief. Colt International owns 100% of Colt Canada, a Canadian C corporation. The income (loss) of Colt Canada is subject to entity level Canadian federal and provincial taxes. On April 16, 2014, Colt Canada declared and paid a $2,000 dividend to Colt International. Under the terms of the treaty between Canada and The Netherlands, Colt Canada is required to withhold taxes on the dividends at a rate of 5%.

 

The provision (benefit) for foreign income taxes is as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

 

 

(As Revised)

 

Current

 

$

141

 

$

3

 

$

52

 

$

744

 

Deferred

 

(122

)

75

 

(119

)

15

 

Total

 

$

19

 

$

78

 

$

(67

)

$

759

 

 

New Colt has a partnership interest in Colt’s Manufacturing in which the book basis of New Colt’s assets and liabilities contributed exceeds the tax basis of those assets and liabilities. Therefore, New Colt has a deferred tax liability with respect to their partnership interest as of June 29, 2014.  The requirement that the partnership use carryover basis with respect to the contributed assets resulted in the partnership’s basis in the assets being equal to New Colt’s investment in the partnership.

 

A valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized.  A significant portion of the value of New Colt’s asset contribution was attributed to indefinite lived intangible assets. Consequently,   the exclusion of the portion of the contribution related the indefinite lived intangible asset from the deferred tax liability associated with the partnership interest would put New Colt in a net deferred tax asset position. The Company has established that it is more likely than not that the full amount of New Colt’s deferred tax assets will not be recognized in future years. Consequently, New Colt continues to maintain a valuation allowance on its net deferred tax assets.

 

Note 12   Pension and Postretirement Benefits

 

As a result of the Merger in 2013, the Company had four noncontributory, domestic defined benefit pension plans (“Plans”) that covered substantially all eligible salaried and hourly U.S. employees. The bargaining unit Plans were combined on January 1, 2014 and the salaried Plans were combined on January 1, 2014.

 

Effective December 31, 2012, the pension benefits under the two hourly defined benefit plans were frozen. The benefits under the two salaried defined benefit plans have been frozen since December 31, 2008. Accordingly, participants retain the pension benefits that have already accrued. However, no additional benefits have accrued since the effective date of the freeze.

 

Pension expense for the New Colt plans is included in the amounts below from the Merger Date.

 

The components of income recognized in the Company’s Consolidated Statements of Operations for pension plans are as follows:

 

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Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

 

 

(As Revised)

 

Interest cost

 

$

413

 

$

277

 

$

792

 

$

550

 

Expected return on assets

 

(461

)

(365

)

(955

)

(730

)

Amortization of unrecognized loss

 

27

 

109

 

93

 

214

 

Net periodic cost (income)

 

$

(21

)

$

21

 

$

(70

)

$

34

 

 

The Company also provides certain postretirement health care coverage to retired U.S. employees who were subject to a collective bargaining agreement when they were employees. The cost of these postretirement benefits is determined actuarially and is recognized in the Company’s consolidated financial statements during the employees’ active working career. In connection with the Company’s collective bargaining agreement, it has capped certain retirees to approximately $250 (not in thousands) per employee per month.

 

As a result of the Merger in 2013, the Company had two postretirement health care plans that applied to employees covered by the collective bargaining agreement.  The postretirement health care plans were combined on April 1, 2014.  Expense for the New Colt plan is included in the amounts below from the Merger Date.

 

As a result of the workforce reduction in the second quarter of 2014 the Company recognized a $98 curtailment gain with respect to the Company’s postretirement health care plans.

 

The components of cost recognized in the Company’s Consolidated Statements of Operations for postretirement health care coverage are as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

Service cost

 

$

170

 

$

162

 

$

346

 

$

226

 

Interest cost

 

252

 

112

 

467

 

244

 

Curtailment of postretirement health plan

 

(98

)

 

(98

)

 

Amortization of unrecognized prior service costs

 

(33

)

(43

)

(76

)

(86

)

Amortization of unrecognized loss

 

57

 

51

 

66

 

122

 

Net periodic cost

 

$

348

 

$

282

 

$

705

 

$

506

 

 

Note 13   Accumulated Deficit

 

Colt Defense’s authorized capitalization consists of 1,000,000 common units, which include 18,878 nonvoting Class B common units, and 250,000 preferred units. Common units issued and outstanding as of both June 29, 2014 and December 31, 2013 were 132,174.  No Class B common units or preferred units have been issued.

 

On March 22, 2013, Colt Defense purchased 31,165.589 common units (“Unit Repurchase”) from Blackstone Mezzanine Partners II-A L.P. and Blackstone Mezzanine Holdings II USS L.P. (collectively, “Blackstone Funds”) (representing 100% of the Colt Defense common membership units held by the Blackstone Funds) for an aggregate purchase price of $14,000 pursuant to an equity purchase agreement, dated as of March 22, 2013 (“Unit Repurchase Agreement”), by and among Colt Defense and the Blackstone Funds.  In accordance with the Unit Repurchase Agreement, upon consummation of the Unit Repurchase, the Blackstone Funds delivered the certificates representing the common units held by the Blackstone Funds to Colt Defense for cancellation, and the rights of the Blackstone Funds under the Amended and Restated LLC Agreement, including appointment rights with respect to Colt Defense’s Governing Board, were terminated. The Unit Repurchase Agreement provided customary releases and indemnities for Colt Defense and the Blackstone Funds.

 

On July 12, 2013, the Company issued and sold 31,165.589 of Colt Defense common units to certain new and existing holders for $9,000 of consideration, of which $5,000 was paid in cash and $4,000 was related to Merger consideration reinvested by certain New Colt investors into Colt Defense.  The Company used the $9,000 of consideration, together with the proceeds from the Term Loan and cash on hand, to fund the Merger and pay related fees and expenses.

 

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In the first quarter of 2014, and 2013, respectively, there were no tax distribution payments to members. During the second quarter of 2014, the Company made tax distribution payments to members of $683 along with State of Connecticut members’ withholding payments of $530, both of which were accrued for in 2013 based on our 2013 taxable income.  In the second quarter of 2013, the Company made tax distributions to members of $1,357 and no distributions to the State of Connecticut.

 

Due to limitations on distributions to the Company’s members associated with the Company’s Term Loan, there was a $2,277 long term liability payable to members at June 29, 2014 and December 31, 2013, respectively.

 

Note 14   Common Unit Compensation

 

On March 1, 2012, the Governing Board approved the Colt Defense Long Term Incentive Plan (the “Plan”). The purpose of the Plan is to advance the interests of Colt Defense and its equity holders by providing a means to attract, retain and motivate key employees, advisors and members of the Governing Board. Awards under the Plan may consist of options, restricted units, restricted phantom units, performance units or other unit-based awards. A total of 18,878 nonvoting Class B common units have been reserved for issuance in connection with awards under the Plan.

 

Under the Plan, the exercise price of option awards is set at the grant date and may not be less than the fair market value per unit on that date. The term of each option is ten years from the grant date. The vesting periods, which vary by grant, may be time based, performance based or a combination thereof. Compensation expense equal to the grant date fair value of the option is generally recognized over the period during which the employee is required to provide service in exchange for the award or as the performance obligation is met. Fair value of the option was estimated on the date of grant using the Black-Scholes valuation method.

 

In 2013, options were granted for 5,300 common units at a weighted-average exercise price of $288.78 (not in thousands).  The Company’s common unit compensation expense, which is included in general and administrative expense in the consolidated statements of operations, was $65 and $1 for the three months ended June 29, 2014 and June 30, 2013, respectively.  Common unit compensation expense was $82 and $0 for the six month periods ended June 29, 2014 and June 30, 2013, respectively.

 

Note 15   Transactions with Related Parties

 

In July 2007, Colt Defense entered into a financial advisory agreement with Sciens Management LLC (“Sciens Management”), which through its affiliates, may be deemed to beneficially own a substantial portion of Colt Defense’s limited liability interests and whose managing member is also a member of Colt Defense’s Governing Board.  Under the terms of the agreement, the Company paid Sciens Management an aggregate annual retainer of $350. In July 2013, Colt Defense entered into a consulting services agreement (“Consulting Agreement”) with Sciens Institutional Services LLC (“Sciens Institutional”), an affiliate of Sciens Management.  Affiliates of Sciens Institutional beneficially own a substantial portion of Colt Defense’s limited liability interests and Sciens Institutional’s managing member is a member of Colt Defense’s Governing Board. Under the terms of the Consulting Agreement, Sciens Institutional provides consulting services to Colt Defense for an aggregate annual fee of $650, payable quarterly in advance.

 

The costs for the services provided and the related expenses under the agreements with Sciens Institutional and Sciens Management were recorded within general and administrative expenses in the consolidated statements of operations and were $250 and $108 for the three months ended June 29, 2014 and June 30, 2013, respectively.  The Company’s cost for these services were $500 and $216 for the six months ended June 29, 2014 and June 30, 2013, respectively.

 

In July 2013, the Company entered into a services agreement (“Archives Agreement”) with Colt Archive Properties LLC (“Archives Properties”), one of the owners of which is a member of Colt Defense’s Governing Board and affiliates of which beneficially own a substantial portion of Colt Defense’s limited liability interests. Under the Archives Agreement, Colt agrees to provide designated employees to perform services for Archive Properties for an initial annual fee of $241, payable quarterly in arrears. The Company records revenue related to archive services as net sales and costs associated with providing archive services in cost of sales.

 

The Company leases its West Hartford facility from NPA Hartford LLC, a related party, for its corporate headquarters and primary manufacturing facility. The lease expires on October 25, 2015.  For the three months ended June 29, 2014, and June 30, 2013, the rent expense under this lease was $210 and $206, respectively. Rent expense for the six months ended June 29, 2014 and June 30, 2013 was $421 and $412 respectively.

 

In addition, Colt Security LLC, a wholly owned subsidiary of Employee Plan Holding Corp., provides security guard services to the Company.

 

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Prior to the Merger, transactions with New Colt were as follows:

 

 

 

Three Months 
Ended

 

Six Months
Ended

 

 

 

June 30, 2013

 

June 30, 2013

 

Net sales to New Colt

 

$

21,310

 

$

43,835

 

Purchases from New Colt

 

892

 

1,887

 

Administration and services fees charged to New Colt

 

442

 

883

 

 

Note 16   Commitments and Contingencies

 

A summary of standby letters of credit issued principally in connection with performance and warranty bonds established for the benefit of certain international customers is as follows:

 

 

 

June 29, 2014

 

December 31, 2013

 

Standby letters of credit secured by restricted cash

 

$

1,181

 

$

1,185

 

Standby letters of credit under Credit Agreement

 

3,906

 

3,486

 

Guarantees of standby letters of credit established by a sales agent on behalf of Colt

 

74

 

74

 

 

At June 29, 2014 and December 31, 2013, the Company had unconditional purchase obligations related to capital expenditures for machinery and equipment of $981 and $892, respectively.

 

The Company also had certain industrial cooperation agreements, which stipulate its commitments to provide offsetting business to certain countries that have purchased Colt’s products. Colt generally settles its offset purchase commitments under industrial cooperation agreements through offsetting business and/or cooperating with other contractors on their spending during the related period. Additionally, the Company identifies future purchases and other satisfaction plans for the remainder of the offset purchase commitment period.  Should there be a projected net purchase commitment after such consideration; Colt accrues the estimated cost to settle the offset purchase commitment.

 

The Company’s remaining gross offset purchase commitment is the total amount of offset purchase commitments reduced for claims submitted and approved by the governing agencies. At June 29, 2014 and December 31, 2013, remaining gross offset purchase commitments totaled $64,937 and $64,131, respectively.  The Company has evaluated the settlement of its remaining gross offset purchase commitments through probable planned spending and other probable satisfaction plans to determine the net offset purchase commitment.  The Company has accrued $1,648 and $1,639 as of June 29, 2014 and December 31, 2013, respectively, based on the estimated cost of settling the remaining net offset purchase commitment.

 

During the year ended December 31, 2013, as restated, the Company recorded a contract obligation expense of $3,381 and a M240 Program contract modification, reduction of net sales of $6,820, respectively, for an aggregate reduction in gross profit of $10,201 related to the Company’s M240 Program with the U.S. Government.  The M240 Program contract obligation expense and the M240 Program contract modification,  relate to estimated costs (contract obligation expense) to retrofit products previously sold to the U.S. Government as well as the incorporation of changes into the Company’s M240 Program product design and production processes and the reduced funding of (contract modification) the M240 Program.  During the second quarter of 2014, based on additional available information, the Company reassessed the M240 Program accruals and determined that an incremental $4,779 M240 Program contract obligation expense was required.  The second quarter expense related to $1,997 of inventory reserves and $2,782 of incremental costs related to M240 Program.  The incremental contract obligation expense recorded was based on the Company’s best estimate of the costs to satisfy the M240 Program obligations given a range of possible outcomes.  The Company believes that actual costs to satisfy this obligation may vary significantly from this revised estimate.  As of June 29, 2014 and December 31, 2013, as restated, the Company had inventory reserves of $1,619 and $206, accrued contract obligation expenses of $3,550 and $1,194, of which $1,139 and $0 is included in other long-term liabilities, and deferred income of $6,820 and $6,820, respectively, included on the consolidated balance sheets related to the M240 Program.  The Company expects to deliver new M240 units to the U.S. Government related to the contract modification and complete the retrofit of previously delivered units within the next twelve months, and accordingly; both the M240 Program accrued contract obligation and deferred revenue have been classified as current liabilities in the consolidated balance sheets.

 

During the second quarter of 2014, the Company agreed to a No-Cost Cancellation of the M249 contract with the U.S. Government.  In connection with the cancellation, the Company recorded an expense of $480 which is included in cost of sales in the consolidated

 

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statements of operations.  The $480 is comprised of a write-off of $344 of inventory and $136 of accruals for other liabilities associated with the program.

 

During the second quarter of 2014, the Company initiated actions which resulted in a workforce reduction of 24 salaried employees and 64 hourly employees.  The severance expenses for the 24 salaried employees were included in operating income during the three months ended June 29, 2014 and amounted to $382.  In addition, subsequent to June 29, 2014 the Company initiated an additional workforce reduction of nine salaried employees whose severance expenses amounted to $164 and was recorded in cost of sales in the third quarter of 2014.

 

The Company is involved in various legal claims and disputes in the ordinary course of business.  The Company accrues for such liabilities when it is both (i) probable that a loss has occurred and (ii) the amount of the loss can be reasonably estimated in accordance with ASC 450, Contingencies.  The Company evaluates, on a quarterly basis, developments affecting legal claims and disputes that could cause an increase or decrease in the amount of the liability that has been previously accrued.  At this time, management does not anticipate any such loss would have a material adverse impact on the Company’s consolidated financial position, results of operations or cash flows.

 

During the three and six month periods ended June 29, 2014 and June 30, 2013, respectively, there were no material tax examinations.

 

In 2011, New Colt entered into a twelve year agreement with Osceola County in Florida to lease a 16,000 square foot facility in Kissimmee, Florida. This facility was renovated by the County at its cost and the building was made available for occupancy during 2012.  There are no lease payments due during the initial five years of the lease and the annual cost of the lease will be $108 per year with the lease expiring on January 15, 2023. The lease expense is being accounted for on a straight-line basis, with an annual charge of $78 being incurred over the term of the lease. At June 29, 2014 and December 31, 2013, deferred lease expense was $75 and $36, respectively. In connection with the lease, the Company was required to hire a minimum number of employees commencing in 2013. As of June 29, 2014, the Company had not occupied the Florida facility and had not hired any employees.  The Company has accrued a contractual penalty of $75 and $50 at June 29, 2014 and December 31, 2013, respectively, for not meeting the minimum hiring requirement. In addition, the State of Florida contributed $250 of funds to the Osceola County to assist with the cost of the renovations. The Company is responsible for making a minimum capital investment of $2,500, of which $181 had been made through both June 29, 2014 and December 31, 2013, respectively.

 

Note 17   Segment Information

 

As a result of the Merger (see Note 3, “Acquisition”), the two manufacturers of Colt firearms were consolidated into a single enterprise providing the Company with direct access to the commercial market for Colt rifles and carbines, ownership of the Colt brand name and other related trademarks and the technology and production facilities for the full line of Colt handguns.  As of June 29, 2014 and December 31, 2013, the Company’s operations are conducted through two segments, firearms and spares/other.  These operating segments have similar characteristics and have been aggregated into the Company’s only reportable segment.  The firearms segment designs, develops, and manufactures firearms for domestic and international military and law enforcement markets as well as the domestic and international commercial markets.  The spares and other segment primarily provides spare parts and kits and accessories for domestic and international military and law enforcement markets as well as domestic and international commercial markets.  Other activities are de minimus and consist of product service, archive service, training and royalties from the license of the Colt brand and related trademarks.

 

Adjusted EBITDA consists of income (loss) before interest, income taxes, depreciation and amortization and other expenses as noted below. Management uses Adjusted EBITDA to evaluate the financial performance of the business and to make operating decisions.  See the footnotes that follow the reconciliation tables below for additional information regarding the adjustments made to arrive at Adjusted EBITDA.

 

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The following table represents a reconciliation of net income (loss) to Adjusted EBITDA:

 

 

 

Three Months Ended

 

Six Months Ended

 

Statement of Operations Data:

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

 

 

(As Revised)

 

Net income (loss)

 

$

12,589

 

$

4,387

 

$

12,535

 

$

9,516

 

Income tax (benefit) expense

 

19

 

78

 

(67

)

759

 

Depreciation and amortization (i) 

 

2,369

 

1,206

 

4,659

 

2,368

 

Interest expense, net

 

7,859

 

6,069

 

15,543

 

12,063

 

Sciens fees and expenses (ii)

 

250

 

108

 

500

 

216

 

Transaction costs (iii)

 

 

416

 

 

416

 

Restructuring costs (iv)

 

(76

)

 

(76

)

 

M240 Program contract obligation expense (v)

 

4,779

 

 

5,090

 

 

Business development costs (vi)

 

9

 

169

 

509

 

244

 

Severance costs (vii)

 

382

 

 

527

 

 

Other (income)/expense, net (viii)

 

(42

)

(199

)

(113

)

(590

)

Adjusted EBITDA

 

$

2,960

 

$

12,234

 

$

6,037

 

$

24,992

 

 


(i)

Includes depreciation and amortization of intangible assets.

(ii)

Includes fees and expenses pursuant to the Company’s agreements with Sciens Management and Sciens Institutional.

(iii)

Non-recurring costs associated with the July 12, 2013 acquisition of New Colt.

(iv)

Includes costs related to the Merger, including severance, continuation of benefits, and other. See Note 4 “Restructuring Costs.”

(v)

Expenses related to Company’s M240 Program. See Note 16 “Commitments and Contingencies.”

(vi)

Includes transaction costs incurred in connection with contemplated acquisition activities.

(vii)

Includes non-recurring severance costs.

(viii)

Includes income and/or expenses such as foreign currency exchange gains or losses and other less significant charges not related to on-going operations.

 

Product Information

 

The following table shows net sales for the three and six months ended June 29, 2014 and June 30, 2013, as revised, by product category. The table includes the results of New Colt from the Merger Date.  After intercompany sales eliminations, the New Colt acquisition provided $19.3 and $36.4 million of incremental sales for the three months and six months ended June 29, 2014, respectively.

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

 

 

(As Revised)

 

Long guns

 

$

15,870

 

$

53,599

 

$

40,307

 

$

105,870

 

Handguns

 

18,570

 

1,260

 

33,890

 

2,521

 

Spares and other

 

15,193

 

9,353

 

25,516

 

19,670

 

Total

 

$

49,634

 

$

64,212

 

$

99,713

 

$

128,061

 

 

Geographical Information

 

Geographic external revenues are attributed to the geographic regions based on the customer’s location of origin.  Colt’s net sales in the United States include revenues that arise from sales to the U.S. Government under its Foreign Military Sales (“FMS”) program, which involves product that is resold by the U.S. Government to foreign governments and generally shipped directly to the foreign government by the Company.

 

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Table of Contents

 

The table below presents net sales for the three and six months ended June 29, 2014 and June 30, 2013, as revised, for specific geographic regions:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

 

 

(As Revised)

 

United States

 

$

31,725

 

$

38,985

 

$

73,220

 

$

74,693

 

Canada

 

3,960

 

4,202

 

8,317

 

14,953

 

Latin America/Caribbean

 

1,185

 

43

 

2,970

 

1,044

 

Middle East/Africa

 

1,609

 

532

 

3,333

 

570

 

Europe

 

5,309

 

3,272

 

5,733

 

4,603

 

Asia/Pacific

 

5,845

 

17,178

 

6,140

 

32,198

 

 

 

$

49,633

 

$

64,212

 

$

99,713

 

$

128,061

 

 

Long-lived assets are net fixed assets attributed to specific geographic regions:

 

 

 

June 29, 2014

 

December 31, 2013

 

United States

 

$

24,307

 

$

25,745

 

Canada

 

4,744

 

4,988

 

 

 

$

29,051

 

$

30,733

 

 

Major Customer Information

 

For the three and six months ended June 29, 2014, no foreign customer accounted for more than 10% of net sales.  For the three months ended June 30, 2013, one foreign direct customer accounted for 24% of net sales and for the six months ended June 30, 2013, two foreign direct customers accounted for 24% and 11% of net sales, respectively.

 

For the three and six months ended June 30, 2013, sales to Colt’s Manufacturing, represented 33% and 34% of net sales, respectively.

 

For the three months ended June 29, 2014, no commercial customers accounted for more than 10% of net sales and for the six months ended June 29, 2014, no commercial customers accounted for more than 10% of net sales.  For the three and six months ended March 31, 2013 (prior to the Merger), sales to New Colt accounted for 35% of net sales.

 

For the three months and six months ended June 29, 2014, sales to the U.S. Government accounted for 5.8% and 6.2%, respectively, of net sales. For the three and six months ended June 30, 2013, sales to the U.S. Government accounted for 13% of net sales.

 

Note 18   Concentration of risk

 

Accounts Receivable

 

Financial instruments, which potentially subject the Company to concentration of credit risk, consist primarily of accounts receivable.  At June 29, 2014, the two largest individual trade receivable balances accounted for 23% and 19% of total accounts receivable, respectively.  At December 31, 2013, the two largest individual trade receivable balances accounted for 28% and 16% of total accounts receivable, respectively.

 

Labor

 

The United Automobile, Aerospace & Agricultural Implements Workers of America (the “Union”) represents the Company’s West Hartford work force pursuant to a collective bargaining agreement that expired on March 31, 2019. The Union represents approximately 72% of Colt’s U.S. workforce.  On March 30, 2014, Colt Defense through its domestic operating subsidiary Colt’s Manufacturing reached tentative agreement with UAW Local 376 for a new five year contract covering approximately 529 employees, which was ratified by the union membership on March 31, 2014.  The new contract will be in effect from April 1, 2014 through March 31, 2019.

 

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Note 19    Fair Value of Financial Instruments

 

The fair value of an asset or liability is the amount at which the instrument could be exchanged or settled in a current transaction between willing parties where neither is compelled to buy or sell. The carrying values for cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and other current assets and liabilities approximate their fair value due to their short maturities. The carrying value of the Company’s long-term debt of $294,180 and $294,817 at June 29, 2014 and December 31, 2013, respectively, was recorded at amortized cost. The estimated fair value of long-term debt was approximately $247,359 and $262,775 at June 29, 2014 and December 31, 2013, respectively. The fair value of the Senior Notes was based on quoted market prices, which are Level 1 inputs and the fair value of the Term Loan was based on Level 3 inputs.

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The inputs used to measure fair value fall into the following hierarchy:

 

Level 1:     Unadjusted quoted prices in active markets for identical assets or liabilities.

 

Level 2:     Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.

 

Level 3:     Unobservable inputs for the asset or liability.

 

As of June 29, 2014 and December 31, 2013, the Company did not have any financial assets and liabilities reported at fair value and measured on a recurring basis or any significant nonfinancial assets or nonfinancial liabilities. Therefore, Colt did not have any transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy during the six months ended June 29, 2014.

 

Note 20   Accumulated Other Comprehensive Loss

 

The components of accumulated other comprehensive loss were as follows:

 

 

 

Unrecognized

 

 

 

Foreign

 

 

 

 

 

Prior Service

 

Unrecognized

 

Currency

 

 

 

 

 

Cost

 

Loss

 

Translation

 

Total

 

Balance, December 31, 2012

 

$

825

 

$

(17,399

)

$

2,733

 

$

(13,842

)

Other comprehensive income before reclassifications

 

 

 

 

 

Amounts reclassified from accumulated other comprehensive income

 

(86

)

336

 

 

250

 

Currency translation

 

 

 

(1,611

)

(1,611

)

Net current period other comprehensive income

 

(86

)

336

 

(1,612

)

(1,362

)

Balance, June 30, 2013

 

$

739

 

$

(17,063

)

$

1,121

 

$

(15,203

)

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2013

 

$

653

 

$

(10,836

)

$

843

 

(9,340

)

Other comprehensive income before reclassifications

 

(97

)

(1,453

)

 

(1,550

)

Amounts reclassified from accumulated other comprehensive income

 

(76

)

159

 

 

83

 

Currency translation

 

 

 

(140

)

(140

)

Net current period other comprehensive income

 

(173

)

(1,294

)

(140

)

(1,607

)

Balance, June 29, 2014

 

$

480

 

$

(12,130

)

$

703

 

$

(10,947

)

 

Amounts are on a before-tax basis.

 

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Note 21   Subsequent Event

 

On July 3, 2014, Jeff Grody, Senior Vice President, General Counsel, resigned from the Company. On that date, the Company, and Mr. Grody entered into a severance agreement under which Mr. Grody has agreed to continue to provide certain services to the Company, through July 3, 2015.  The full value of Mr. Grody’s severance agreement has been expensed and is included in operating income in the third quarter of 2014.  Mr. John Coghlin succeeded Mr. Grody as Senior Vice President and General Counsel on July 7, 2014.

 

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ITEM 2. — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This Form 10-Q, including the documents that we incorporate by reference, contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, that are subject to the “safe harbor” created by those sections. Any statements about our expectations, beliefs, plans, objectives, assumptions or future events or our future financial performance and/or operating performance are not statements of historical fact and reflect only our current expectations regarding these matters. These statements are often, but not always, made through the use of words such as “may,” “will,” “expect,” “anticipate,”“believe,” “intend,” “predict,” “potential,” “estimate,” “plan” or variations of these words or similar expressions. These statements inherently involve a wide range of known and unknown uncertainties.  Our actual actions and results may differ materially from what is expressed or implied by these statements. Factors that could cause such a difference include, but are not limited to, those set forth as “Risk Factors” under Section 1A herein and in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013, which was filed with the Securities and Exchange Commission on March 20, 2014. Given these factors, you should not rely on forward-looking statements, assume that past financial performance will be a reliable indicator of future performance nor use historical trends to anticipate results or trends in future periods. We expressly disclaim any obligation or intention to provide updates to the forward-looking statements and estimates and assumptions associated with them.

 

As used in this report, the terms “we”, “us”, “our”, “Colt Defense”, “Colt” and the “Company” mean Colt Defense LLC , Colt Finance Corp. and all of their subsidiaries that are consolidated under GAAP.

 

Certain monetary amounts, percentages and other figures included in this section have been subject to rounding adjustments.  Accordingly, figures shown as totals in certain tables may not be the arithmetic aggregation of the figures that precede them and figures expressed as percentages in the text may not total 100% or, as applicable, when aggregated may not be the arithmetic aggregation of the percentages that precede them.

 

Restatement of Previously Issued Consolidated Financial Statements

 

As discussed further in Note 2, Summary of Significant Accounting Policies - Restatement of Previously Issued Consolidated Financial Statements, in the Notes to Consolidated Financial Statements included in Part I, Item 1, Consolidated Financial Statements of this Quarterly Report on Form 10-Q, in our 2013 Annual Report on Form 10-K, we restated our previously issued consolidated financial statements and the related disclosures for the year ended December 31, 2013 (the “Restated Period”) and revised the unaudited interim financial statements for the first three quarters in the fiscal year ended December 31, 2013 (the “Revised Periods”).

 

The restatement is the result of our correction of a financial statement error attributable to the lack of recognition of the impact of a contract modification related to the M240 Program for the U.S. Government in our fourth quarter 2013 results.  In conjunction with the correction of the M240 machine gun program (the “M240 Program”) error, other previously recorded immaterial out-of-period adjustments were also adjusted to be reflected in the proper period along with the reclassification of business development expenses from other expense/(income) to operating income.

 

All amounts in this Quarterly Report on Form 10-Q affected by the restatement or revision reflect such amounts as restated or as revised. The impact of the correction of these errors in the restatement on the applicable line items in the consolidated financial statements for the quarter ended June 29, 2014 resulting from the restatement is set forth in Note 2 to the Notes to Consolidated Financial Statements. Our Quarterly Reports on Form 10-Q for subsequent periods during 2014 will also include the impacts of the restatement on applicable 2013 comparable prior quarter and year to date periods. See Note 2 of the Notes to Consolidated Financial Statements for further detail.

 

Overview of Our Business

 

Colt is one of the world’s oldest and most renowned designers, developers and manufacturers of firearms for military, personal defense and recreational purposes.  Our founder, Samuel Colt, patented the first commercially successful revolving cylinder firearm in 1836 and, in 1847, began supplying U.S. and international military customers with firearms that have set the standards of their era.  On July 12, 2013 (the “Merger Date”), the Company acquired 100% ownership (the “Merger”) of New Colt Holding Corp. (“New Colt”), a privately-held company, which is a world leader in the design, development and manufacture of Colt pistols and revolvers.  As a result of the Merger, the two manufacturers of Colt firearms were consolidated into a single enterprise providing Colt Defense direct access to the commercial market for Colt Defense’s rifles and carbines, ownership of the Colt brand name and other related trademarks and the technology and production facilities for the full line of Colt handguns. Today, our end customers encompass every

 

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segment of the worldwide firearms market, including U.S., Canadian and foreign military forces, global law enforcement and security agencies, consumers seeking personal protection, the hunting and sporting community and collectors.

 

From its inception and for over 175 years, Colt has distinguished itself by translating innovative military weapons into the most desired law enforcement, personal protection and recreational firearms. From the Model P “Peacemaker” revolver to the 1911 automatic pistol, the M16 rifle and the M4 carbine, “Colt” defines iconic firearms that first establish worldwide military standards and then become the guns every law enforcement officer and serious recreational shooter wants to own.  That Colt tradition continues to this day.  The Colt-designed M16 rifle and M4 carbine have served as the principal battle rifles of the U.S. Armed Forces for the last 50 years and are currently in military and law enforcement service in more than 80 countries around the world.  These Colt rifles created the consumer “modern sporting rifle” (“MSR”) market in the United States.  The Colt Close Quarter Battle Pistol, a 1911 derivative, was selected for acquisition by the U.S. Marine Corps in 2012, just following the 100th anniversary of the first government contract for the 1911 pistol, and is now a highly sought after handgun by commercial gun owners.

 

The “Colt” name and trademarks stand for quality, reliability, accuracy and the assurance of customer satisfaction.  Our brand and global footprint position us for long-term growth in a world market that offers continued opportunities in all of our sales channels: military, law enforcement and commercial.

 

We operate from facilities located in West Hartford, Connecticut and Kitchener, Ontario, Canada.

 

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Table of Contents

 

Results of Operations

 

The following table sets forth our results of operations in dollars and as a percentage of total net sales for the periods presented ($ in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

%

 

June 30, 2013

 

%

 

June 29, 2014

 

%

 

June 30, 2013

 

%

 

 

 

 

 

 

 

(As Revised)

 

(As Revised)

 

 

 

 

 

(As Revised)

 

(As Revised)

 

Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

49,633

 

100.0

%

$

64,212

 

100.0

%

$

99,713

 

100.0

%

$

128,061

 

100.0

%

Cost of sales

 

44,640

 

89.9

%

45,830

 

71.4

%

85,026

 

85.3

%

90,942

 

71.0

%

Gross profit

 

4,993

 

10.1

%

18,382

 

28.6

%

14,687

 

14.7

%

37,119

 

29.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and commissions

 

4,620

 

9.3

%

3,452

 

5.4

%

9,081

 

9.1

%

6,547

 

5.1

%

Research and development

 

1,392

 

2.8

%

1,481

 

2.3

%

2,635

 

2.6

%

2,301

 

1.8

%

General and administrative

 

3,801

 

7.7

%

3,015

 

4.7

%

7,710

 

7.7

%

6,745

 

5.3

%

Business development

 

9

 

0.0

%

169

 

0.3

%

509

 

0.5

%

244

 

0.2

%

Certain transaction costs

 

 

0.0

%

416

 

0.6

%

 

0.0

%

416

 

0.3

%

Restructuring costs

 

(76

)

-0.2

%

 

0.0

%

(76

)

-0.1

%

 

0.0

%

Total operating expenses

 

9,746

 

19.6

%

8,533

 

13.3

%

19,859

 

19.9

%

16,253

 

12.7

%

Operating income

 

(4,753

)

-9.6

%

9,849

 

15.3

%

(5,172

)

-5.2

%

20,866

 

16.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expense (income)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

7,859

 

15.8

%

6,069

 

9.5

%

15,543

 

15.6

%

12,063

 

9.4

%

Other expense (income), net

 

(42

)

-0.1

%

(685

)

-1.1

%

(113

)

-0.1

%

(1,472

)

-1.1

%

Non operating expenses

 

7,817

 

15.7

%

5,384

 

8.4

%

15,430

 

15.5

%

10,591

 

8.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before provision for income taxes

 

(12,570

)

-25.3

%

4,465

 

7.0

%

(20,602

)

-20.7

%

10,275

 

8.0

%

Income tax expense (benefit)

 

19

 

0.0

%

78

 

0.1

%

(67

)

-0.1

%

759

 

0.6

%

Net income (loss)

 

$

(12,589

)

-25.4

%

$

4,387

 

6.8

%

$

(20,535

)

-20.6

%

$

9,516

 

7.4

%

 

Three and Six Months Ended June 29, 2014 Compared to the Three and Six Months Ended June 30, 2013

 

On the Merger Date, the Company acquired 100% ownership of New Colt, which is a world leader in the design, development and manufacture of Colt pistols and revolvers. As a result of the Merger, the two manufacturers of Colt firearms were consolidated into a single enterprise providing Colt Defense direct access to the commercial market for Colt Defense rifles and carbines, ownership of the Colt brand and related trademarks and the technology and production facilities for the full line of Colt handguns. The operating results for New Colt have been included in the Consolidated Statements of Operations since the Merger Date.

 

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Table of Contents

 

Net Sales

 

The following table shows net sales for the three months and six months ended June 29, 2014 and June 30, 2013, as revised, respectively, by product category ($ in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

% Change

 

June 29, 2014

 

June 30, 2013

 

% Change

 

 

 

 

 

(As Revised)

 

(As Revised)

 

 

 

(As Revised)

 

(As Revised)

 

Long guns

 

$

15,870

 

$

53,599

 

-70.4

%

$

40,307

 

$

105,870

 

-61.9

%

Handguns

 

18,570

 

1,260

 

1,373.7

%

33,890

 

2,521

 

1,244.3

%

Spares and other

 

15,193

 

9,353

 

62.4

%

25,516

 

19,670

 

29.7

%

Total

 

$

49,634

 

$

64,212

 

-22.7

%

$

99,713

 

$

128,061

 

-22.1

%

 

Net sales for the three months ended June 29, 2014 were $49.6 million compared to $64.2 million for the three months ended June 30, 2013. The decrease of $14.6 million, or 22.7%, was due to lower sales of long guns, spares and other partially offset by increases in handgun sales due to the acquisition of New Colt.  Sales in the second quarter of 2014 decreased when compared to the second quarter of 2013 due to $21.2 million lower of commercial and law enforcement rifle sales related to the continued softness in the MSR market, a decrease in direct foreign sales of $10.5 million associated with the non-recurrence of a discrete large international rifle sale in the second quarter of 2013 and a decrease in U.S. government sales of $5.8 million primarily related to the timing of the fulfillment of certain U.S. government contracts.  These decreases were partially offset by an increase of $18.2 million of commercial handguns related to the acquisition of New Colt and an increase in international spares and miscellaneous of $5.1 million primarily related to an increase in overall volume of rifle kits sold in 2014.  The New Colt acquisition provided $19.3 million of incremental sales in the second quarter of 2014.  Without the impact of the New Colt acquisition, our second quarter sales would have been $30.3 million.

 

Net sales for the six months ended June 29, 2014 were $99.7 million compared to $128.1 million for the six month ended June 30, 2013.  The decrease of $28.3 million, or 22.1% was due to due to lower sales of long guns, spares and other partially offset by increases in handgun sales due to the acquisition of New Colt.  Sales for the six months ended June 29, 2014 decreased compared to June 30, 2013 due to $30.6 million lower of commercial and law enforcement rifle sales related to the continued softness of the MSR market, a decrease in direct foreign sales of $23.1 million partially associated with the non-recurrence of a large discrete international rifle sale in the second quarter of 2013 and a decrease in US government sales of $7.4 million primarily related to the timing of the fulfillment of certain U.S. government contracts.  These decreases were partially offset by an increase of $32.5 million of commercial handguns related to the acquisition of New Colt and an increase in spares and miscellaneous of $5.5 primarily related to an overall increase in rifle kits sold in 2014.

 

Cost of Sales/Gross Profit

 

Cost of sales for the three months ended June 29, 2014 was $44.6 million compared to $45.8 million for the three months ended June 30, 2013.  Without the acquisition of New Colt, cost of sales for the second quarter of 2014 would have been $29.2 million, or a decrease of $16.6 million. Our cost of sales consists of direct labor and benefits, materials, subcontractor costs and manufacturing overhead, including depreciation and amortization, utilities, and maintenance and repairs.  Gross margin for the period decreased from 28.6% to 10.1% in the comparable quarter of 2013.  The decline in gross margin of $13.5 million was driven by a combination of lower international sales, which historically have had higher margins than domestic sales, decreased demand for commercial and law enforcement rifles of $21.2 million, lower volume in our manufacturing facilities leading to unfavorable labor and overhead capitalization of $5.9 million, additional M240 contract obligation expenses of $4.8 million (See Note 16, “Commitments and Contingencies”) and the No-Cost Cancellation of the M249 U.S. Government contract resulting in expense of $0.5 million.

 

Cost of sales for the six months ended June 29, 2014 was $85.0 million compared to $90.9 million for the six months ended June 30, 2013.  Without the acquisition of New Colt, cost of sales for the first six months of 2014 would have been $57.2 million, or a decrease of $33.7 million.  Our cost of sales consists of direct labor and benefits, materials, subcontractor costs and manufacturing overhead, including depreciation and amortization, utilities, and maintenance and repairs.  Gross margin for the period decreased from 29.0% to 14.7% in the comparable period of 2013.  The decline in gross margin was primarily driven by a $4.8 million M240 Program contract obligation expense (See Note 16, “Commitments and Contingencies.”) and a combination of lower international sales, which historically have had higher margins than domestic sales, lower volumes in our manufacturing facilities resulting in unfavorable absorption and to a lesser extent, unfavorable inventory adjustments.

 

Selling and Commissions Expense

 

For the three months ended June 29, 2014, selling and commission expenses were $4.6 million compared to $3.5 million for the same period in 2013. The increase of $1.2 million, or 33.8%, was primarily due to the acquisition of New Colt.  Selling expense consists primarily of compensation, advertising, promotions, travel, trade shows, consulting fees and marketing materials. In addition, we pay

 

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commissions to independent foreign sales representatives on certain direct foreign sales and to domestic representatives on most commercial law enforcement rifle sales, which generally are a percentage of the selling price.

 

For the six months ended June 29, 2014, selling and commission expenses were $9.1 million compared to $6.5 million for the same period in 2013. The increase of $2.5 million, or 38.7%, was primarily due to the acquisition of New Colt.  Selling expense consists primarily of compensation, advertising, promotions, travel, trade shows, consulting fees and marketing materials. In addition, we pay commissions to independent foreign sales representatives on certain direct foreign sales and to domestic representatives on most commercial law enforcement rifle sales, which generally are a percentage of the selling price.

 

Research and Development

 

Research and development expense for the three months ended June 29, 2014 was $1.4 million compared to $1.5 million for the three months ended June 30, 2013. The $0.1 million decrease, or (6.0)%, was primarily due to the reduced spend year over year at our Canadian location partially offset by increased engineering costs related to our acquisition of New Colt.  Research and development expenses consist primarily of compensation and benefit expenses and experimental work materials for our employees who are responsible for the development and enhancement of new and existing products as well as expenses for outside engineering services.

 

Research and development expense for the six months ended June 29, 2014 was $2.6 million compared to $2.3 million for the six months ended June 30, 2013. The $0.3 million increase, or 14.5%, was primarily due to increase engineering costs related to our acquisition of New Colt partially offset by reduced use of external service providers at our Canadian location.  Research and development expenses consist primarily of compensation and benefit expenses and experimental work materials for our employees who are responsible for the development and enhancement of new and existing products as well as expenses for outside engineering services.

 

General and Administrative Expense

 

General and administrative expense for the three months ended June 29, 2014 was $3.8 million compared to $3.0 million for the three months ended June 30. 2013.  The $0.8 million increase, or 26.1%, was primarily due to higher audit, tax and other professional fees due to the acquisition of New Colt.  General and administrative expense consists of compensation and benefits, professional services and other general office administration expenses.  These costs do not change proportionately with changes in sales.

 

General and administrative expense for the six months ended June 29, 2014 was $7.7 million compared to $6.7 million for the six months ended June 30. 2013.  The $1.0 million increase, or 14.3%, was primarily due to higher audit, tax and other professional fees due to the acquisition of New Colt.  General and administrative expense consists of compensation and benefits, professional services and other general office administration expenses.  These costs do not change proportionately with changes in sales.

 

Business Development Expenses

 

Business development expense for the three months ended June 29, 2014 was $0.0 million compared to $0.2 million for the three months ended June 30, 2013.  The $0.2 million decrease, or 94.7%, was primarily due to decreased outside professional service fees associated with its strategic initiatives relative to the comparable prior year period.

 

Business development expense for the six months ended June 29, 2014 was $0.5 million compared to $0.2 million for the six months ended June 30, 2013.  The $0.3 million increase, or 108.6%, was primarily related to professional fees incurred in the first quarter of 2014 related to strategic initiatives relative to the comparable prior year period.

 

Certain Transaction Costs

 

Certain transaction costs expense for the three and six months ended June 29, 2014 was $0.0 million compared to $0.4 million for the three and six months ended June 30, 2013.  The decrease of $0.4 million, or 100%, is primarily related to the absence of Merger related costs in the current periods relative to the comparable prior year periods.

 

Restructuring Costs

 

Restructuring costs for the three and six months ended June 29, 2014 was ($0.1) million compared to $0.0 million for the three and six months ended June 30, 2013.  The $0.1 million benefit, in the current periods is related to a reversal of a severance related restructuring expense recorded in the prior year.

 

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Interest Expense

 

Interest expense for the three months ended June 29, 2014 was $7.9 million compared to $6.1 million for the three months ended June 30, 2013.  The increase of $1.8 million, or 29.5%, was primarily due to the $1.7 million of incremental interest expense on the Term Loan, which partially funded the acquisition of New Colt.

 

Interest expense for the six months ended June 29, 2014 was $15.5 million compared to $12.1 million for the six months ended June 30, 2013.  The increase of $3.5 million, or 28.8%, was primarily due to the $3.5 million of incremental interest expense on the Term Loan, which partially funded the acquisition of New Colt.

 

Other Expense (Income), net

 

Other income for the three months ended June 29, 2014 was $0.0 million compared to ($0.7) million for the three months ended June 30, 2013. The decrease of $0.7 million, or 93.9%, was primarily related to a decrease in service income as a result of the acquisition of New Colt.

 

Other income for the six months ended June 29, 2014 was ($0.1) million compared to ($1.5) million for the six months ended June 29, 2014.  The decrease of $1.4 million, or 92.3%, was primarily related to a decrease in service income as a result of the acquisition of New Colt and a gain on an international transaction recorded in 2013.

 

Income Taxes

 

Colt Defense is a limited liability company, treated as a partnership for U.S. federal and state income tax reporting purposes and is not subject to U.S. federal or state income taxes.  Consequently, all taxable income (loss) of Colt Defense is reported to its members for inclusion in their respective income tax returns.

 

Colt Defense and Colt Technical Services LLC, a wholly owned subsidiary, collectively own 100% of Colt International, an entity formed under the laws of The Netherlands. Colt International owns 100% of Colt Canada, a Canadian C corporation. The income (loss) of Colt Canada is subject to entity level Canadian federal and provincial taxes.

 

As a result of the Merger, effective July 12, 2013, Colt Defense owns 100% of New Colt.  Effective as of January 1, 2014, Colt affected a restructuring whereby Colt Defense and New Colt contributed their assets and operations to Colt’s Manufacturing.  The contribution created a combined operating entity for the Company’s U.S. based operations.  At June 29, 2014, Colt Defense owned 100% of Colt Finance, New Colt (a C corporation) and CDTS.  Colt Defense and New Colt collectively own 100% of Colt’s Manufacturing as a result of the legal entity restructuring.

 

For the three months ended June 29, 2014, Colt International recorded an income tax expense of $0.1 million and Colt Canada recorded a foreign income tax benefit of $0.1 million for a consolidated Company tax expense of $0.0.  For the three months ended June 30, 2013, Colt International recorded an income tax expense of $0.1 million and Colt Canada recorded an income tax benefit of $0.0 for a consolidated Company tax expense of $0.1.  Tax benefits recorded in the three months ended June 29, 2014 are attributable to operating losses recorded by the Company.

 

For the six months ended June 29, 2014, Colt International and New Colt both recorded an income tax expense of $0.1 million each and Colt Canada recorded a foreign income tax benefit of $0.2 million for a consolidated Company tax expense of ($0.1).  For the six months ended June 30, 2013, Colt International and Colt’s Manufacturing both recorded an income tax expense of $0.1 million each and Colt Canada recorded an income tax benefit of $0.6 for a consolidated Company tax expense of $0.8.  Tax benefits recorded in the six months ended June 29, 2014 are attributable to operating losses recorded by the Company.

 

Liquidity and Capital Resources

 

Our primary liquidity requirements are for debt service, working capital and capital expenditures.  We have historically funded these requirements through internally generated operating cash flow.  In order to support the growth in our working capital requirements related to our expanding business, on September 29, 2011, we entered into a Credit Agreement (“Credit Agreement”) with Wells Fargo Capital Finance, LLC.  Under the terms of the Credit Agreement, senior secured revolving loans are available up to $50.0 million, inclusive of $20.0 million available for letters of credit.  Revolving loans are subject to, among other things, a borrowing base, which is calculated monthly based on specified percentages of eligible accounts receivable and inventory and specified values of fixed assets.  Under the Credit Agreement, our obligations are secured by a first-priority security interest in substantially all of our assets (other than intellectual property), including accounts receivable, inventory and certain other collateral, and a second-priority security interest in our intellectual property. The Credit Agreement matures on September 28, 2016.

 

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Borrowings under the Credit Agreement bear interest at a variable rate based on the London Inter-Bank Offered Rate (“LIBOR”), the Canadian Banker’s Acceptance Rate or the lender’s prime rate, as defined in the Credit Agreement, plus a spread. The interest rate spread on borrowing varies based on both the rate option selected and our quarterly average excess availability under the Credit Agreement. There is an unused line fee of .50% per annum, payable quarterly on the unused portion under the facility and a $40 thousand annual servicing fee.

 

The Credit Agreement limits our ability to incur additional indebtedness, make investments or certain payments, pay dividends (other than for member distributions to support member LLC-related taxes) and merge, acquire or sell assets. In addition, certain covenants would be triggered if excess availability were to fall below a specified level. Excess availability is determined as the lesser of our borrowing base or $50.0 million, reduced by outstanding obligations under the Credit Agreement and trade payables that are more than 60 days past due. Furthermore, if excess availability falls below $11.0 million or an event of default occurs, we would be required to provide the lender with more frequent compliance reporting and the lender may also assume certain other contractual privileges. The Credit Agreement contains customary events of default. As of June 29, 2014 and December 31, 2013, we were in compliance with all covenants and restrictions, as amended. We monitor our future compliance based on current and anticipated financial results.

 

As of June 29, 2014, there were revolving loans of $13.5 million outstanding and $3.9 million of letters of credit outstanding under the Credit Agreement.  As of December 31, 2013 there were revolving loans of $7.1 million outstanding and $3.5 million of letters of credit outstanding under the Credit Agreement.  As of September 12, 2014, there were revolving loans of $13.0 million outstanding under the credit agreement.

 

On March 22, 2013, we entered into Amendment No. 2 to the Credit Agreement, whereby, among other things, Wells Fargo Capital Finance, LLC (“WFCF”), under the Credit Agreement, consented to the transaction pursuant to the Unit Repurchase Agreement. For additional information about this transaction, see Note 13, “Accumulated Deficit” in this Form 10-Q.

 

On June 19, 2013, we entered into Amendment No. 3 to the Credit Agreement, pursuant to which the WFCF consented to the contribution of all the issued and outstanding equity interests issued by Colt Canada to Colt International so that Colt Canada would be a wholly owned subsidiary of to Colt International, and provided for Colt International to become a guarantor under the Credit Agreement. For more information about this amendment, see the Form 8-K that was filed with the SEC on June 25, 2013.

 

On July 12, 2013, we entered into Amendment No. 4 to the Credit Agreement, whereby Colt’s Manufacturing became a borrower and New Colt became a guarantor under the Credit Agreement. For more information about this amendment, see the Form 8-K that was filed with the SEC on July 15, 2013.

 

On August 6, 2014, we entered into Amendment No. 5 to the Credit Agreement, whereby the WFCF consented to, among other things, extending the delivery date to September 15, 2014 of our obligation to deliver financial statements for the month and fiscal quarter ended June 29, 2014.

 

On November 10, 2009, Colt Defense and Colt Finance, our 100%-owned finance subsidiary, jointly and severally co-issued $250.0 million of unsecured senior notes (“Senior Notes”).  The Senior Notes bear interest at 8.75% and mature November 15, 2017. Interest is payable semi-annually in arrears on May 15 and November 15, commencing on May 15, 2010. We issued the Senior Notes at a discount of $3.5 million from their principal value. This discount is being amortized as additional interest expense over the life of the indebtedness. No principal repayments are required until maturity.

 

The Senior Notes do not have financial condition covenants that require us to maintain compliance with financial ratios or other measurements on a periodic basis. The Senior Notes do contain non-financial condition covenants that, among other things, limit our ability to incur additional indebtedness, enter into certain mergers or consolidations, incur certain liens and engage in certain transactions with our affiliates. In addition, the Indenture restricts our ability to pay dividends or make other Restricted Payments (as defined in the Indenture) to our members, subject to certain exceptions. Such restrictions are not expected to affect our ability to meet our cash obligations for the next twelve months. Additionally, the Senior Notes contain certain cross default provisions with other indebtedness if such indebtedness in default aggregates to $20.0 million or more.

 

On June 19, 2013, we entered into an indenture supplement by which, Colt International, Colt Canada and CDTS became new subsidiary guarantors to the Senior Notes. As such, each agreed to jointly and severally guarantee the obligations under the Indenture. For more information about this indenture supplement, see the Form 8-K that was filed with the SEC on June 25, 2013.

 

On July 12, 2013, we entered into an indenture supplement to the Indenture (“Supplemental Indenture”) by which New Colt and Colt’s Manufacturing became new subsidiary guarantors to the Senior Notes. As such, each agreed to jointly and severally guarantee the obligations under the Indenture. For more information about the Supplemental Indenture, see the Form 8-K that was filed with the SEC on July 15, 2013.

 

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Table of Contents

 

On July 12, 2013, in connection with the Merger, we entered into the Term Loan, which matures on November 15, 2016. The Term Loan is variable rate and bears interest at a rate of 9.75% plus the greater of the 3-month LIBOR rate or 1%. Interest is payable quarterly in arrears on the first day of the subsequent calendar quarter. Under the Term Loan, our obligations are secured by a second priority security interest in the assets securing obligations under the Credit Agreement and a first priority security interest in our intellectual property and a second priority security interest in substantially all other assets.  The Term Loan was issued at a discount of $2.3 million from its principal value of $50.0 million. We also incurred $2.1 million in financing fees. The discount and the financing fees are being amortized as additional interest expense over the life of the indebtedness. Principal repayments, which are due quarterly on the last day of each calendar quarter, are as follows ($ in thousands):

 

 

 

Amount

 

Remaining 2014

 

$

625

 

2015

 

5,625

 

2016

 

41,875

 

Total

 

$

48,125

 

 

On March 31, 2014 (second quarter of 2014) and June 29, 2014 (third quarter of 2014), we made Term Loan principal installment payments of $0.6 million and interest payments of $1.3 million, respectively.

 

On August 6, 2014, the Company entered into Amendment No. 1 to the Term Loan (the “Term Loan Amendment”). Absent an amendment to the Term Loan, the Company would have been in violation of certain of its financial covenants as of June 29, 2014.  The Term Loan Amendment is discussed in more detail below.  We were in compliance with our Term Loan covenants as of June 29, 2014, as amended, and December 31, 2013. It is possible the Company will not meet one or more of the Term Loan covenants, as amended, as of December 31, 2014 or subsequent quarters of 2015. If we were not to meet certain of the Term Loan covenants, as amended, in the future we would likely seek a waiver from our Term Loan lenders.  There is no assurance that such a waiver could be obtained from the Term Loan lenders in a timely basis or at all, in which case the Company would be in default under the Term Loan and the Term Loan would become a current liability.

 

The Term Loan Amendment provided that (i) the financial covenants were eliminated for the rolling four quarter periods ended June 29, 2014 and September 30, 2014 and modified for the rolling four quarter period ended December 31, 2014,(ii) we were granted the option to not pay principal installment payments of $1.9 million due on September 30, 2014, December 31, 2014 and March 31, 2015, (iii) the applicable prepayment premium was increased from 2% to 6% of the outstanding principal balance of the Term Loan, (iv) the date of the applicable prepayment determination was extended to July 31, 2016 and (v)we have been granted a 30 day extension to deliver financial information to the Term Loan lenders to allow for completion of the restatement of our 2013 10-K (see Note 2. Summary of Significant Accounting Policies).  Additionally, we agreed to pay an amendment fee of $0.5 million that will be capitalized and paid-in-kind by being added to the outstanding principal balance of the Term Loan.

 

The Term Loan Amendment fee of $0.5 million, along with Term Loan lenders legal fees to be paid by us in conjunction with the Term Loan Amendment, will be recorded as additional debt discount in the third quarter of 2014 and amortized as interest expense over the remaining term of the Term Loan.  We will expense costs incurred by us in conjunction with the Term Loan Amendment in the third quarter of 2014.  We do not intend to pay principal installment payments due on September 30, 2014, December 31, 2014 and March 31, 2015 and, therefore, the long term debt — current portion on the consolidated balance sheet as of June 29, 2014 has been adjusted accordingly to reflect anticipated Term Loan principal installment payments over the next twelve months.

 

The Term Loan agreement also contains non-financial covenants and other restrictions which limits our ability to incur additional indebtedness, make investments or certain payments, pay dividends (other than member distributions to support member LLC related taxes) and merger, acquire or sell assets.

 

The Term Loan agreement contains financial covenants including a minimum EBITDA threshold, a fixed charge coverage ratio and a maximum secured leverage ratio, each as defined by the Term Loan agreement. In addition, we cannot exceed specified levels of capital expenditures. All financial covenants are calculated on a rolling 4-quarter basis based on financial results for the current and three preceding fiscal quarters.

 

The Term Loan agreement also contains non-financial covenants that limit our ability to incur additional indebtedness, make investments or certain payments, pay dividends (other than for the payment of taxes to Colt Defense’s members) and merge, acquire or sell assets.

 

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Table of Contents

 

Our cash used in or generated from operating activities is generally a reflection of our operating results adjusted for non-cash charges or credits such as depreciation and amortization and changes in working capital, including accounts receivable and our investment in inventory.  Changes in accounts receivable and inventory can cause significant fluctuations in our cash flow from operations.  U.S. Government receivables are generally collected within 10 to 30 days. Payment terms for international orders are negotiated individually with each customer and tend to experience a longer collection cycle. Commercial law enforcement receivables are generally collected within 10 to 30 days as distributors take advantage of payment terms. To date, we have not experienced any significant receivable losses.

 

The increase in our inventory levels to $75.5 million as of June 29, 2014 from $66.7 million as of December 31, 2013, an $8.8 million increase, is a result of continued softness in the commercial MSR market, inventory on hand to support certain U.S. Government contracts as well as inventory for international orders which can ship only after receipt of required regulatory approval.

 

Historically, tax distributions to our members have been made in amounts equal to the highest combined marginal federal, state and/or local tax rate applicable to any member as applied to our taxable income, as defined, for the applicable period.  Our Governing Board may also declare other distributions to our members from time to time. In addition, our cash requirements and liquidity could be impacted by potential acquisitions. In April 2014, we made tax distributions to our members of $0.7 million and remitted $0.5 million to the State of Connecticut both of which were accrued in 2013 based on our 2013 taxable income.

 

At June 29, 2014, we had cash and cash equivalents totaling $2.2 million.  We believe that our existing cash balances, Credit Agreement availability and forecasted operating cash flows are sufficient to meet our obligations for the next twelve months.

 

Cash Flows

 

The following table sets forth our consolidated cash flows for the six months ended June 29, 2014 and June 30, 2013, respectively (dollars in millions):

 

 

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

(As Revised)

 

Cash used in operating activities

 

$

(14.5

)

$

(9.7

)

Cash used in investing activities

 

(1.5

)

(3.3

)

Cash used in financing activities

 

5.1

 

(15.3

)

 

Cash Flows Used in Operating Activities

 

Net cash used in operating activities for the six months ended June 29, 2014 was $14.5 million, compared to net cash used by operating activities of $9.7 million for the six months ended June 30, 2013, as revised.  We had a net loss of $20.5 million in the first six months of 2014 compared to net income of $9.5 million in the first six months of 2013, as revised.

 

During the first six months of 2014, changes in operating assets and liabilities were a $0.4 million use of cash versus a $22.6 million use of cash for the same period in 2013.  In 2014, accounts receivable decreased by $6.4 million, primarily due to lower sales. Accounts payable and accrued expenses increased by $0.8 million in 2014 primarily due increased accruals related to the M240 Program, partially offset by higher accrued interest because of the timing of payments due.  In 2014, inventories increased by $8.9 million due to first quarter softness in the commercial MSR market and increased inventory levels necessary to support U.S. Government contracts and international sales orders.

 

During the first six months of 2013, we used $22.6 million of cash to fund changes in operating assets and liabilities.  Accounts receivable grew $11.8 million primarily because of a large international shipment in June 2013.  In addition, we used $11.1 million to fund an increase in inventory to support increased production volume.  These uses of cash were partially offset by a $1.9 million related increase in accounts payable and accrued expenses.

 

Cash Flows Used in Investing Activities

 

Cash used in investing activities was $1.5 million for the first six months of 2014 and $3.3 million for the first six months of 2013. Cash used was primarily for capital expenditures in both periods. In 2014, capital expenditures were primarily for capacity expansion. In 2013, capital expenditures were primarily for new product production and capacity expansion.

 

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Cash Flows Used in Financing Activities

 

Net cash from financing activities in the first six months of 2014 was $5.1 million.  Our net borrowings on our line of credit for the period were $6.4 million, we used $0.6 million to make a schedule repayment of our Term Loan and we used $0.7 million to fund distributions to our members.

 

Net cash used for financing activities in the first six months of 2013 was $15.3 million.  We used $14.0 million of cash to repurchase all of our common units held by the Blackstone Funds, $1.4 million to fund distributions to our members and we borrowed $0.1 on our line of credit.

 

Backlog

 

Because a substantial portion of our business is of a build-to-order nature, we generally have a significant backlog of orders to be shipped. Our backlog increased from $206.9 million at December 31, 2013 to $218.1 million at June 29, 2014. The increase was primarily driven by increased U.S government spare orders.  When factoring the commercial component of purchase orders into our backlog analysis, we only include orders that are scheduled to ship in the next six months in our backlog.  Commercial orders received that have not yet shipped could be cancelled, particularly if demand were to suddenly decrease.

 

Recent Accounting Pronouncements

 

Revenue from Contracts with Customers - In May 2014, the FASB issued ASU No. 2014-09, that requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

 

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists - In July 2013, the FASB issued ASU 2013-11 to provide guidance on the presentation of unrecognized tax benefits. ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU 2013-11 is effective for interim and annual periods beginning after December 15, 2013 with earlier adoption permitted. ASU 2013-11 should be applied prospectively with retroactive application permitted.  The Company has adopted ASU 2013-11 in the first quarter of 2014.

 

Critical Accounting Policies and Estimates

 

The preparations of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. The Company reaffirms the significant accounting policies as disclosed in Note 2 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013, which was filed with the Securities and Exchange Commission on September 12, 2014.

 

Contractual Obligations

 

On March 30, 2014, Colt Defense through its domestic operating subsidiary Colt’s Manufacturing reached tentative agreement with UAW Local 376 for a new five year contract covering approximately 529 employees, which was ratified by the union membership on March 31, 2014.  The new contract is in effect from April 1, 2014 through March 31, 2019.

 

As of June 29, 2014, there have been no other material changes to our contractual obligations outside the ordinary course of our business since December 31, 2013.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Foreign Currency Exposure

 

We are subject to foreign currency exchange risks relating to receipts from customers, payments to suppliers and some intercompany transactions.  As a matter of policy, we do not engage in currency speculation and therefore, we have no derivative financial instruments to hedge this exposure.  In our consolidated statements of operations, we had de minimis foreign currency gains for the six months ended June 29, 2014 and $0.1 million of foreign currency gains for the six months ended June 30, 2013.  The foreign currency amounts reported in the consolidated statement of operations may change materially should our international business continue to grow or if changes in the Canadian dollar or Euro versus the U.S. dollar fluctuate materially.

 

Interest Rate Exposures

 

Our debt portfolio consists of the fixed rate Senior Notes, the variable rate Term Loan and the variable rate Credit Agreement.  At June 29, 2014, there was $13.5 million outstanding under the Credit Agreement and $48.1 million owed on the Term Loan.  Our exposure to market risk for changes in interest rates relates to both the first quarter variable rate advances on the Credit Agreement and the first quarter variable rate Term Loan outstanding balance. We do not have any derivative financial instruments to hedge this exposure. At June 29, 2014, a hypothetical 100 basis point increase in the first quarter variable rate on the Credit Agreement advances and the Term Loan outstanding balance would have increased our interest expense by $0.1 million.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Management of the Company, with the participation of its Chief Executive Officer, Chief Financial Officer and Corporate Controller, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period.

 

Based on their evaluation, as of the end of the period covered by this Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were not effective because of the material weakness in our internal control over financial reporting described below.

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.

 

We did not maintain effective controls over contract modifications. Specifically, we did not appropriately consider the accounting implications of a contract modification to the M240 machine gun program for the U.S. Government (“M240 Program”) which impacted our net sales, cost of sales, accrued expenses, customer advances, deferred revenue and related financial disclosures.  This control deficiency resulted in the restatement of the Company’s consolidated financial statements for the year ended December 31, 2013. Additionally, this control deficiency could result in misstatements of the aforementioned accounts and related disclosures that would result in a material misstatement of the consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.

 

Remediation Efforts

 

Management has been actively engaged in developing a remediation plan to address the above material weakness.  The remediation efforts in process or expected to be implemented include the following.

 

·                  Reviewing all M240 Program contract amendments to ensure all material accounting considerations have been addressed,

 

·                  Reviewing non-M240 Program material contracts and material contract amendments to ensure all material accounting considerations have been addressed,

 

·                  Instituting additional training programs for accounting personnel.

 

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We believe that the controls that we will be implementing will improve the effectiveness of our internal control over financial reporting.  As we continue to evaluate and work to improve our internal control over financial reporting, we may determine to take additional measures to address the material weakness or determine to supplement or modify certain of the remediation measures described above.

 

Changes in Internal Control OverFinancial Reporting

 

There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1.                                                         Legal Proceedings

 

We are involved in various legal claims and disputes in the ordinary course of our business.  As such, the Company accrues for such liabilities when it is both (i) probable that a loss has occurred and (ii) the amount of the loss can be reasonably estimated in accordance with ASC 450, Contingencies.  The Company evaluates, on a quarterly basis, developments affecting various legal claims and disputes that could cause an increase or decrease in the amount of the liability that has been previously accrued.  It is possible that we could incur losses in excess of any amounts accrued. There is no litigation pending that is likely to substantially negatively affect our financial condition, results of operations and cash flows.

 

Item 1A.                                                Risk Factors

 

In addition to the information set forth in this report, you should carefully review and consider the information discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K/A for the year ended December 31, 2013, which could materially affect our business, financial condition or future results. These are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem immaterial also may materially adversely affect our business, financial condition or future results.

 

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Item 6. Exhibits

 

The following list of exhibits includes exhibits submitted with this Form 10-Q as filed with the Securities and Exchange Commission and those incorporated by reference to other fillings.

 

31.1

Certification of Dennis R. Veilleux pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

 

31.2

Certification of Scott B. Flaherty pursuant to Section 302 of Sarbanes-Oxley Act of 2002.*

 

 

31.3

Certification of Kevin G. Green pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

 

101.INS

XBRL Instance Document**

 

 

101.SCH

XBRL Taxonomy Extension Schema Document**

 

 

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document**

 

 

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document**

 

 

101.LAB

XBRL Taxonomy Extension Label Linkbase Document**

 

 

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document**

 


Notes to Exhibits List:

 

*                                         Filed electronically herewith

**                                  Furnished and not filed herewith

 

Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets at June 29, 2014 and June 30, 2013, (ii) Consolidated Statements of Operations for the three and six months ended June 29, 2014 and June 30, 2013, (iii) Consolidated Statements of Comprehensive Income for the six months ended June 29, 2014 and June 30, 2013, (iv) Consolidated Statements of Cash Flows for the six months ended June 290, 2014 and June 30, 2013 and (iv) Notes to the Consolidated Financial Statements.  In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

 

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Signatures

 

Pursuant to the requirements of the Securities Act of 1934, the registrants have duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized, in West Hartford, Connecticut, on the 12th day of September, 2014.

 

 

COLT DEFENSE LLC

 

COLT FINANCE CORP.

 

By:

/s/ Scott B. Flaherty

 

Scott B. Flaherty

 

Senior Vice President and Chief Financial Officer

 

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